The power of dividend investing is pretty well-known these days. Higher-yielding stocks tend to offer higher returns over time than low- or no-yield stocks, according to research from Jeremy Siegel and others. In fact, the 20 best-performing survivor stocks from the original S&P 500 in 1957 are all dividend payers. What's more, reinvesting dividends acts as a "bear-market protector and return accelerator," according to Siegel. The extra shares purchased and accumulated at higher dividend yields during down periods act as a protector in falling markets, and these extra shares rising in value turn into a "return accelerator" when prices rise.
As the recent economic crisis illustrated all too well, however, you can't buy just any high-yielding stock. Dividends that are cut or suspended entirely can wreak havoc on a stock price, and thus your portfolio. Fortunately, there are some steps you can take to lessen your chances of buying one of these train wrecks. James Early, advisor of our Motley Fool Income Investor service, suggests looking at the payout ratio for starters. That's simply the percentage of a company's net income that is used to pay its dividend. Obviously, the higher the payout ratio, the tougher it is for a company to meet its dividend obligation. James looks for a payout ratio below 80% for safer companies, and a sub-60%- or even 50%-payout for companies you consider risky.
Source: Motley Fool
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