Looking for Yield in All the Wrong Places

Big, fat, juicy yields can look sexy, but they’ll break your heart in the end like a super fast club chick if they can’t be maintained. There are some winners among the financials, but you’ll be sorry if you take home the wrong one for the wrong reason.

Dividend yield is one common value trap that can entice inexperienced and experienced investors alike. Right now, the financial sector is full of some the juiciest dividend yields around. The dividend yield is calculated by dividing the cash distributed to shareholders by the price per share. Citigroup Inc. [C], for example, currently pays stockholders $1.28 per share and is trading around $25, yielding a little over 5%.

Dividends can be extremely enticing…

It’s hard to say no…especially to cash. After all, Economics 101 tells us that a dollar today is worth more than a dollar tomorrow. A high dividend yield can make for a decent investment even if the stock price does nothing. With Citigroup’s 5% yield, an investor can get a 100% return on the initial investment in just over 14 years if the dividends are reinvested…and that’s if the stock price doesn’t go up a penny. American Capital Strategies, Ltd. [ACAS] is sporting a cool 12.5% dividend which would double an investor’s investment in just over 5 1/2 years. What’s sexier than that?

Why dividends can be dangerous:

[Investing] only for the yield is like getting married only for the sex. If the thing that attracted you in the first place dries up, you’ll find yourself asking, “What else is there?”

Jason Zweig, p.146, The Intelligent Investor — Revised Addition

As you would in selecting a life partner, make sure you can identify value-adding characteristics that can stand the test of time.

Like you blowing your money on that super fast club chick, a company with a liberal dividend policy may not be reinvesting for the future. Even worse, a company may not have the earnings available, and may have to cut or discontinue dividends indefinitely. In which case, your sexy stock’s appearance could fade fast, if that’s all you’re in it for.

Analysts watched very closely today as Citigroup reported its $5.1 Billion loss. They will continue to look for any indication that may cause Citigroup to reduce its $1.28 dividend. Citigroup only made 72 cents per share in ‘07. If Citigroup has another year like that, management may want to cut the dividend to let the company breathe a little while it gets back on its feet. If the dividend is cut, all those in it for the yield will most likely sell out causing the stock price to plunge. But for the prudent, true love may manifest itself in an excellent buying opportunity.

Disclaimer: The statements above do not represent the opinions of YBPGuide. Investors should be cautious about any and all investment related recommendations and should consider the source and objective before investing. Various factors, including personal or corporate ownership may influence opinion. Greg does not own shares of Citigroup Inc. or American Capital Strategies, LTD. All investors are advised to conduct their own independent research before making a purchase decision. Investors are also advised that past performance is never a guarantee of the future.

More on dividends:

http://www.commondreams.org/views03/0520-09.htm

http://www.fool.com/investing/dividends-income/2008/04/18/a-dividend-stock-that-will-set-you-for-life.aspx

http://www.fool.com/investing/dividends-income/2008/02/28/my-dividends-are-bigger-than-yours.aspx