High-yielding stocks can be misleading—you need to be sure their dividends are sustainable

High-yielding stocks pay a dividend with a higher yield than most shares—but that can be a danger sign.

When looking for stocks with high dividend yields, you should resist the temptation of seeking out stocks with the highest yield—simply because they have above-average yields. That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Want high-yielding stocks? Look for blue chips.

You can look at blue chips as among the strongest and most secure stocks in the market.

Blue chip stocks are generally well-established, dividend-paying corporations with strong business prospects. These are companies that also have strong management capable of making the right moves to compete in a changing marketplace.

Investing in blue chip stocks can provide an additional measure of safety in today’s turbulent markets. And the best ones offer an attractive combination of low p/e’s (price-to-earnings ratio), steady or rising dividend yields (annual dividend divided by the share price), and promising growth prospects.

Here’s the biggest risk with high-yielding stocks

As we said earlier, when looking for stocks with high dividend yields, you should avoid the temptation of seeking out stocks with the highest yield—simply because they have above-average yields.

That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have a high dividend yield that has been maintained or raised during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

A track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will be profitable for you in the future.

Invest mainly in high quality stocks

It’s essential to invest in stocks that have some history of sales, if not profits. If you break this rule and invest in, say, junior mines or tech startups, you should only do so if you have a high opinion of the value of the junior’s assets and/or business plan, and you buy with money you can afford to lose. After all, you could very well be mistaken about their value. Your low-quality buys might eventually wind up worthless.

Canadian dividend stocks are a strong investment in any market

A company with a long-term record of paying dividends is generally one that is most deserving of the “blue chip” label in its traditional sense. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.

Canadian dividend stocks offer both capital-gain growth potential and regular income. In fact, dividends are likely to still be paid regardless of how quickly the price of the underlying stock rises.

Dividends from Canadian companies come with a tax credit, to reflect corporate income taxes. This cuts your tax rate.

Avoid selling your blue chip shares too early

It’s all too easy to sell a stock that looks like it’s headed for a downturn, only to buy another that is headed for a collapse. For that matter, if you make a habit of selling whenever you feel the market’s risk has gone up, you will wind up selling your best stocks way too early.

You can always find a rationale for selling. Market commentators are continually thinking up new ones, based on recent market strength or weakness, historical market patterns, political or economic predictions, changes in tax policies—the list is endless. This is a good thing. After all, you can only buy a stock if somebody who owns it wants to sell.

Before you act on a selling rationale, take a broader look. Consider facts about the stock, and about your investment goals and temperament. If the selling rationale makes sense and you find additional good reasons to sell, then selling may be the right thing to do. But it’s always a bad idea to sell a good stock for trivial or transitory reasons.

Are high-yielding stocks like blue chips currently in your portfolio? How have they performed? Are they among the best investments you own? Share your story with us in the comments.