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How to Tell if a Stock's Dividend Is Too Good to Be True

By Motley Fool Staff - Updated May 2, 2018 at 3:49PM

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Here’s a quick check to see if a stock’s dividend is worth a closer look.

A "yield trap" is a stock with a high dividend whose underlying business is on shaky ground. Here's one quick way to check if a stock has an unusually high dividend that deserves a closer inspection."

A full transcript follows the video.

This video was recorded on April 30, 2018.

Michael Douglass: With all of that, let's talk about the criteria. The first one is the one that probably attracted you to the company in the first place -- an unusually high dividend yield. To be clear here, unusually high dividend yield really depends, to some extent, on the sector that we're talking about. A real estate investment trust or REIT, they tend to have higher dividend yields because they're actually required to pay out almost all of their otherwise-taxable earnings as dividends. That's just how REITs are structured. MLPs tend to have really high dividend yields just as a sector. Tech companies tend to have relatively low dividend yields. So, while a 5% or 6% dividend yield in a REIT isn't necessarily outside the realm of normal, in a tech company, it might be. A bank that's yielding 7-8%, that immediately causes this yellow flag. Again, it's a potential issue.

Matt Frankel: Yeah. It's all about comparing the company with its peers. I mentioned earlier AT&T and Verizon. That's a great way to compare two stocks that are very similar business models to see if one has an unusually high yield. Even within sectors, there are fast-growing tech stocks and then there are the mature companies like, say, Microsoft. So, it pays to look at a company in relation to its peer group, I would say, to see if it has an unusually high yield or not, before you move on and check that box.

Douglass: Right. And one thing that we'll be sharing in the write-up is some general thoughts, within financials, as to what a pretty typical dividend yield for each of the main financials sectors, at least, looks like, just so you get that feel for, "OK, 6%, that seems like a lot." Or, maybe it's not, in this case. So, again, to reiterate one more time -- this will be the last time I say it, I promise -- no one criterion is necessarily enough for concern. It's really once we get to two.

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