Best of the Week
Most Popular
1.UK House Prices BrExit Crash NOT Likely Despite London Property Market Weakness - Nadeem_Walayat
2.BrExit Morning - New Dawn for Britain, Independence Day! - Nadeem_Walayat
3.LEAVE Wins EU Referendum - Sterling and FTSE Hit Hard, Pollsters, Bookies and Markets All WRONG! - Nadeem_Walayat
4.BrExit Implications for UK Stock Market, Sterling GBP, House Prices and UK Politics... - Nadeem_Walayat
5.Trading BrExit - Stocks, Bonds, Sterling, Opinion Polls, Bookmaker Odds and My Forecast - Nadeem_Walayat
6.FTSE and Sterling Brexit Trading, Deconstruction of the EU Referendum Result - Nadeem_Walayat
7.UK Interest Rate Cut to 0.25% Imminent and More QE Money Printing - Nadeem_Walayat
8.Trading BrExit - British Pound Plunges, FTSE Stock Futures Slump on LEAVE Shock Referendum Win - Nadeem_Walayat
9.The Stock Market is Reading it Wrong! - Chris_Vermeulen
10.Breakouts Galore in Gold and Silver - Jordan_Roy_Byrne
Free Silver
Last 7 days
Soybean Commodity Price to Soar Again - 23rd July 16
SPX Stock Market Uptrend Continues - 23rd July 16
Gold And Silver – Debt Addiction Will Carry Precious Metals Higher, Guaranteed - 23rd July 16
Pokemon Go - How to Play, First Use, Balls, Stops, Catching Pokemon's... Great Excercise! - 23rd July 16
7 Signs That the Gold Market Remains Resilient - 23rd July 16
Basic Income in The Time of Crisis - 23rd July 16
Silver Bull Faces Correction - 22nd July 16
The Serious Warning No One’s Talking About - 22nd July 16
Stock Market Insight from Greed, Volatility, and Put/Call Ratio - 22nd July 16
What Will Happen To the Stock Market When Interest Rates Rise? - 22nd July 16
How to Escape the World’s Biggest Ponzi Scheme - 22nd July 16
Addicted to Debt - We Can’t Borrow from the Future Anymore - 21st July 16
Not Everything Is Bullish for Gold - 21st July 16
Don’t Get Sucked Back Into the Stock Market - The Big Picture Hasn’t Changed - 21st July 16
Silver – Caught Inside - 21st July 16
Forex: "The Markets Are Getting Exciting!" - 20th July 16
China Economic Troubles - Is Kyle Bass Finally Getting His Revenge? - 20th July 16
Why Lithium Will See Another Price Spike This Fall - 20th July 16
The Peak Oil Paradox Revisited - 19th July 16
SPX Challenges the Upper Trendline - 19th July 16
Missing ’28 Pages’ of the 9/11 Report Released into Blitzkrieg of World Events - 19th July 16
Likelihood of Organized Disruption at GOP Convention - 19th July 16
More on the ‘Breadth Thrust’ and Stock Market Internals - 19th July 16
FX Traders: Get a Free Week of Forecasts (Details inside) - 19th July 16
Ups and Downs in Gold and Crude Oil Price - 19th July 16
Keep an Eye on ‘Bitcoin’ as the Next ‘Financial Crisis’ Starts! - 18th July 16
Erdogan Might Have Known about the Coup but Didn’t Prevent It on Purpose - 18th July 16
More Deflation Ahead: Silver, Gold And Their Mining Stocks A Must-Have - 18th July 16
Stock Market Minor Top? - 18th July 16
5 Best Gold and Silver Junior Mining Stocks in 2016 - 17th July 16
Gold And Silver – NWO-Created Tragedies Will Never End, Seek Truth - 16th July 16
How Long Can Buybacks Continue To Support A Market Which Is Standing On A Fundamentally Flawed Premise? - 16th July 16
Will They Come For Your IRA? - 15th July 16
Gold’s Record Selling Overhang - 15th July 16
Capitalism Has Entered a New Era—and Historic Stock Market Investing Returns Are Gone Forever - 15th July 16
Gold Price Could Hit $5,000 or Even $10,000 in a Few Years - 15th July 16
Junior Gold and Silver Mining Funds or Individual Gold and Silver Mining Stocks - 15th July 16
The Soaring Risk of Flying in Bernanke's Helicopter - 15th July 16
The Broad Stock Market, Helicopters and Gold - 15th July 16
The Curious Case of Vanishing Lady Liberty; Only Gold and Silver Remember Her - 15th July 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Forex Forecasts

Stocks to Avoid At All Costs, Don't Fall For High Dividend Yield Traps

Companies / Dividends Aug 08, 2012 - 06:02 AM GMT

By: Money_Morning

Companies

Best Financial Markets Analysis ArticleMartin Hutchinson writes: Buying stocks with high dividend yields is an excellent way to invest. But it's not fool-proof.

