High Yield Stocks

High Yield Stocks. Finding stocks with the highest yield can bring big rewards.

Understanding High Yield Stocks

A DIVIDEND refers to the payment many companies make to shareholders out of their excess earnings. It's usually considered a per-share amount. Companies will compare dividends, referred to as the "dividend yield," or simply the "yield." This is the dividend amount divided by the stock price. It refers to the percentage of your purchase price that the company will return to you in dividends. For example: If a stock pays an annual dividend of $2 and trades at $50 a share, it has a yield of 4%.

Not all stocks will pay dividends. If a company is in good growth and can best benefit shareholders by reinvesting its earnings in the business, that's what it will do. Microsoft doesn't offer a dividend, but the company's shareholders don't complain. A stock with no dividend or yield isn't necessarily lost.

Still, many investors will prefer a dividend, both for the income and the security it provides. If your company's stock price falters, you always have the dividend. And it is definitely a real plus for a mature stock with steady, but unspectacular growth.

Don't make the mistake of merely searching for stocks with the highest yield -- it can quickly sink your ship. Think about the stock mentioned above with the $2 dividend and the 4% yield. 4% is well above the market average, which is usually below 2%. All the same, this doesn't mean all is well with the stock. What will happen if the company misses an earnings projection and the price falls overnight from $50 a share to $40? That's a plummeting 20% drop in value, but it actually raises the yield to 5% ($2/$40). Would you want to invest in a stock that just missed earnings estimates due to a higher yield? It's always crucial to make sure the company clears all your other financial hurdles.

When searching for stocks with high dividend yields, look at the company's payout ratio. It tells you the percentage of earnings management is offering to shareholders in the form of dividends. If the number is above 75% think of it as a red flag -- it could mean the company is failing to reinvest enough of its profits in the business. A high payout ratio can mean the company's earnings are on the decline or that it is trying to entice investors who find little else to get excited about.