Searching for stocks based on their dividend alone is risky business. Too many times investors have been 'burnt' by companies that have reduced or completely removed their dividend payout as a result of poor earnings.
The simplest (and arguably the best) investing strategy is to invest in what you know. Peter Lynch, superstar investor and famed fund manager at Magellan, believes, "If you're prepared to invest in a company, then you ought to be able to explain why in simple language that a fifth grader could understand, and quickly enough so the fifth grader won't get bored."
If you can't explain why you're buying it, don't buy it – dividend yields aren't an exception to the rule because a capital loss could wipe off any potential dividend gain in a day or less.
With that in mind, here are five companies that offer strong dividend yields and, perhaps more importantly, room for further earnings growth.
Unlike its blue-chip counterparts, such as the big banks and miners, Telstra (ASX: TLS) pays a legendary dividend. Its status as a great dividend payer is an amalgamation of its market dominance and healthy cash flow. It'll continue to offer its strong dividend for years to come and there is potential for it to increase. Investors can rest easy knowing that the telco is likely to experience single-digit growth in the short term thus minimising the potential for a significant capital loss.
Another stock that pays a strong dividend is Myer (ASX: MYR). There will always be a place for traditional brick-and-mortar retailers, although it may be from a reduced base than what we've historically become accustomed to. Myer has taken steps to ensure its online presence and has revamped a number of its stores ahead of a busy Christmas holiday period. With record low interest rates, investors could take advantage of a strong dividend and increased consumer confidence.
Retail and financial chain Cash Converters (ASX: CCV) recently suffered an irrational setback in share price yet still has a bright future ahead. It pays a strong 4.3% dividend with franking credits and trades on low multiples. It has operations here in Australia and abroad which are continually experiencing top- and bottom-line growth.
BWP Trust (ASX: BWP) is small company that could be considered a 'core' stock. In addition to other properties under its management, it has a portfolio of commercial real estate leased to Bunnings Warehouse stores throughout Australia. It has a very stable 6.2% dividend yield.
Finally, no portfolio would be complete without a small and exciting stock. Capitol Health (ASX: CAJ) is a small-cap healthcare stock that provides facilities and diagnostic imaging services to the Victorian healthcare industry through 35 clinics. It has risen 405% in the past 12 months, trades on 50 times earnings and pays a 1.2% dividend fully franked.
Foolish takeaway
To quote Peter Lynch again, "behind every stock is a company, find out what it's doing." This is important not only because it gives you an insight to the likelihood of the company's prospects, but also the ability to assess whether or not it suits your tolerance to risk and overall investment strategy.
