How to spot high-yield dividend stocks that will supercharge your long-term gains

Use these tips to pick the best high-yield dividend stocks for your portfolio

Investors generally look to aggressive stocks for capital gains and to more conservative stocks for income. However, there are some growth stocks that offer yields as high—or even higher—than yields on more established companies.

Still, you need to focus more than ever on quality when it comes to finding the best high-growth dividend stocks.

High-yield dividend stocks with a history of paying a dividend

One of the best ways of picking quality high-yield dividend stocks is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one thing that all the best dividend stocks have in common .


When to trust your dividends

“One of the best ways to judge whether a company will keep paying its dividend, or even increase it, is the dividend payout ratio. This simply measures what portion of a company’s earnings are allotted to paying dividends. If a company keeps its payout ratio fairly steady, say at 7% of earnings, and its earnings grow…”
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Dividends are a sign of investment quality

Some good companies reinvest profits instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks. For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. 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 provide an attractive mix of safety, income and growth.

Watch out for unusually high dividend yields

Investors should avoid judging a company based solely on its dividend yield (the percentage you get when you divide a company’s current yearly payment by its share price). That’s because a high-yield can sometimes be a danger sign rather than a bargain. For example, a dividend paying stock’s yield could be high simply because its share price has dropped sharply (because you use a company’s share price to calculate yield) in anticipation of a dividend cut. That’s why we recommend that you look beyond dividend yield when making investment decisions, and look for companies that have also established a sound business and a history of building revenue and cash flow.

The biggest risk with high-yield dividend stocks

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

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

In contrast, companies that continually reward investors, and retain enough cash to finance their businesses, will provide an attractive mix of safety, income and growth.

All in all, a track record of dividend payments is a strong sign of reliability and a strong indication that investing in the stock can be profitable for you in the future.

High-yield dividend stocks and DRIPS

Some high growth dividend stocks give their shareholders the opportunity to participate in dividend reinvestment plans (DRIPs). This lets investors use their dividends to buy new shares, sometimes at a discount to the market price.

DRIPs bypass brokers, so you save on commissions. DRIPs also eliminate the nuisance effect of receiving small cash dividend payments.

DRIPs help high yield dividend stocks attract more investors. They also let them conserve funds by issuing shares instead of paying out cash, which most growth companies like to do.

Dividends can be a big part of long-term investment gains

If you stick with top quality high dividend yield stocks, the income you earn can supply a significant percentage of your total return—as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.

To summarize then, when it comes to investment safety, a long history of steady dividends is more important than a current high dividend yield.

Do you have high-yield dividend stocks in your portfolio? How have they performed for you? Share your experience with us in the comments.

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