Sorry to disappoint you, Fools: However much you may imagine it, dividend checks don't make that ka-ching sound when they land in your account. There's no jackpot siren or shower of rainbow confetti, either.
High-yielding stocks are more than just the sum of their distributions. No two dividends -- or dividend-paying companies -- are alike, so try to avoid any romanticized dreams of celebration.
You can get rich from dividends. It's just not as easy as you think. Then again, it's not as hard as you think, either. I've got three tips to make you a better income investor.
1. Don't chase yields
There's nothing as ego-bruising as snapping up a stock only because of its high yield. A dividend is only as secure as the company's ability to pay its declared distributions.
Income investors like to watch their companies' payout ratios, making sure that each investment is earning more than enough to cover its regular dividend. But sometimes, the bottom line can turn sour in a hurry. Companies such as sluggish financial services providers Bank of America (NYSE: BAC ) and First Franklin (Nasdaq: FFHS ) seemed to have attractive yields until they slashed their payouts earlier this week.
Shareholders who held on going into this week's markdowns, figuring that the higher yields would save the day, learned the cruel lesson that unsustainable yields can be reduced.
2. Take a hike with the hikers
Every Monday, I profile four stocks that increased their dividends during the previous week. Typically, these increases send an upbeat message that a company is comfortable enough to part with a few more of its greenbacks.
Watch for companies that regularly raise their dividends. When I see a utility company like NW Natural (NYSE: NWN ) -- which has boosted its shareowner distributions in each of the past 53 years -- I get excited. When I see a security products specialist like Brady (NYSE: BRC ) buck cyclical swings to generate 23 consecutive years of increases, I get pumped. Industrial equipment giant Carlisle (NYSE: CSL ) ? It's working on a 32-year streak. Even a troubled sector like restaurants can cook up a winner. McDonald's (NYSE: MCD ) has increased its dividends annually since initiating its payout policy in 1976.
3. Avoid the one-time dividends
There are several reasons why companies issue huge one-time distributions, but none of them impresses me. Sometimes a hefty payout will leave a company saddled with debt, as Domino's (NYSE: DPZ ) was after the pizza chain's $13.50-a-share dividend last year. Other times it is simply a matter of returning money to shareholders in a hurry.
Because there's no free lunch, these huge disbursements result in big tax bills for you, and big ex-dividend price adjustments for the stocks. Unless you're comfortable assessing what a company and its balance sheet will look like after a one-time dividend hit, it's best to stay away.
Add it up
The moral of this story should be familiar: Even yield-hungry investors should remember to buy companies, not dividends. Readers of our Income Investor newsletter would be the first to tell you that. Our newsletter's monthly stock recommendations can't just have attractive yields; they must have attractive prospects, too.
After all, what good is a dividend if the share price falls by more than the sum of your dividend checks? With a little Foolish savvy and a few careful choices, dividend investing can be the perfect strategy for investors who want real profits, rather than imaginary celebrations.
If you need a few of our best dividend stocks for new money, try Motley Fool Income Investor free for 30 days.
This article was originally published April 22, 2008. It has been updated.
Longtime Fool contributor Rick Munarriz pays attention to yield signs. He does not own shares in any of the companies in this story. Bank of America is an Income Investor pick. The Fool has a disclosure policy.
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