When investors purchase shares of dividend-yielding stocks, they are given the opportunity to receive the dividends or have them reinvested. Simply purchase a stock and you can watch your portfolio slowly accumulate even more shares over the course of several years.
Reinvesting dividends is often considered a good move as it capitalizes off compounded interest, but as with most investment strategies, there's a potential downside to consider.
The wisdom and folly of reinvesting dividends
If a stock does well, reinvesting dividends can lead to some handsome profits. Consider the investor benefits from the gain off the initial purchase price, plus the dividend value, and then add the value of additional dividend-purchased shares and their dividend revenue. There's also the potential for dividend reinvestment appreciation (change in value of the dividends reinvested back into the stock).
If a stock does poorly, the value of dividends reinvested could presumably compensate for overall share value losses. But if the stock value drops too much, the dividend rewards may be insufficient.
To add salt to the wound, even the unlucky investors are obliged to pay taxes on dividend income. This can also be a trial for investors with profitable stock holdings, as that money is presumably held up in reinvesting equities, and tax money must therefore be taken from personal funds.
In all, dividend reinvesting can be truly profitable if the company maintains a good and consistent performance. Therefore, it's important when choosing a dividend reinvesting stock to consider its sustainability.
Investing ideas: Choosing the right dividend stocks
Wondering which high yield dividend stocks have caught Wall Street's attention?
To create this list, we started with a universe of about 180 high yield dividend stocks. To control the quality of the list, we only focused on the names that have dividend payout ratios below 50% (i.e., less than 50% of their profits are paid out as dividends)
Next, we collected data on institutional money flows, and identified the names that have seen a significant rise in big money buying during the current quarter.
Institutional investors seem to think these high dividend yields are sustainable -- do you?
Use this list as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas.)
List compiled by Eben Esterhuizen:
1. Sinclair Broadcast Group
2. TIM Participacoes
3. NYSE Euronext
5. Aircastle LTD
6. Seagate Technology
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Eben Esterhuizen and Rebecca Lipman not own any of the shares mentioned above. Institutional data sourced from Fidelity.
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