This blue-chip stock’s 7% dividend is too good to be true

Interest rates are stuck at just 2.5% and, according to one investment bank, could be headed even lower as soon as September.

This will likely see even more Australians turn towards the stockmarket for superior returns, with particular attention being paid to the S&P/ASX 200 Index’s (Index: ^AXJO) (ASX: XJO) higher-yielding stocks.

For instance, companies like Telstra Corporation Ltd (ASX: TLS), National Australia Bank Ltd.  (ASX: NAB) and even BHP Billiton Limited (ASX: BHP) could well become targets of the yield-hungry investor.

Another stock which will likely garner attention is Commonwealth Bank of Australia (ASX: CBA). According to Morningstar’s analysts’ expectations, the bank could pay a dividend of $3.97 per share.

That’s a fully franked yield of 4.9% or a massive 7% grossed up!

Compared to the “risk-free” returns (that is, those offered by term deposits or government yields)… That 7% has to be a better option, right!?

Before getting to the answer, I should start off by stating that a stock’s dividend yield should never be solely relied upon when investing in a stock.

There are so many other things that also need to be considered – for instance, the company’s ability to keep growing earnings and whether or not the price being paid for the shares is a reasonable amount.

In Commonwealth Bank of Australia’s case, the dividend is most certainly appealing, and you’d be pushing it to find a higher quality corporation, but the shares themselves are by no means trading at an attractive price.

Currently sitting at $81.35, the bank is trading on a projected P/E ratio of 15.2 (well above its 10-year average) and a Price-Book value of 2.91. Those measures indicate that investors expect earnings to continue growing at a strong rate over the coming years.

While low interest rates could well see the bank’s profits climb higher in the near term, they are likely to come under pressure when interest rates inevitably drop and bad debt charges rise.

This would likely result in the shares pulling back in price, thus offsetting any gains made from the dividends received.

Here's a MUCH better dividend stock than CBA

Commonwealth Bank's shares have delivered some mega-returns for shareholders in recent years, but the big money now looks set to be made from other high yielding stocks. For example, the Motley Fool's top analysts have recently named their Top Stock for 2014-2015, which not only offers a grossed up 7% dividend yield but also exceptional growth prospects. Best of all: it's your FREE. Just click here to download your free copy of "The Motley Fool's Top Dividend Stock for 2014-2015" today.

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

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