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Don’t get too attached to dividend yields

According to The Australian, equity investors have enjoyed an average 6% rise in dividends for the year to June 30 and there are signs that they could grow a further 7.5% over 2013-14 for the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).

While dividend investors would certainly see this as a good sign for things to come, it may not be quite as good as first thought. Instead, it appears that some companies may be going a little too far to please investors in terms of dividend payouts – particularly those companies that are actually taking out loans to pay their shareholders.

Over the last year, with interest rates having fallen to an all-time low, investors have turned their attention towards companies with large dividend yields. Each of the banks have significantly benefited from this trend, whilst other companies such as Woolworths, Wesfarmers and Telstra (ASX: TLS) have also seen enormous increases in value.

Whilst GDP is forecast for less than 2.5% however, many companies are likely to begin returning lower profits which, in turn, would create difficulty to maintain such high shareholder returns. This would result in reduced dividends that would negatively impact share prices. Furthermore, whilst a number of companies, such as Suncorp (ASX: SUN) and Woodside Petroleum (ASX: WPL), have announced special dividends in recent times, those payouts cannot necessarily be relied upon in future periods.

Recognising this risk, Commonwealth Bank (ASX: CBA) and Telstra have both signaled that they do not wish to be known as companies that continually lift dividends, unless it is economically viable for them to do so.

However, for the near term at least, “strong and tax-effective yields can still be achieved from the local market”, according to financial commentator and co-manager of Beulah Capital’s equity yield fund, Tom Elliott. Elliott believes that equity markets are still the right place for investors looking for yield with interest rates remaining so low.

Foolish takeaway

There are many risks involved in investing in a company specifically for its high dividend yield. Should the stock fall (as the company gets too overpriced), any gains made through the form of dividends could be reversed.

On the other hand, there are plenty of reasonably priced stocks that still offer both an attractive dividend yield as well as growth potential. For instance, are you interested in our #1 dividend-paying stock? Discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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