Avoid these 2 mistakes investors make with stocks

Dividends are a popular way to get income from the stock market. Regular payments made to shareholders can equal positive cash flow.

When investing in dividend stocks, first-time investors often fall into some common mistakes.

Here are two to keep in mind.

Not all companies are created equal

There is no shortcut when choosing equity stocks and there is no single model that works for all companies. When considering investing for dividends, the individual strengths and weaknesses of the target company should be considered.

This is especially true when it comes to dividend coverage. This metric is used to assess how much cash a company has to cover its equity obligations. Most likely, if its capital is less than the total number of shares, there will be a problem.

Companies that need stable cash flow to operate generally pay a lower dividend and therefore, have a higher coverage. However, some companies do not need a lot of capital to operate and therefore pay a high dividend with a low investment. This shows how low coverage is not a bad thing.

It is important to find out how the company operates before making a decision based on coverage alone. Even a company with a high coverage ratio may reduce dividends if it has a lot of debt financing.

These factors vary from company to company, so each needs to be evaluated on an individual basis.

Investing for yield

Investing only for yield is not a good long-term strategy. Products are highly variable and often high for the wrong reasons, such as crash pricing.

Some investors buy stocks just before the ex-dividend date as a way to lock in the yield at a certain level. This can be a smart strategy but it doesn’t guarantee anything. Ignoring a company’s fundamentals and potential price movements is risky. If the stock falls above the yield before settlement, then everything is worthless.

Before making a decision based on earnings, investors should always carefully evaluate the financial condition of the company.

Examples to consider

In 2023, Vodafone had a very high yield FTSE 100by 10.8%. But falling profits forced it to cut its dividend in half, bringing the new yield closer to 5%. Investors who bought yield and saw no problems would be disappointed.

The telecoms giant BT Group it currently has a yield of 5.7% and enough cash to pay dividends. However, it is sinking into a debt of £18.9bn, increasing the likelihood of budget cuts in the near future.

A technical staff company Three (LSE: STEM) looks very promising and may be worth considering. It has a yield of 5.8% which is well covered by cash flow. Additionally, its revenue has nearly doubled since 2021 while its debt has declined. Annual dividends also rose from 11p to 16.9p per share.

But a challenging job market led to a profit warning last month that once worried investors. A 61% drop in pre-tax profit sent the stock tumbling. Now with a price-to-earnings (P/E) ratio of just 6, it looks attractive. But if the market does not recover, it may fall further.

Still, I like its long-term prospects. Revenues have been rising for several years and analysts are predicting an average price increase of 30% over the next 12 months.