A high dividend yield can signal that a company’s shares are a bargain or that trouble is looming. The job of the value investor is to tell the former case from the latter. Common sense helps. If the broad stock market yields just under 2% and if a stock under consideration yields, say, 9%, there are only a few explanations. The firm might be a pass-through company that invests in something risky, like dodgy debt. Or, it might be a once prosperous but now withering company that hasn’t announced a dividend cut yet -- but everyone believes will soon. The cases that are more difficult to judge are those that fall in between those examples. What about a 5% yield in a 2% world?

Source: SmartMoney

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