Dividends are a hot topic for many investors right now. The turmoil of the financial meltdown is still fresh and the tangibility of a quarterly cash payout hits the spot like a cool glass of lemonade on a midsummer day in the desert.
Not surprisingly, investors have been drawn to companies that feature massive dividend yields. And why not? If you're going to go for dividends, why not go big.
The catch is that many -- if not most -- of the companies with huge dividend yields get those yields by paying out nearly all, if not all, of their income through those dividends. Take midsize bank New York Community Bancorp
By focusing on the dividend yield alone, investors can end up overlooking the bigger picture. A dividend-paying company with a high payout ratio may have a tougher time maintaining its payout if it hits a speed bump. It may also have little capital left behind to reinvest in the business and might be forced to load up on debt or sell new shares if it wants to grow. Or it may simply be admitting that its growthy days are in the past.
A laser-focus on dividend yields also means that investors may not be comparing potential investments on an apples-to-apples basis.
At first glance, the 2.9% dividend yield for fellow bank PNC Financial Services
Could PNC actually pull that off? The bank is in much better shape than, say, Bank of America
It may seem odd to stack PNC's theoretical 13% payout against NYCB's actual 8.4% yield. But this is meant as a thought exercise and a reminder that a dividend yield is only part of the story. Many really great companies have the earnings power to pay truly massive dividends, but simply choose to reinvest some of their earnings for future growth, buy back shares, or hang onto some extra cash. That doesn't mean you should consistently pass up big dividends for smaller ones, but it does mean that you may miss out on some really great companies if the one and only stop in your research is to ogle a stock's yield.
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The Motley Fool owns shares of PNC Financial Services Group, Citigroup, and Bank of America. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Fool contributor Matt Koppenheffer owns shares of Bank of America, but does not have a financial interest in any of the other companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or Facebook. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.