It's hard not to love dividends. Whether the stock market is up or down, healthy dividend-paying stocks will keep sending you chunks of change regularly, filling your investment accounts with cash. Better still, growing companies tend to increase their payouts over time, too. Such growing dividends can help you keep up with or beat inflation. And growing companies will have growing stock prices, too. Altogether, it's a win-win-win!
But don't just rush out and buy into the fattest dividend yields you can find -- because that can end badly. Here's a look at what dividends are and why high yields can be risky, along with a look at some of the highest-yielding stocks in the Nasdaq.
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Dividend basics
Dividends are payments from companies to shareholders, typically in the form of a quarterly distribution of cash. It's usually fairly established companies with fairly reliable cash flows that pay dividends, because once a business initiates a dividend, it won't want to shrink or eliminate it, as that will disturb shareholders and would-be shareholders. (That said, when a company is facing serious challenges, dividends can be reined in for a short or long while.)
To arrive at a dividend yield, you take the stock's annual dividend (you may need to multiply its current quarterly payout by four) and divide it by the stock's current price. So if Scruffy's Chicken Shack (ticker: BUKBUK) is trading at $100 per share and pays out $1 per quarter, you would multiply $1 by four, arriving at an annual dividend of $4, and then divide that by $100, getting 0.04, or 4%. Scruffy's dividend yield is 4%.
Here's why it's important to understand the math behind dividend yields: Think of that calculation as the fraction that it is: 4/100, with the annual dividend on top and the stock price below. Dividend amounts usually don't change very often. Many companies might increase their payouts once a year, but many others issue increases less frequently. A stock's price, though, generally changes throughout the trading day and from day to day. When the stock price falls, the yield will therefore rise -- and vice versa. For example, if Scruffy's shares fall to $80, the yield would be $4 divided by $80, or 0.05, or 5%.
Tread carefully with high yields
By now you might be starting to suspect why a high dividend yield can be a red, not a green, flag: It's because it might reflect a stock that has crashed. And if a stock has crashed, the company may be facing some big problems. Not all problems are worrisome, though. Some are temporary, such as a big fire at a main production facility. Others may be long-lasting, such as an emerging competitor with a better, cheaper product. A company with a protracted problem may end up shrinking or eliminating its dividend.
Not all high yields are problematic, though. A company may simply be producing more cash than it has uses for, in which case it may just be extra generous with its shareholders. (This may mean that it isn't going to be growing briskly, if it's not plowing lots of money into buying more advertising, hiring more workers, and building new factories.)
Three of the highest-dividend-paying stocks in the Nasdaq
Below are three of the companies in the Nasdaq with the highest dividend yields, as of late January. Note that these yields are very high. The S&P 500, in contrast, recently yielded only around 1.4%, and most dividend payers sport yields in the low single digits.
- AFC Gamma, 16.8%
- AGNC Investment, 15.3%
- Vodafone (NASDAQ: VOD), 11.5%
Based in Florida, AFC Gamma is a very small company, with a recent market capitalization of $243 million, that "originates, structures, underwrites, and invests in senior secured loans, and other types of loans and debt securities for established companies operating in the cannabis industry in states that have legalized medical and/or adult use cannabis." It's organized as a real estate investment trust (REIT) and profits mostly by making and purchasing loans, not buying properties. Its last earnings report featured shrinking income, too. Its dividend yield is high, but this is no big blue-chip dividend payer.
AGNC Investment, with a recent market value of $6.7 billion, is another mortgage REIT. It's also one that has cut its dividend multiple times in the past, and it could cut it again, though the company is bullish on its prospects. It uses leverage (i.e., debt) to juice its performance, but on the other hand, it invests mainly in mortgages backed by the U.S. government. So go ahead and consider it, but if you buy, plan to keep an eye on it.
Vodafone is a major telecommunications company outside the U.S. (mainly in Europe), with a recent market value near $24 billion. There's plenty to like about the company, but note that its steep dividend yield is largely due to a stock price decline: Shares were recently down nearly 30% from their 52-week high. That's at least partly due to Vodafone struggling in some markets and not growing briskly in recent years.
If you want to consider investing in any ultra-high-yield stocks such as these, be sure to read up on them a lot before taking any action. Make sure the companies aren't facing any serious problems -- and then follow their progress. Remember, too, that you can do very well with dividend payers yielding only, say, 5% or less -- and/or with companies that are hiking their payouts significantly and regularly.
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Selena Maranjian has positions in Vodafone Group Public. The Motley Fool recommends Vodafone Group Public. The Motley Fool has a disclosure policy.
