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The Motley Fool

Ask the Fool

A Reorganized S&P 500

Q: I heard that the S&P 500 recently reorganized itself. What does that mean? — A.B., Winona, Minnesota

A: The Standard & Poor’s 500 index of 500 big companies is adjusted regularly, with some companies being removed from the index while others are added to replace them. For example, Twitter was added to the index in June to replace Monsanto, as Monsanto was being acquired by the German company Bayer and would no longer be a stand-alone company or stock.

The index recently underwent a bigger transformation than usual, though, as it changed how it classifies and groups certain companies. Gone is the Telecoms sector, replaced by a new Communications Services sector. The new sector will contain not only companies that provide various communication platforms but also companies offering media content. Some of its components will be Comcast, AT&T, Verizon Communications, Walt Disney, Facebook, Twitter, Netflix and Google’s parent, Alphabet. The change was made to better classify companies with operations that span both communication channels and content.

The reorganization won’t really affect those invested in the overall S&P 500 index, but if you’ve invested in any funds specializing in various sectors, the holdings in them may well have changed.

Q: What do you think about investing in companies that have filed for bankruptcy protection? Their stocks look cheap — might they not recover and be good investments? — R.Y., Strasburg, Virginia

A: It’s best to steer clear of bankruptcies.

Holders of common stock tend to get little or nothing when companies emerge from bankruptcy, while creditors and others might get some pennies on the dollar. These companies also often emerge with new stock, their old stock rendered worthless. Give them some time to perform post-bankruptcy before considering investing.

Fool’s School

Know Your Dividend Red Flags

It can be hard to beat dividend stocks. The best ones not only pay you regularly throughout the year (and increase those payouts over time), but their share prices also grow. Still, just like other stocks, dividend payers are not guaranteed to do right by you. Learn to spot red flags and you may be able to avoid some losses.

Researchers Eugene Fama and Kenneth French, studying data from 1927 to 2014, found that dividend payers outperformed non-payers, averaging 10.4 percent annual growth vs. 8.5 percent. Meanwhile, dividends have accounted for 42 percent of the return of the S&P 500 Index between 1930 and 2017, per Morningstar data.

Still, every year, plenty of companies reduce or even eliminate their payouts — often in times of trouble, when their stock prices are also heading south. Red flags such as extremely high yields, industry headwinds, spotty track records and high payout ratios can warn you to minimize your losses.

A huge dividend yield can be due to the stock having plunged in price, with few investors believing in it. If an industry enters a downswing, as happens in cyclical industries and during economic crises, there may not be any earnings to distribute, leading to dividend cuts or suspensions — which can turn out to be temporary or permanent.

Companies with inconsistent histories of dividend payments can be disappointments — especially in a bear market, when external factors may strain their resources. Fortunately, many companies sport long dividend histories. Procter & Gamble, for example, has paid a dividend every year since 1891!

A company’s payout ratio — calculated by dividing the annual dividend by earnings per share — reflects the sustainability of its dividend. If a company is paying out more than it’s making, that’s not a good sign, so a payout ratio well below 100 percent is best.

To see some promising dividend-paying stocks we’ve recommended, check out our “Motley Fool Stock Advisor” service at fool.com/services.

EDITOR’S NOTE: The Motley Fool is an investment column created by brothers David and Tom Gardner and distributed by Andrews McMeel Syndication.

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