Buying stocks with high dividend yields is an excellent way to invest. But it's not fool-proof.
In fact, if you shop by yield and yield alone, you're playing dangerous game. It's called picking up nickels in front of a steamroller.
Admittedly, it may work for a while, but eventually I can assure you the steamroller will prevail.
That's why in today's low-growth environment, it's critical to know which dividend stocks NOT to buy.
Avoid the real duds and the dividends alone will be enough to bail you out of minor mistakes. Find yourself on the wrong side of the fence, and your high-yield investment could end up being pretty costly.
Success comes from understanding the difference between the two. Here are three ways to separate the winners from the losers.
Avoid Stocks that are "On the Clock"
First, at all costs, investors need to avoid dividend stocks where the source of income will dry up in a few years, and the dividend payout doesn't add up to the amount you're paying for the stock.
You wouldn't think there would be any of those, but there are! Investors fall for them because of their high yields.
Here are a few examples where one day the well will suddenly go dry leaving investors with empty cups.
Great Northern Iron Ore Properties (NYSE: GNI, Stock Forum) GNI yields a monster 17% and has a P/E of 4 times. In business since 1906, it looks very attractive-on the outside. However, on the inside its main asset is a lease on iron ore deposit-bearing land in the Mesabi range which runs out in 2015. With three years left on the lease, investors can only earn 51% (3×17) of their money back. I just want to know where's the other 49% is? There are some residual assets, but not enough.
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