High dividend stocks carry a higher risk than most stocks that pay dividends. With investing, generally speaking, the higher the potential pay out, the higher risk that’s involved. This is no different with high yield stocks; if their dividend yield percentage is too good to be true, then you might want to examine the company quite closely.
You see, companies offer dividends for a variety of reasons. One big reason is to entice long-term investors to hold their stock. A dividend ensures investors get a cash payment on a consistent basis, despite whatever might actually be occurring with the stock itself. This encourages large investors to sink huge amount of money into the company just for that regular payment, which they can then reinvest, compounding its earning power.
Now, if a company has a suspiciously high dividend yield, say over 10%, it could mean that they are really hurting for cash, and are taking this measure as a means of fund raising, and luring in investors who might otherwise not be interested in the company. This doesn’t necessarily mean that all high dividend paying stocks are “out to get you,” it merely means that a high yield can be a warning sign, and some deeper analysis is required in these cases.
What you want to look at is the companies history as far as their finances and dividends go If they’ve consistently paid dividends, and its been continuously rising along with their profits, then this is a good sign. If the company is large, has been around for a while, has a low debt to capital ratio, and continues to profit quarter after quarter, these are also good signs of a solid company worth investing in.
It’s not necessarily that all high dividend yield stocks are suspect, but more reward (in the form of that dividend) means there must be more underlying risk involved. If you are a risk averse investor, but are still interested in dividend investing, there are plenty of lower dividend yield stocks that don’t pay as much but have paid and will likely continue to pay these lower dividends without quite as much risk.