A High-Yield Danger: Sector Overload

There are lots of good reasons to favor dividend-paying stocks, including their strong history of outperforming non-payers. That said, focusing only on fat dividends can be risky. And even if you seek robust dividends in attractive companies, you might end up overconcentrated in one or a few sectors, making your portfolio more vulnerable to the market's sudden mood swings.

To demonstrate, I screened on Motley Fool CAPS for the highest-yielding large-cap stocks with market caps greater than $10 billion. See if you notice anything interesting about the eight top-yielding companies:

Data: Motley Fool CAPS.

That's right -- there are seven companies listed, but only four sectors represented. Three of the outfits are basic materials specialists, while two are utilities, and two are telecom stocks. There are no food, or health-care, or retailing companies, no transportation or software enterprises. Moreover, as you look down the list, you'll find even more companies from this same small set of industries.

Why you need to diversify
Overconcentration can be a boon if things go your way -- basic-materials companies, for example, may surge once a global economic recovery gets firmly under way. But that narrow focus is a double-edged sword. Remember that yields go up when a stock price falls. Thus, when all the financial companies swooned in the midst of the recent credit crisis, their yields soared (until, in many cases, they got slashed). If you'd invested at the wrong time, you might have added a bunch of high-yielders to your portfolio, only to see them keep falling for quite a while.

The remedy here is simple: Keep searching for worthy investments, but make sure to spread them out across a range of industries. That way, you'll be less likely to suffer if one or more industries falls sharply.

Several familiar names may offer you the dividend play of a lifetime.