Investors have been told over and over to love dividends, as they provide income and stability to a portfolio. While those themes are often true, there can be a dark side to dividend investing. A number of companies have unbelievably high dividend yields. It is often questionable whether these companies can maintain such high yields.
Investors like dividends for more than just the periodic income they provide. A strong dividend generally signals that a company is especially stable, and it is supposed to reflect its expected earnings power in the future.
The highest dividend yield in the Dow Jones Industrial Average is about 5%. When a company’s dividend yield is more than twice that, investors may be taking on serious risk. That is because there are two ways for yields to climb so high — either the company can increase the dividend payment or the company’s share price may have taken a hit. While we always hope for the former, a very high dividend yield often implies the latter. Having a dividend yield north of 10% is far higher than what investors can earn on most junk bonds.
24/7 Wall St. searched for companies with dividend yields of at least 10%. Some are pure dividends, some are considered dividend equivalent yields because they include a return on capital.
Most of the five companies with potentially dangerous, high dividend yields are in sectors that typically provide investors with high payouts. These include the mortgage real estate investment trusts (REITs), master limited partnerships (MLPs) and business development companies.