A high dividend yield may be a reflection of a company's mature status.

Some large, established businesses may find it difficult to identify enough growth investments to efficiently deploy their profits. In such a case, management often returns profits to shareholders in the form of dividends.

A good example of this would be telecommunications and utility companies.

In other instances, the business structure of a company itself may require the company to distribute the majority of their cash flow to investors for tax purposes, as is the case with REITs (real estate investment trusts). REITs were created in the 1960s as a tax-efficient vehicle to fund the growth of American real estate. These entities are not required to pay federal income tax, provided they payout 90%+ of their income as dividends.

Unfortunately, boosting dividend yields can also be a way for management to pacify frustrated investors when the stock isn't performing. As you can imagine, this almost never works out well - the temporary yield boost can make the stock look tempting at first, but as profits drop and the struggling company's financial woes deepen, these unsustainable payouts eventually get cut. This can be a dangerous trap for dividend investors seeking yield.

To avoid these so-called "dividend traps", it's important to understand the overall health of a company, and also how dividends fit into management's overall corporate strategy.

News

Company

Stock Tools

Stock Ideas