In fact, if you shop by yield and yield alone, you're playing a dangerous game. It's called picking up nickels in front of a steamroller.


Admittedly, it may work for a while, but eventually I can assure you the steamroller will prevail.

That's why in today's low-growth environment, it's critical to know which dividend stocks NOT to buy.

Avoid the real duds and the dividends alone will be enough to bail you out of minor mistakes. Find yourself on the wrong side of the fence and your high-yield investment could end up being pretty costly.

Success comes from understanding the difference between the two. Here are three ways to separate the winners from the losers.

Avoid Stocks that are "On the Clock"
First, at all costs, investors need to avoid dividend stocks where the source of income will dry up in a few years, and the dividend payout doesn't add up to the amount you're paying for the stock.

You wouldn't think there would be any of those, but there are! Investors fall for them because of their high yields.

Here are a few examples where one day the well will suddenly go dry leaving investors with empty cups.

Great Northern Iron Ore Properties (NYSE: GNI): GNI yields a monster 17% and has a P/E of 4 times. In business since 1906, it looks very attractive-on the outside. However, on the inside its main asset is a lease on iron ore deposit-bearing land in the Mesabi Range which runs out in 2015. With three years left on the lease, investors can only earn 51% (3x17) of their money back. I just want to know where the other 49% is? There are some residual assets, but not enough.

Whiting USA Trust (NYSE: WHX): Another high-yielder, WHX pays out no less than 27%. The company has the right to a specified amount of oil produced from particular wells, which is due to run out in August 2015. Here the math will pay you back 81% (3X27), so it's possible you could make some money. However, it all depends what oil prices do. Shares are down 50% in the last month, which suggests that investors have finally done their arithmetic.

BP Prudhoe Bay Royalty Trust (NYSE:BPT): BPT yields 8%, stands on a P/E of 12.2 times, which looks perfectly normal. Set up in 1989, this trust has the right to a royalty on production from BP's Prudhoe Bay oil field. However, output from this field is expected to begin declining in 2018, and to cease altogether in 2027. Admittedly, this one's trickier, you have to make some assumptions. However one analyst, Shane Blackmon, has assumed an oil price of $90 per barrel and concluded that the total value of dividends payable by BPT before it runs dry will be $83. Since BPT's current price is $115, it's another one to avoid, though less obvious!

Many royalty trusts, used in the energy business, have a finite lifespan, or relate to oil wells etc. that will run dry - they are in other words an annuity not a real evergreen business.

It's tough to figure out whether that's true for most companies - but worth doing some research to find out!

Avoid Stocks with the Risk of a Dividend Cut
Investors should also avoid buying stocks where the earnings path is far below the annual dividend rate.

No matter how good the cash flow is in these companies, the dividends will eventually be cut back. When that happens the share price will tumble.

Here's an example of the second type of loser, where the earnings are far below the dividend rate.

Frontier Communications (NYSE: FTR): With Frontier, the warning signs are everywhere you look. The company has a trailing four quarter earnings per share of $0.10. Consensus forecasts for 2012 and 2013 are $0.20 and $0.21 respectively. Yet the dividend is $0.40. You don't need to be good at math to question that one.

In fact, Frontier seems to be spiraling out of existence. Three years ago the dividend was $1 per share and the stock price was double its current level. The company did a major merger with Verizon's rural landline operations in 2010, and either seems to have lost its strategic focus on rural subscribers or the focus never made sense in the first place. I'm not sufficiently an expert in the telecom sector to tell you which. Either way, in spite of a 10.8% dividend yield, FTR is a value destroyer.

Avoid Stocks with a Temporary Business Model
The last is less obvious and more difficult to spot. It's important for income investors to avoid stocks where the business model depends on temporary circumstances since the earnings could disappear quickly if circumstances change.

A good example of this is what's going on with mortgage REITS like American Capital Agency Corp (Nasdaq: AGNC), Annaly Capital Management (NYSE: NLY) and Chimera Investment Corporation (NYSE: CIM).

These companies invest in government guaranteed home mortgages, then fund them through repurchase agreements, earning the spread between short-term and medium-term interest rates.

If you can leverage this up to 10 times, as AGNC does, you end up with a very nice business in current markets. This allows AGNC to pay dividends of $5 per share and yield 14%.

However if these companies get their hedging wrong, or interest rates rise, they are dead meat since the value of their assets will decline while the cost of their funding will rise above their yield.

This is a picking up nickels in front of a steamroller business if there ever was one. It's just not suitable for investors with a time horizon longer than a few months.

As you can see, there are several ways you can actually lose money on your high income investment.

But if you can avoid them, what's left will give you a pretty good return!

Source :http://moneymorning.com/2012/08/08/dividend-stocks-dont-fall-for-these-high-yield-traps/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2016 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife