Best of the Week
Most Popular
1.What Happened to the Stock Market Crash Experts Were Predicting - Sol_Palha
2.London Housing Market Property Bubble Vulnerable To Crash - GoldCore
3.The Plan to Control ALL Your Money is Now at Advanced Stage
4.Why Gold Is Set For An Epic Rally This Spring - James Burgess
5.MR ROBOT NHS Cyber Attack Hack - Why Israel, NSA, CIA and GCHQ are Culpable - Nadeem_Walayat
6.Emmanuel Macron and Banking Elite Win French Presidential Election 2017 - Nadeem_Walayat
7.Trend Lines Met, Technical's are Set - US Dollar is Ready to Rally (Elliott Wave Analysis) - Enda_Glynn
8.The Student Debt Servitude Sham - Gordon_T_Long
9.Czar Trump Fires Comey, Terminates Deep State FBI, CIA Director Next? - Nadeem_Walayat
10.UK Local Elections 2017 - Labour Blood Bath, UKIP Death, Tory June 8th Landslide - Nadeem_Walayat
Last 7 days
SPX/NDX/NAZ Hit New All-time Highs - 27th May 17
GBPUSD Top in Place, GOLD Price Ready to Rocket? - 27th May 17
Silver Mining Stocks Fundamentals - 27th May 17
BBC Newsnight Falls for FAKE POLLS, Opinion Pollsters Illusion for Mainstream Media to Sell - 27th May 17
UK Local Election Results Forecast for General Election 2017 - 26th May 17
Stock Market & Crude Oil Forecast! - 26th May 17
Opinion Pollsters UK General Election Seats Forecasts 2017 - 26th May 17
Bitcoin and AltCoins Crypto Price Correction - 26th May 17
Bearish Head and Shoulders in EURUSD? - 26th May 17
SELL US Stocks - Massive Market CRASH WARNING! - 26th May 17
EURGBP: A Picture of Elliott Wave Precision - 26th May 17
Credit Downgrades May Prompt Stock Market Capital Shift - 26th May 17
Rosenstein and Mueller: the Regime Change Tag-Team - 25th May 17
Stock Market Top - Are We There Yet? - 25th May 17
Should I Invest My Fortune in Gold? Inaugural Lecture by Dr Brian Lucey - 25th May 17
USD/CAD Continues Decline - 25th May 17
Bitcoin Price Goes Loco! Surges through $2,500 Despite Unclear Fork Issues - 25th May 17
The US-Saudi Arms Deal - Sordid Saudi Signals - 25th May 17
The No.1 Commodity Play In The World Today - 24th May 17
Marks and Spencer Profits Collapse, Latest Retailer Hit by Brexit Inflation Tsunami 2017 - 24th May 17
Why Online Trading Platforms Are Useful for Everyone - 24th May 17
The Stock Market Will Tank Hard - 24th May 17
It’s Better to Buy Gold & Silver When It DOESN’T Feel Good - 24th May 17
Global Warming - Saving Us From Us - 24th May 17
Stock Market Forecast for Next 3 Months - Video - 23rd May 17
Shale Oil & Gas Production Costs Spiral Higher As Monstrous Decline Rates Eat Into Cash Flows - 23rd May 17
The Only Metal Trump Wants More Than Gold - 23rd May 17
America's Southern Heritage is a Threat to the Deep State - 23rd May 17
Manchester Bombing - ISIS Islamic Terrorist Attack Attempt to Influence BrExit Election - 23rd May 17
What an America First Trade Policy Could Mean for the US Dollar - 22nd May 17
Gold and Sillver Markets - Silver Price Sharp Selloff - 22nd May - 22nd May 17
Stock Market Volatile C-Wave - 22nd May 17
Stock Market Trend Forecast and Fear Trading - 22nd May 17
US Dollar Cycle : Deep Dive - 21st May 17
Bitcoin Breaks the $2,000 Mark as Cryptocurrencies Continue to Explode Higher - 21st May 17
Stocks, Commodities and Gold Multi-Market Status - 21st May 17
Stock Market Day Trading Strategies and Brief 20th May 2017 - 21st May 17
DOW Needs to Rally Big or Correction is Next - 20th May 17
EURUSD reaches DO or DIE moment! - 20th May 17
How to Get FREE Walkers Crisps Multi-packs! £5 to £28k Pay Packet Promo - 20th May 17

Market Oracle FREE Newsletter

Why 95% of Traders Fail

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