With yields on ultra-safe debt stuck in the gutter, many investors are reaching for higher income through dividend-paying stocks. That's a fine strategy -- as long as you're comfortable with the extra risks involved.
To minimize those risks, you won't want to reach too high. Dividend yields that are more than about 4%, for example, are usually worth extra research. You'll also want to screen for dividends that are backed up by strong earnings and sales growth. Ideally, those dividends will have a good chance of rising -- or at least staying put.
Later in this article I'll analyze one dividend stock that I think meets that test. But first let's take a look at two heavy-yielders that don't.
Pitney Bowes : 9.8% yield
This global mail services company is in retreat. Pitney Bowes has seen its shares crater by more than 50% over the past five years as mail volumes tanked. But because its dividend has actually crept up over that time, the stock's yield is now reaching toward the double digits. Does that mean it's time for dividend investors to rejoice?
Not so fast.
Yes, that dividend may not look alarming when compared with the company's earnings. The payout last year was 68% of net income, which is high, but about the same as it was in 2008.
Pitney Bowes' revenue tells a different story, though. Sales have plunged by 20% over the last five years. And while the company has been able to squeeze more profits out of every shrinking sales dollar, that trend can't continue for much longer without risking the dividend.
New CEO Marc Lautenbach has his hands full as he looks to turn this business around. Last quarter's sales drop of just 1% was a step in the right direction. But however that turnaround progresses, it's clear that Pitney Bowes will end up a very different company from the dividend aristocrat it had been for so long.
Garmin : 5.4% yield
GPS and navigation device maker Garmin is in much the same boat. The company's sales and profits are both down about 25% since 2008, helping push the stock lower by 40%. And yet the company's dividend payment has more than doubled over that time. As a result of those twin forces, Garmin's yield is impressive at more than 5%.
But Garmin's revenue slide seems far from over. Sales were down 16% last quarter as four out of Garmin's five business segments turned in weaker results. The company's automotive segment led with a 25% drop in sales, while the fitness group was the only one that managed a gain.
Despite those challenges, management insists that it is "committed to an attractive dividend yield." Yes, Garmin has some room to maintain its current payout. But while the yield might be attractive, the payout ratio isn't. In 2008, Garmin paid out a comfortable 28% of net income. Last year that ratio rose to nearly 70% of earnings.
Consider this instead
For a more secure -- but still generous -- dividend, take a look at Procter & Gamble . The consumer giant's sales are close to five-year highs, and yet its dividend yield, at 3%, is just a smidge below its five-year average. And as for safety, the company's payout ratio is perched at a solid, but comfy, 50%. Here's a look at how that ratio has been brought down lately as cash flow increased.
P&G had to issue a couple of profit warnings in late 2011 after suffering market share losses to competitors like Unilever. But management seems to have stopped the bleeding. P&G held or grew market share in brands that represented 50% of sales last quarter. That number was 45% in the quarter before, and just 30% in the quarter before that.
Buoyed by that success, P&G just boosted its sales and profit outlook for the year. The company also plans to invest heavily in share buybacks, aiming to purchase between $5 billion and $6 billion in shares this year.
Its dividend yield might not have the wow factor of Pitney Bowes' 10% or Garmin's 5%. But it is well protected by a diverse and growing base of earnings. And it is very likely to rise in the years ahead, too.
More dividend stocks
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The article 2 Big Dividends to Avoid (and 1 to Embrace) originally appeared on Fool.com.Fool contributor Demitrios Kalogeropoulos has no position in any stocks mentioned. The Motley Fool recommends Procter & Gamble and Unilever. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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