High-yield stocks are dividend-paying stocks or preferred stocks with dividend yields that are higher than known benchmarks. Note that dividend yield is one of the key metrics used for evaluating and choosing the right dividend stocks.
An inexperienced investor might be compelled to purchase high-yield stocks. After all, the yield gives him or her an idea how much dividend he or she can receive. However, evaluating the soundness of a dividend stock based on its yield alone is not enough.
This article lists and discusses the advantages and disadvantages of high-yield stocks, especially the pros and cons of investing in high-yield dividend stocks.
Pros: Advantages of High-Yield Stocks
The main advantage of investing in high-yield stocks is obvious: it allows you to reap the benefits of your investment as fast as possible because of the higher dividend payouts. This is ideal for building a passive stream of income.
In addition, stocks with higher-than-average dividend yields can enable you to grow your wealth or maximize your wealth potential at a faster pace compared with low-yield stocks and non-dividend-paying stocks such as common stocks.
Receiving bigger earnings makes you liquid and enables you to build a cash position quicker. You can reinvest your earnings from dividends in new dividend stocks, thereby growing your passive earning potential further while maximizing the power of compounding.
Another advantage of high-yield stocks is that the risk of holding them for too long lessens because of the faster and relatively bigger returns. Holders of non-dividend-paying stocks depend on capital appreciation alone for investment returns.
Some dividend stocks with high yields are also cheaper. This comes from the fact that a decreasing stock price results in an increase in its dividend yield. Hence, in several cases, some high-yield stocks have low stock prices.
Cons: Disadvantages of High-Yield Stocks
However, remember that yield is not enough to determine if a particular dividend stock is suitable for you. There are other key metrics to look for. These are the dividend payout ratio, earnings per share, and price-to-earnings ratio, among others.
A high dividend yield can also signal that the issuing company might be in distress and is up for a dividend cut. There are different reasons why the yield of a particular stock is so high. One of such stems from sudden crashes in the stock price.
For example, a stock that trades at $50.00 per share and provides $3.00 in payout has a dividend yield of 6 percent. However, if its stock price suddenly depreciates to $30.00 while still giving the same amount of dividend in the meantime, the yield is at 10 percent.
Some stocks with higher-than-average yields could also be overvalued, thus resulting in a sharp downward trend in their stock prices in the immediate future. Hence, before picking a high-yield stock, you should first determine why its dividend yield is so high.
High-yield stocks are also subject to interest rate risks. Whenever a central monetary authority raises interest rates, most investors tend to gravitate toward government bonds because they have a risk-free rate of return than dividend-paying stocks.
A Note on Choosing High-Yield Stocks
Of course, it is important to reiterate the fact that investing in high-yield stocks can be worthwhile, especially if you have done your homework and you want to build or expand further an income-generating investment portfolio.
Remember that yield is not everything. You should focus on other metrics. It is essential to all check the dividend history of involved companies. Choose high-yield stocks that have maintained or raised high yields even during market and economic downturns.