Try to avoid dividend yield traps

Question: There’s a stock I have my eye on that pays a 10 percent dividend yield. This sounds too good to be true. Is it?

Answer: Generally speaking, doubledigit dividend yields indeed are too good to be true. They often either are being paid by unstable companies or simply represent too much of a company’s earnings to be sustainable.

There are questions you should ask to help avoid dividend yield traps, a common term for stocks with too-goodto-be-true dividends. Does the stock pay an unusually high dividend for its industry? Most telecom stocks have yields around 5 percent, so CenturyLink’s 11percent should set off alarm bells. But senior housing REITs tend to pay 6 to 7 percent now, so Senior Housing Property Trust’s 8 percent yield isn’t necessarily out of the ordinary.

Next, does the payout represent an excessive percentage of a company’s net income? Senior Housing Property Trust pays out about 86 percent of its funds from operations, a normal payout for a REIT. CenturyLink pays out more than 135 percent of its trailing-12-month earnings, a potential red flag.

Finally, are there problems with the business long term? For example, some brick-and-mortar retailers are having trouble adapting to the e-commerce surge, so 10 percent-yielding DDR Corp, an owner of shopping centers, could have trouble maintaining its payout. Senior housing is a growing market, so Senior Housing Properties Trust doesn’t have a similar trend working against it.