These Dividend Stocks Can Deliver a False Sense of Security

You might have caught the recent Barron's cover that read "Dow 16,000!"

It was hard to miss - the cover pictured a wide-grinning bull bouncing on a pogo stick.

The issue outlined why large fund managers were bullish about the next year, with 74% of those polled saying the market was headed higher.

That is the single highest reading ever in the poll, indicating wild enthusiasm among those controlling the largest pots of money.

The major reason driving stock market euphoria is the zero interest rate policy (ZIRP) of the U.S. Federal Reserve.

ZIRP has made the stock market the only game in town. It seems they like stocks because there is nothing else to do with the money.

In fact, the inability to get yield from other sources has also pushed central banks into stocks. According to a recent Bloomberg News report, about 24% of central bankers say they own stocks or plan to buy in the near future. The Bank of Japan plans on doubling its position in equities, and both the Swiss and Czech national banks boosted stock holdings to at least 10% of reserves.

Buying stocks in search of yield has been a prevailing view among individual investors as well for much of the past two years.

In particular the quest for yield among individual investors has led them to seek out dividend stocks, especially dividend-paying blue chip stocks, without regard for fundamentals.

Now as stock prices have risen and sentiment is overly bullish, many of these stocks are not particularly cheap on fundamentals and may be vulnerable if the big money managers become bearish and start selling. Despite their recent high bullish readings, these money managers have proven to be a very fickle group.

They could also turn bearish because even though they're optimistic about the markets, these money managers believe that the economy over the next decade will grow at the same anemic rate as it has over the past few years.

Most of them think the threat of inflation will be greater in the future than it is now. One of the greatest threats to the stock market is the specter of rising interest rates and more than 90% of managers surveyed think Treasuries are overvalued and should decline.

Most of them also think it will take more than five years for the European Union to resolve its financial crisis, which could also pose a threat to stock prices.

All this is why investors should be carefully going through their portfolios and paying especially close attention to blue chip holdings. The dividend yield and well-known nature of these stocks can easily lead to a false sense of security.

Many of them are starting to show fundamental deterioration. As the recession lessens and the economy began to grow a little some of these companies had decent sales and earnings growth that is now slowing and the stock prices could be vulnerable to a sustained and possible substantial decline.

There are several signs of slowing growth that investors should be aware of that can serve as an indication it is time to sell one of your dividend-paying blue chip stocks.

We outlined a few you should watch out for.

Signs it's Time to Dump these Dividend Stocks

The first sign that a dividend stock might be losing its luster is the most obvious, a slowing of earnings growth.

If the company has been growing earnings at a 20% rate for the past few years and this year is only showing increases of 10% or so, this is a potential red flag. Check the earnings trend over the past few years and if it is showing a steady decline of even a few percentage points a year, the company could be growing stagnant.

A good check is to see what type of growth analysts expect for the next three to five years. If they are only seeing single-digit growth it may well be time to sell the stock.

If the earnings growth rate for the past few years is much higher than the revenue growth rate be aware that this indicates the company is growing by reducing. Rather than any real increase in demand for its products and services the growth has come by reducing expenses and headcount.

While this is a good thing in the short run it is not sustainable. Eventually revenue demand needs to increase as well, or earnings and the stock price will decline.

Keep an eye on profit margins as well. If margins are steadily declining this tells you that the company is either having problems with raw material prices or is discounting its products to generate revenue. Both could lead to lower earnings and a decline in the stock price.

It seems that everyone loves the stock market and especially dividend stocks right now. That is a very good reason to begin to suspect it is time to review your holdings to make sure you're investing in the best of the group, and not those with slowing sales and earnings growth.

For more on the best dividend stocks to own, check out last week's article: How to Invest in Dividend Stocks to Build True Wealth