Dividends are a hot topic for many investors right now. The turmoil of the financial meltdown is still fresh and the tangibility of a quarterly cash payout hits the spot like a cool glass of lemonade on a midsummer day in the desert.
Not surprisingly, investors have been drawn to companies that feature massive dividend yields. And why not? If you're going to go for dividends, why not go big.
But the catch is that many -- if not most -- of the companies with huge dividend yields get those yields by paying out nearly all, if not all, of their income through those dividends. Take the popular mortgage REIT Annaly Capital
By focusing on the dividend yield alone, investors can end up overlooking the bigger picture. A dividend-paying company with a high payout ratio may have a tougher time maintaining its payout if it hits a speed bump. It may also have little capital left to reinvest in the business and might be forced to load up on debt or sell new shares if it wants to grow.
A laser-focus on dividend yields also means that investors may not be comparing potential investments on an apples-to-apples basis.
At first glance, Microsoft's
What would happen if Microsoft were more like Annaly and paid out 90% of its income? That small 2.5% yield would suddenly jump to 10.1%.
Sure, Microsoft's business has its challenges -- Apple
A big fan of dividends myself, I applaud investors' interest in buying companies that know how to share their profits. However, in the quest for income, it's important that these intrepid yield seekers don't miss the big picture.