On the surface, it seems obvious that chasing big dividends is smart trading. But in practice, a double-digit dividend stock may also be a red flag.
Because dividend yield is based on the dividend per share and current price per share, if the price plummets, the yield goes up. A big dividend could result from bigger problems in the fundamentals.
For the purpose of evaluating dividend yield, the reasons behind these changes are not important; what is important is the underlying cause of the decline. So if you chase big dividend yield as the only test of investing or trading a stock, be prepared for possible price decline and the potential for severe problems. Those big yields exist for a good reason. It is smart to know that reason before buying shares.
To overcome this problem, don't look only at the current dividend yield. Look at the 10-year record and also review what has been going on in other key fundamental indicators: revenue and earnings, P/E ratio, and debt ratio. These tell the bigger story. Also check current news about a company. If they have announced plans to file bankruptcy, the stock price may have fallen in recent days, and one result is a very large dividend. But it is not good news for stockholders, so b3e careful. Don't rely just on the yield.
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