3 Reasons To Avoid The Top Dividend Paying Stocks

To the average eye, searching for the top dividend paying stocks may seem like a great way to invest your money. Just think, snabblån invest a couple thousands dollars into a few stocks that yield double digit dividends and you can retire early! As nice as that sounds, investing in dividend paying stocks is a little more complex then that. It requires due diligence on the stocks that you plan to invest in, as well as careful planning and execution.

As much as we would all love to invest in a stock that returns a 15% dividend payment, there are way too many reasons not to. I have detailed a few of these reasons below.

Reasons NOT to Invest in the Top Dividend Paying Stocks Here are a few (there are more) examples of why investing in the top yielding stocks can be very risky.

Misleading Yield – Many of the top dividend paying stocks can be a little misleading at first. As a share price decreases, the dividend yield increases. Provided there is a valid reason for a stocks price decline (which is normally the case), the high dividend yield is a lagging indicator. More than likely, the company will be forced to make a dividend cut to free up cash and take care of any troubles they may be having. The bottom line is to make sure you research any top dividend paying stock prior to making an investment. Income Trusts – Many of the top dividend paying stocks that you can find today are known as income trusts. There are plenty of these double digit yielding stocks that are structured to payout the majority of their earnings in the form of a dividend. On the surface, this seems to be a great investment opportunity. However, most of the time it is just too good to be true. Many of these trusts are in the oil and natural gas exploration business or heavily invested in the real estate market. Income trusts are typically in highly speculative markets and have a strong chance of going under, so keep this in mind. Liquidity – Several of the highest dividend paying stocks actually have a very low trading volume. This means the liquidity in the stock is not very good and you may run the risk of not being able to sell your position at a competitive price. The same goes for when you purchase a stock. Low volume is not just a problem for dividend paying stocks, but many high yielding securities tend to trade on low volume. Run a Stock Screen If you want to truly understand the risks involved when investing in the top dividend paying stocks, run a stock screen and see what comes back. Find a stock screen tool that will allow you to enter the dividend yield of a company. Search for the highest dividend yields for all publicly traded companies. When your results return, chances are you probably have never heard of most of the stocks. You will also probably find that the majority of the stocks on your list have very low volumes and not a lot of information about the company.

I recently ran this same stock screen through my online discount broker looking for stocks that had a dividend yield greater than 15%. My results returned 40 securities that paid this level of distribution. Here are the top 5 results -

Robocom Systems Intl Inc. (RIMS.OB) – 128.57% Annuity & Life RE Hldgs (ANNRF.PK) – 111.11% Proshares Trust (TLL) – 100.02% ML Biotech Hldr (BBH) – 84.14% Nucryst Pharmaceut Com NPV (NCST) – 82.05% I then headed over and checked out the fundamental details of each of these stocks. Three of the top five stocks on my screen were actually penny stocks with extremely light trading volume. The only stock that even looked like a potential investment was Proshares Trust, but it was a far stretch.

The point of this exercise is to prove that the top dividend paying stocks by dividend yields are some of the riskiest investments that you can make. Just because a companies dividend yield is high, doesn’t mean the company has strong fundamentals. Remember that stocks with high yields are that way for a reason. Investors don’t believe the company can maintain it’s current yield and expect the distributions will come back down!