5 High-Risk Dividend Stocks

Editor's note: The original version of this article incorrectly characterized Tri-Continental as a high-yielding stock. Tri-Continental is a closed-end fund and should not have been included. We regret the error.

Few people have heard of Nordic American Tanker Shipping. But if you'd bought this Bermuda-based shipping company in late 2002, you'd have seen your stock price more than triple by 2007. And with fat dividend checks yielding 15%, you could have funded your retirement like it was going out of style.

Nordic American Tanker typifies the exciting, if oxymoronic, frontier of investing: mixing dividends -- an iconic symbol of safe, cash-rich stocks -- with wildcat capital gain prospecting. Sometimes you make a killing. Sometimes you don't get paid at all. Welcome to high-risk dividend stocks.

The bet is simple: The market doubts these stocks, doubts their dividends, doubts their potential for capital gains. If the market's right, disappointment follows; the company's operations falter, and the rich dividend indicated by the stock's historical yield doesn't pan out. If the investor's right, he or she can rake in enough cash in a year to double the capital gains of a "normal" stock.

Double-digit yields
High-risk dividend payers come with the promise of big returns. And since a cash return is the least risky return there is, high-risk dividend stocks can end up being less risky than growth stocks with similar promise.

Let's start off by looking at two stocks with jaw-dropping yields and market caps of more than $800 million:

For the wild at heart, these stocks may be your cup of tea. But I'd have to stop far short of recommending them for most investors. Why? Besides the volatility that comes with their stock prices, dividends as high as those paid by these stocks are frequently unsustainable.

Double-digit yields that might work for you
What about more stable high-yielders? Now we're getting closer to my area of expertise -- I run a newsletter that picks dividend stocks, and its portfolio is beating the S&P 500 by nearly seven percentage points. As a starting point, I screened for stocks yielding more than 6% (notice that we have to go much lower than the first batch to approach stability), with payout ratios of less than 85%. A sustainable payout ratio is key because a stock paying out more than it can afford to will likely need to lower its dividend before too long.

Here are three stocks with moderate yields, lower payout ratios, and a history of dividend payments and dividend growth. Think of them as lower-risk stocks in a higher-risk pool:

What to do from here? If you've got some "mad money" burning a hole in your pocket, placing some well-considered bets in the high-risk, skyscraper-yield pool may be the move for you.

If you're comfortable with risk, but not that comfortable, consider giving a steady-but-high-yielding stock a try. And if you like the occasional big yield on top of a base of steady, rich dividend stocks, I invite you to take a look at Income Investor.

Three tips you can take to the bank
How can you tell the difference between your dividend stock in shining armor and a handsome impostor just waiting to break your heart? Here are three pointers to help assess whether you've got a highflier or a dividend dud in your portfolio:

1. Start using a cash payout ratio. Accrual accounting does peculiar things to numbers. Depreciation requirements make reported earnings for certain types of stocks -- REITs and master limited partnerships in particular -- vastly different from the cash these companies take in. Don't be snookered by stock screens that fail to take this into account -- you could actually miss some perfectly good investments.

2. Check for a recent stock price decline. Don't be scalped by stock price movement! If a stock's price gets lopped in half, its yield doubles. Simple math. But that's also the market's way of saying it's lost faith in the stock. Has the market overreacted? That's a million-dollar question, but at least check the stock's chart to see if it's one you should be asking.

3. Look for a history of dividend increases. Sounds obvious, but it's often forgotten. There are many good reasons to invest in stocks without a history of lifting their payouts, but if you're gunning for a sure winner, nothing's more reassuring than a history of paying out more and more moola.

Looking for some more dividend-stock tips? You can try the market-beating Income Investor service free for 30 days simply by clicking right here. It's got a stable of steady-as-she-goes dividend payers, along with some rich yielders for aggressive investors.

This article was first published on Mar. 6, 2007. It has been updated.

Motley Fool Income Investor analyst James Early owns no shares of any stocks mentioned above. Citizens Communications is an Income Investor recommendation. The Motley Fool has a disclosure policy.