In this time of ultra-low interest rates and the subsequent hunt for income in share markets, it would be too easy to simply buy the stocks with the highest yield.

But this is fraught with danger if you’re potentially buying into businesses that are considered to have prospects that are somewhat doubtful, or have been poor generators of shareholder wealth in the past.

It’s fantastic to be able to buy into businesses that are indeed growing and lifting their dividend, but what if the opposite were to occur, and the yields are artificially inflated due to steep falls in the share prices of the businesses?

I’m a little sceptical when I look at companies with dividend yields too far above 3-4% and, if you see dividend yields like the ones tabled below, I’d certainly pause and investigate why these stocks trade where they are.

Company Yield (%) Franking (%)
1) Seven West Media Ltd (ASX: SWM)

 

10.8 100
2) Cromwell Group (ASX: CMW)

 

8.8 0
3) National Australia Bank Ltd. (ASX: NAB)

 

 

7.0 100 

Seven West Media Ltd

Looking first at Seven West Media, we have a company that describes itself as ‘Australia’s leading multiple platform media company’ and has investments across free-to-air television (Channel 7 and its regional affiliates), newspapers (predominantly The West Australian), magazines and its Yahoo7 online presence.

Now, although Yahoo7 and ‘online’ is expected to be the fastest-growing segment of the business, it’s not going to be enough to overcome the forecast fall in respective earnings, despite estimated dividends of 6.3% and 9.9% over the next couple of financial years.

Such prospects perhaps explain why the share price has fallen from $1.23 to $0.735 more recently, but I can’t help but feel Seven West Media would make a poor investment at today’s price with the expected cut to the dividend meaning the yield today is simply a mirage.

Cromwell Group

Cromwell Group is a listed Australian Commercial Real Estate Investment Trust and property fund manager, and is forecast to experience a fall in its earnings of close to 12 percent over the next two years.

The overall performance of the various portfolios within the group can be considered to be cyclical over time with its main investments being biased towards the office sector.

Whilst this isn’t a bad thing, any potential investor should be cognisant of the fact that the distribution from an investment in this stock will vary over time, as can be seen from its history over the last 11 years.

The up-front yield is pretty good, but it’s the sustainability of the yield for investors wanting to hold on to the stock throughout a full economic cycle that I question.

National Australia Bank Ltd.

It appears the common theme for high-dividend payers is the forecast for a fall in earnings or anaemic growth at best, and the National Australia Bank is no exception.

Its earnings are expected to increase by 3.5% over the next two years, but with a potential cut in the dividend of around half of one percent (not exactly a good thing if you’re looking for an income that keeps up with the cost of living).

With the multitude of pressures applying to the banking sector at the moment, including threats by the Australian Labor Party pushing the Federal Government to establish a Royal Commission into the big four banks, financial planning scandals, increased capital requirements by regulators, historically low provisions for bad and doubtful debts, and record-high property prices, the banks, and the National Australia Bank in particular, are a perfect storm for poor returns and dividend cuts.

Foolish takeaway

For my money, if you’re serious about dividends, then you need to have dividend growth.

Three good examples of company’s growing dividends consistently and over time include Retail Food Group Limited (ASX: RFG), Corporate Travel Management Ltd (ASX: CTD), and Thorn Group Ltd (ASX: TGA).

Corporate Travel you question? It’s undoubtedly true that it’s yield is currently only 1.6%, but buying shares today in anything means you’re only going to be receiving the dividends of the future, not the past.

For this reason, owning shares in a company like Corporate Travel, with its dividend growing by close to 30% each year, means that long-term share holders will probably have a much higher chance of eating well in retirement.

Do your research before buying anything and be very sceptical of headline yields. There’s usually a very interesting story behind them that you really ought to know.

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Motley Fool contributor Edward Vesely owns shares of Corporate Travel Management Limited. The Motley Fool Australia owns shares of Corporate Travel Management Limited and Retail Food Group Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.