Yields Too Good to Be True

Most investors seem to appreciate the value of dividends. No matter what the market is doing or what your stock is doing, as long as it's healthy, it's likely to keep paying you its dividend. The stock price might stagnate for five years, but during that time, you'll still receive quarterly dividend payments. Nice, eh?

As my colleague Rich Greifner has pointed out, a whopping 41% of the S&P 500's total return from 1926 to 2004 came from dividends. Therefore, it can seem logical to seek out companies with steep dividend yields. I found these among the S&P 500:

Source: MSN Money.

Be careful when looking at such lists, though; don't just jump at the biggest yields you see. The banks above, for example, are in a struggling industry, weighed down by our nation's mortgage mess. Many banks, such as Washington Mutual (NYSE:WM), have cut their dividends, and there's speculation that Wachovia might follow suit, perhaps eliminating its dividend entirely.

Newspapers, too, such as those owned by Gannett (The Arizona Republic, The Cincinnati Enquirer, and The Tallahassee Democrat, among many others), face a challenging environment. Newell Rubbermaid might look less attractive on a yield basis, but you should never focus solely on one or a few metrics. Its operating and net income levels have been rising over the past few years, whereas that hasn't been the case with many bank stocks.

What to do
When you approach dividends, do so with a level head. Look for sustainable payout ratios. Look for sustainable competitive advantages. Look for growth.