Why an Ultra High Dividend Yield Alone Doesn't Make a Stock a Buy

Early on in my investing life, I identified dividends as a key focus area. Unfortunately, I had a fair amount of success in buying stocks with ultra-high yields, with my starting point for considering a new investment at 10%. Time, and capital losses, taught me that a big dividend yield is nice, but it is not enough information on which to base an investment decision.

Here are a few examples of what I mean.

The BDC business model is leveraged

Back before the Great Recession, I owned a couple of business development companies (BDC). These BDCs provide loans to small- and mid-size companies, passing through much of the interest income they earn to shareholders in the form of dividends. When I bought into industry-leading names (at least at the time) like Allied Capital, they were paying 10%-plus dividend yields.

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And then a deep recession hit, and the leverage inherent in the BDC business model suddenly mattered a great deal. Dividends got cut, companies went out of business, and Allied Capital ended up selling itself on the cheap to another company.