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. So a stock paying $2.00 per share and priced at $40 is yielding 5%. ($2 / $40) But if the stock price declines to $32, the yield is 6.25% ($2 / $32)
A big dividend could result from bigger problems in the fundamentals. If a company is likely to go out of business, the price may plummet and the result could be a very large dividend yield. So just looking for big-dividend stocks is not enough to overcome market risk. You also have to study the price history and reasons behind big price declines.
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.
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