Story by Mark Hartley
MotleyFool

Frustrated young white male looking disconsolate while sat on his sofa holding a beer

Frustrated young white male looking disconsolate while sat on his sofa holding a beer© Provided by The Motley Fool

Dividend stocks are a popular way to earn passive income on the stock market. The regular payments made to shareholders can equate to a decent flow of cash.

When investing in dividend shares, early investors often fall foul of some common mistakes.

Here are two to keep in mind.

Not all companies are created equal

There’s no shortcut when picking dividend stocks and no single model that applies to all companies. When considering investing for dividends, the individual strengths and weaknesses of each company must be accounted for.

This is particularly true when it comes to dividend coverage. This metric is used to assess how much cash the company has to cover its dividend obligations. Presumably, if its cash is less than the full amount of dividends, there’s going to be a problem.

Companies that need steady cash flow to operate typically pay a low dividend and as such, have high coverage. However, some companies don’t need much cash to operate and so pay a high dividend with low coverage. This reveals how low coverage isn’t necessarily a bad thing.

It’s important to find out how the company operates before making a decision based solely on coverage. Even a company with high coverage may cut the dividend if it has a lot of debt to finance.

These factors differ from company to company, so each one needs to be assessed on an individual basis.

Investing for the yield

Investing purely for the yield isn’t a good long-term strategy. Yields fluctuate wildly and are often high for the wrong reasons, such as a crashing price. 

Some investors buy stocks just before the ex-dividend date as a way to lock in a yield at a certain level. This can be a smart strategy but doesn’t guarantee anything. Ignoring the company’s fundamentals and potential price movements is risky. If the stock falls more than the yield before payment, then it’s all for nothing. 

Before making a decision based on the yield, investors should always carefully assess the company’s financial position