4 Important Rules of Dividend Investing with Stocks

Finding stocks with the highest dividend yields to invest in sounds like a great plan, but it really isn’t that simple. Some stocks that have the highest dividend yields have a declining business and will be unable to pay that dividend in the future, while others have a solid balance sheet to support that high dividend yield. As is the case with most things related to the stock market, one has to understand that each investment decision needs to be made on a case by case basis and there is no uniform rule of what makes a dividend safe. If you are going to be a dividend investor, there are a few rules you must keep in mind.

4 Important Rules of Dividend Investing

  1. Always consider the business model and earnings potential – Though you may be looking for the stock paying the highest dividend, you also need to consider the business model the company has and what kind of earnings potential they have in the future. A dividend is only part of the equation, obviously a stock’s price fluctuations will mean a lot to your portfolio as well. It does you no good to find the highest paying dividend stock out there if that stock is going to get cut in half while you own it.
  2. Look for companies with solid cash flow – Any company that is paying a high dividend yield should have a pretty nice stash of cash on hand in their balance sheet. It is important that the company be able to continue to have solid cash flow that will support their ability to keep their dividend payout ratio high. More specifically the free cash flow ratio payout figure is great to use since you are able to track how much of the company’s free cash flow is going toward paying out a dividend.
  3. Consistent dividend growers are your friend – A company that is consistently able to raise their dividend payout year after year is one that you want to own. These businesses are obviously quite confident in their ability to continue to provide dividend payouts if they continually raise their dividend. A consistent dividend growing company is one that is generally in very solid shape financially.
  4. If it looks too good to be true it probably is – As with other things in finance, if a stock’s high dividend yield looks too good to be true then it likely is. There are many stocks that are yielding an extremely high amount one week, only to drop the dividend the next week and then go bankrupt a few weeks later. Many times if a stock has plummeted in price, causing the dividend yield to go sky high the market is telling you something and you would be wise to listen.

Investing in high yielding dividend stocks is great, and it can be a great safe haven investment, but you have to know what you are doing. Not all dividends are created equal and it is up to you to decipher which high dividend yielding stocks are worthy of your investment.

Aaron K. Smith is a freelance writer with experience working in the mutual fund industry and writing about investing and the stock market. View all posts by Aaron.

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