When it comes to dividends, some are wondering if things have become too good to be true.
Of the companies in the Standard & Poor's 500, 46 are paying relatively fat annual dividend yields of 5% or more. Some of these cash payouts are real head-turners, including the 18.9% yield of investment firm American Capital acas.
Most of the mega dividends are coming from financial companies such as Bank of America bac at 7.9% and Citigroup c at 6.1%, but some non-financials, such as drugmaker Pfizer pfeat 7.0%, are paying, too.
Such yields are especially alluring to investors tired of getting low 3% returns even from high-yield savings accounts. And if the market has bottomed, and individual stocks have stabilized, the big dividends could be a great payment for patient investors, says John Snyder, portfolio manager for Sovereign Asset Management. "If investors have a time horizon of beyond three months, some of these stocks will work out," he says. "You're getting paid while waiting."
But there's a danger the fat dividends are only setting investors up for torment when the companies cut or eliminate them, says Don Taylor of Franklin Rising Dividends fund. Often, a dividend yield is high because Wall Street suspects the payout will be cut. Tuesday, two of the formerly highest-yielding stocks in the S&P 500, Regions Financial and Wachovia, slashed their dividends 74% and 87%, respectively. And a stock can always decline in value more than its dividend payout, wiping out any benefit.
Investors can reduce risks by:
•Sticking with those best able to maintain their dividends. Bank of America is considered one of the relatively strong banks, says Tom Cameron, portfolio manager at Dividend Growth Advisors, which owns the stock. The company has raised dividends every year for 30 years and will soon reveal its plans for 2008. "Bank of America is the pretty pig in the beauty contest," he says.
Snyder owns SunTrust sti, which yields 7.8%. While the bank is exposed to some troubled loans, it has been able to preserve its dividend in part by selling Coca-Cola ko shares it has owned for decades.
•Finding dividend payers with the biggest chances of increases. Investors should usually avoid the highest-dividend payers, says Richard Platte of Ave Maria Rising Dividend fund. Instead, he's buying companies with modest dividend yields, such as paintmaker Sherwin-Williams shw at 2.7%, that are likely to raise them.
But dividends are not money in the bank, especially after 23 S&P 500 companies have cut their dividends this year, nearly double those that did in all of 2007. "This is not without risk," Snyder says.