High Yield Dividend Stocks: What Every Investor Should Look For

But don’t despair. There are still a few decent ways to make your cash earn some income without putting it at too great a risk.

My wife takes care of our filing, and during one of her filing sprees some time ago she walked into my office with the brokerage statement for her IRA and asked me why the interest was less than $1. “Interest rates have gone down that much,” I said.

She replied, “That’s terrible,” and turned around, went back into her office, and stuffed the statement into the appropriate file.

Inflation was eating away at our savings, and our broker had nearly stopped paying any interest at all. When I sent him an email, he wrote back: “I am sad to say the current yield on our money market fund is 0.01%. If we travel back in time to 2007 that rate would have been around 4.00%.”

I was shocked! I even made him spell it out, and he confirmed that was no typo; it wasn’t supposed to say 1% or 0.01%… it was actually 1/100 of 1%.

In one of our recently published reports, The Cash Book, we showed retirees how to protect their cash. Safety is essential for cash, but safe places – such as checking accounts, money market funds, and even ultra-short bond funds – offer virtually no yield, while the threat of inflation is very real. Even with “official” inflation moving at a modest 3% per year, settling for a conservative money market fund’s token yield of 0.05% or so means the purchasing power of your cash is leaking away. You need a yield that matches the inflation rate just to stay even.

You shouldn’t have to accept pathetic yields nor sacrifice safety to the whims of the stock market just to eke out enough to keep up with inflation.

I’m sure I’m not the only investor who had seen his monthly interest-income cash dwindle but put off dealing with it because I had “bigger fish to fry” in the rest of my portfolio.

If you’re now in the same boat, it’s time to fix the problem. Don’t ignore those sad yields on your cash any longer. Today, minimum risk and improved yield is more important than ever. While not close to what we enjoyed just a few years ago, a 1% return instead of a 0.01% return is a hundredfold improvement. That improved yield translates into less need to take high risks elsewhere in your portfolio. When your cash is doing its job, you don’t need risky bets to get your portfolio where it needs to go.

Over the next few weeks we’ll cover a variety of ways you can make your money work harder for you and actually minimize your risk. And given the number of questions I get about high yield dividend stocks I think it’s appropriate to start with them first.

Equities (stocks) can be another way to beat the yields on bonds in the US market. Of course, when you buy a stock, you don’t even get a promise that your principal will be repaid. Nonetheless, with yields so low elsewhere, there are high-volume, blue-chip equities that can be good additions to your income portfolio. In the best scenario, they may give you both good yield and capital appreciation. The same can’t be said of bonds, since rates are already so low. Keep in mind that dividend equities should be only a part of your yield portfolio, not all of it. And don’t weigh yourself too heavily toward any one stock.

Since the late 1950s, 10-year US Treasury yields have been consistently higher than the average dividend yield for the S&P 500. But now with the S&P average dividend yield at 1.98% and the 10-year Treasury yield at 1.64%, this trend has reversed, making dividend-paying stocks more attractive than almost ever before. That’s just one of the reasons why we’re looking for blue chips that are financially sturdy and that offer yields that more than make up for the market risk.

When evaluating the stability of a high-yielding dividend paying stock, the first metric to look at is the company’s fundamentals. Much of this information is freely available online on websites like Yahoo! Finance and MSN Money, or through research tools with your online brokerage account. You might have to do a little math, but there’s nothing complicated about this. So here are the first set of questions you need to ask about any stock, regardless of whether it pays a dividend.

•         Do they have more current assets than current lia¬bilities?

•         Do they have enough cash to cover average operating expenses?

•         What about debt? What percentage of operating income goes toward servicing long-term debt payments?

Answering these questions should give you a good idea as to the company’s finan¬cial stability. Also, stable free cash flow and operating margins greater than or equal to its competitors can help identify any potential competitive advantages.

Once we have established that the company is fundamentally sound, the firm’s dividend needs evaluation. Companies will sometimes publish their dividend policies on their web¬site (often on a page titled “Investors” or wording to that effect) or annual reports, but they also frequently withhold this information. Luckily, there are a few metrics that can help assess the durability of the dividend.

The most common indicator for dividend stability is the payout ratio. The payout ratio is equal to Dividends per Share/Earnings per Share, and shows you how much of the com¬pany’s earnings went toward dividend payments. The lower the better and anything over 80% should be considered a red flag.

As an aside, the S&P dividend payout ratio is currently at 37%, well below its long-term average of 50%. This means that the potential for dividend increases is more likely than usual. And, since companies have been hoarding cash as a result of overarching uncer¬tainty in the economy, we could see rising dividend payouts in coming years.

Next, you’ll want to look at the company’s dividend history. A few questions you’ll want to pose:

•         Has the dividend been cut recently or in times of economic or market turmoil?

•         How many years in a row has the company raised its dividend payout?

•         Has the dividend payout been rising while the payout ratio and debt levels remain the same?

A consistent track record of raising dividends is a good sign. Some companies that have raised their dividends 25 consecutive years fall into the elite category of Dividend Aristocrats (only 51 stocks fall into this category).

However, the last metric is the most important. If a company is able to consistently raise its dividend without having to divert profit and/or take on debt, that company’s dividend is safe.

These metrics reflect a company’s ability to meet its short-term debts and help assess the safety of the dividend. In case of rough waters, the companies with better fundamentals will be the survivors and the ones less likely to bail on dividend payouts when times get tight.

With these tools in hand you should be able to start doing research on dividend stocks for your own portfolio.

In our Money Forever letter we recently developed a monthly income plan using some of the safest dividend stocks on the market. The plan is easy to start and doesn’t require an extensive background in investing, just a willingness to learn and a desire for monthly income. Click here to find out more.