Here's something I hope never happens to you. You buy a company that's paying a rather fat dividend. You know the business has had some problems and you're not sure whether the stock price will appreciate much, but you figure the high dividend yield will provide a nice cushion. But soon after, management announces it's cutting that dividend, and the stock price implodes.
Fortunately, there are some telltale clues you can easily uncover that will alert you to potential dividend time bombs.
Cash is king
Mathew Emmert, chief analyst of the Motley Fool Income Investor newsletter, makes his living finding safe and profitable dividend payers. Here are some things he watches out for among high-yielding stocks:
- A company that's paying out more cash in distributions than it's earning from operations.
- Worse still, a company in that situation that issues new debt to maintain its dividend.
- Any company in situation No. 1 that might experience a significant cut in revenues -- whether through the loss of large key customers, or because it relies heavily on just one product.
There are other factors that might set off the time bomb, but these three are easy to spot and very important.
Last April, Mathew warned of eight companies exhibiting some of the above factors. Three -- Equity Office Properties, StarTek, and General Motors
Some of the remaining five companies are showing signs of improvement, while others are still in trouble.
Better safe than sorry
If you're looking for income, there's no reason to stray into dangerous waters. Here are a few examples of dividend-payers with plenty of cash flow to cover their payouts and little chance of significant revenue loss.
Deere & Co.
Data provided by Capital IQ.
I'm not saying these companies are "buys," just that they're not likely to be reducing their dividends any time soon. Mathew does have specific buy recommendations, however, as well as a special report on dividend time bombs. It's all available for free if you'd like to be our guest at Income Investor for 30 days. You'll have access to the latest issue -- and two new stock recommendations -- when it releases today at 4:00 p.m. EST.
Rex Moore is unsure about this whole Sudoku craze. At time of publication, he owned no companies mentioned in this article. Unilever is an Income Investor recommendation. The Fool has adisclosure policy.