The late years of the 1990s were a great example of this. Internet stocks with little to no earnings were burning up the charts, pumping out huge gains and leading many investors to believe that an early retirement was close at hand.
The housing boom of the early to mid-2000's also showcased this dynamic. Everyone and their grandmother became an expert at speculating in real estate. The narrative on the Street was that "housing prices never go down."
We all know exactly how both of those stories ended.
Investors jumping on the bandwagon looking for quick and easy gains turned out to incur huge losses.
But now, a few years down the road, there is another kind of investment that is gaining critical mass. With yields on fixed-income assets hammered into the ground by the Federal Reserve in the past four years, dividend stocks and funds have are now seeing huge capital inflows.
But greed is creeping into the dividend scene as well, with many investors taking on abnormal amounts of risk reaching for yield.
Take Windstream Corp. (NYSE: WIN). On the surface, the rural telecom's huge 10.4% dividend yield may seem like a quick path to riches. But a closer look reveals big risks. That's because the single most important factor when evaluating the sustainability of a dividend is flashing bright-red warning signals.
I am talking about the dividend payout ratio, a simple equation that divides a company's annual dividend by its earnings. A reading above 1 means a company is paying more in dividends than it is actually earning, which is a big warning signal that the dividend could be in jeopardy of being cut.
In the case of Windstream, its dividend payout ratio of 1.79 means the company is paying almost twice as much in dividends than it earns. The higher yield has also been fueled by shares falling 15% in the past year, neutralizing any gain on yield with capital losses.
Ideally, investors should look for a low payout ratio, leaving plenty of financial flexibility for a company to sustain and grow its dividend payments.
Here are eight companies on the S&P 500 with high yields and low payout ratios, making them the most guarded and sustainable dividends in the market.
Altria Group manufactures and sells cigarettes, smokeless products and wine worldwide and has a market cap of $67 billion. With consumer demand that is considered highly inelastic, Altria has been in favor with investors in the past two years, lifting its share price to a market-beating 38% gain.
But in spite of these gains, Altria still carries a hefty 5.3% dividend yield, almost three times the 10-year Treasury yield of 1.8%. The company's payout ratio of 0.82 is also one of the lowest for companies with dividend yields of more than 5%.
Equity Residential is a real estate investment trust (REIT) that buys, develops and manages multi-family properties in the United States. Shares have seen huge gains in the past four years after bottoming out in March of 2009, and then climbing more than 215%.
But with a dividend yield of 5.3%, Equity Residential still has plenty to offer investors hungry for a steady income stream. The company's payout ratio of 0.51 is exceptionally low compared to other high-yielding stocks but also to the overall market.
Risks to Consider: Some analysts argue that a low payout is bad, because it's an indication that the company is struggling to pay more to its investors. I disagree, but this is another perspective for dividend investors to consider.
Action to Take --> A steady income stream from high-yielding stocks is what every investor dreams. But while a high dividend payment is nice, it's important to also measure the sustainability of a dividend payment.
These eight stocks not only have high dividend yields of more than 5%, but also low payout ratios that give them flexibility to increase dividend payments. Out of the group, I particularly like Altria Group because of its inelastic demand profile and Equity Residential because of its leverage against a recovery in real estate.