Interest rates are low and big dividend yields are on offer from some of Australia's most reputable companies. So it makes sense to have some exposure to dividend-paying blue chips in the S&P/ASX 200 (INDEXASX: XJO), especially when inflation is a precarious 3%.
Not so fast…
Before you go and risk your hard-earned money in the stock market however, it's vital to consider more than just a dividend yield. As every seasoned investor knows, a company's dividend payment can quickly come under pressure if it cannot generate sustainable free cash flows. What's more, capital losses will quickly wipe-out any benefit of the proposed dividend.
Telstra Corporation Ltd (ASX: TLS) is a company many investors think of when dividends are brought up. Thanks to competitive advantages in a number of markets, it boasts enviable profit margins and large cash flows. However with the stock price rising over 80% in the past three years it's no longer a standout buy. Investors should look for other, cheaper, dividend stocks available on the market.
National Australia Bank Ltd. (ASX: NAB), like Telstra, is also offering a big dividend yield, currently 5.7% fully franked. The problem for NAB shareholders is the bank's UK exposure which continues to face risks outside the bank's control. In my opinion, until NAB can sort out its mess and pay down bad debts (which they appear to be doing), the risks of capital loss on its shares are very real.
Lastly, Woodside Petroleum Limited (ASX: WPL) has also been paying out big fully franked dividends over the past 12 months and its share price has reacted accordingly, up 13%. However, some analysts have begun to question whether the stock is currently overpriced and, according to Morningstar's analysts' consensus forecasts, dividends per share are expected to drop in coming years. If the payouts do indeed fall, it's unlikely the share price will hold up at today's prices.
Our #1 dividend stock idea – Yours FREE!