Following the gut-wrenching financial meltdown, housing bust, and worldwide recession, investors are finding their way back to dividends. And if you ask me, that's a great thing because, as I recently pointed out, research has shown that dividend-paying stocks simply perform better over time.
Like the world-weary prince that's finally found his princess, the last thing investors want to see now is the dividend payers in their portfolio slash their payout. While there are exceptions, in most cases, a stock that loses its dividend provides a double-whammy for your portfolio because not only have you lost your income stream, but the stock has likely been battered by the market.
So how do you avoid picking stocks that will put a dividend in your pocket one day and have you grasping at air the next? Here are three red flags to look out for.
1. High debt load
Debt can help juice returns, but a hefty debt load can be the bane of a dividend investor's existence. Since debt holders always come ahead of common shareholders, when it comes to getting paid, if there's not enough money to go around the lenders will get the loot while stockholders get a nice, tall glass of shut-the-heck-up.
The problem is typically worst when it comes to companies in a cyclical industry. When the economy is good, they can take on a whole bunch of debt and appear to have the wherewithal to pay the interest and then, BAM!, the cycle turns and shareholders are left with bupkis. Ford (NYSE: F ) and Cemex are two good examples as both companies' shareholders were merrily cashing dividend checks a decade ago but now get no payout thanks to lots of debt and a cyclical swing.
Right now, investors might want to keep an eye on Ferrellgas Partners (NYSE: FGP ) and Masco (NYSE: MAS ) . While the pair currently pays respective dividends of 8.8% and 2.5%, they have higher debt loads than many comparable companies.
2. Monster yield
Unlike prospective capital gains, dividends yields are out there for everyone to see. So why in the world would anybody pass up the opportunity to invest in a company with a yield of 8% or even 15%? Easy, because they don't believe that the company will actually maintain its payout. And you know what, they're often exactly right.
Of the companies with a market cap above $500 million and a dividend yield of 8% or better at the beginning of 2001, a full quarter of them have since completely eliminated their dividend.
Of course while it can be a gamble to chase hefty yields, it is one that has the propensity to pay off nicely when the market is wrong. For example, at the beginning of 2001, Nationwide Health Properties (NYSE: NHP ) had a whopping 14.3% yield. Though the yield did decline over the period, it held up pretty well and today is even a few cents higher than the 2001 level. Adjusted for dividends, the stock's total return has been more than 550% since the beginning of 2001.
3. It's in a troubled industry
Not all that long ago, investors collected a dividend from both The New York Times Company and Eastman Kodak (NYSE: EK ) . Both companies are in industries that are in decline, and that means not only pressure on the top line but also the need to invest in the business in an attempt to adopt to industry changes. For obvious reasons, this means less cash left over for dividends.
The Washington Post Company has a much more diversified business than its name suggests, but Gannett's 1.2% dividend could face the same fate as that of The New York Times.
Looking outside the newspaper industry, landline telephone companies like CenturyLink (NYSE: CTL ) and Frontier Communications (NYSE: FTR ) currently have healthy cash flow and big dividend yields (you may want to refer back to No. 2), but landline telephone seems like a bit of a relic in a world of mobile phones and voice-over-Internet services.
Dividends that stick
Now that you know a few dividend red flags to look out for, why not check out a few dividends worth owning? My fellow Fools have put together a special report -- "13 High-Yielding Stocks to Buy Today" -- and you can get a free copy by clicking here.