High Dividend Yields May Signal Trouble Ahead

Often a historically high dividend yield signals that a company is in trouble and dividends cuts are likely to occur. For example, General Motors (GM) offers a $2.00 dividend which at $22 translates to a 9.1 percent yield (dividend divided by stock price). But with all of its troubles, is the $2.00 dividend safe? If GM were to need cash, it would certainly cut the dividend and the yield would fall.

In September 2002 Duquesne Light Holdings (DQE) cut its dividend from $1.68 to $1.00 reducing the dividend yield from 14 percent to 8 percent, still a handsome yield. The stock price did not decline because it had already dropped from $34 to $12. Currently the dividend yield is 5.88 percent ($1/$17).

When you see a high dividend that tempts you to buy a stock, be sure to research the stock first. Do not buy the stock if: the stock is on the downside, the dividend is more than current earnings or the dividend yield is much higher than yields for other stocks in the sector.