Best of the Week
Most Popular
1.The Greatest Stock Market Crash Of Your Life Is Just Ahead… – Warns Harry Dent - GoldCore
2.Budget 2016: Borrowing, Lifetime ISA, House Prices, Economy, Syria, Brexit and Stocks - Nadeem_Walayat
3.Gold Price Intermediate Top - Clive_Maund
4.Brussels Terror Attacks, Death of the European Union, BrExit Wake up Call - Nadeem_Walayat
5.Stock Market Maybe This Time is Different? - Tony_Caldaro
6.UK House Asking Prices Break Above £300k! Housing Market Paralysis - Nadeem_Walayat
7.A Big Reason Why Silver Price Is Set To Soar - Hubert_Moolman
8.The Financial Crisis Has Just Begun; Is The American Dream Is Over? - Chris_Vermeulen
9.Gold Stocks Spring Rally - Zeal_LLC
10.GLX, GLDX, Baby Gold Bull Market Stillborn? - Rambus_Chartology
Last 7 days
When the Truth is Found to be Lies, Confidence in Currency Dies - 2nd May 16
How Brexit Could Help All of Europe - 2nd May 16
US House Prices Outpacing Official Inflation Rate, Household Income - 2nd May 16
USD Still Declining... - 2nd May 16
Gold & Silver Rally Huge as Central Bankers & Analysts Flub - 2nd May 16
Stock Market Bounce Day - 2nd May 16
Stock Market Uncertainty Following Two-Month Long Rally - Will It Continue? - 2nd May 16
Stock Market Correction Underway "Upside Objective Reached" - 2nd May 16
USD, Yen and an ‘Inflation Trade’ Update - 2nd May 16
Gold Commitments of Traders and More - 1st May 16
The Magic of Gold Ratio Charts - 1st May 16
Consensus Forming: China Heading Back Into Financial Crisis - 30th Apr 16
The Next Technical Price Targets for Gold & Silver - 30th Apr 16
Stock Market Downtrend Should be Underway - 30th Apr 16
Gold And Silver – A Clarion Alarm Call For All Paper Assets - 30th Apr 16
US Economic Statistics LIES, LIES AND OMG, MORE LIES - 30th Apr 16
Stock Market Strong Elliott Wave Relationship is Developing - 29th Apr 16
Fed's Kaplan: Brexit to Factor in US June Interest Rate Decision - 29th Apr 16
Silver Miners Strong in Grim Q4 - 29th Apr 16
Is Silver a better bet than Gold in the Near Future? - 29th Apr 16
How to Use the CoT Report in Gold Investing? - 29th Apr 16
Sri Lanka is Intriguing: Areas to Consider for Value Investing - 29th Apr 16
Gold “Chart of The Decade” – Maths Suggest $10,000 Per Ounce Says Rickards - 29th Apr 16
Are We or Are We Not in a New Gold Bull Market? - 29th Apr 16
Silver: The “Five Year Plan” and the Great Leap Forward - 28th Apr 16
Michael Hudson: The Wall Street Economy Has Taken Over The Economy and Is Draining It! - 28th Apr 16
AUD/USD - Trend Reversal or Just a Bigger Pullback? - 28th Apr 16
A Gold Revaluation Could Transform Your Financial Status - Overnight - 28th Apr 16
Monetary Policies Misunderstood - 28th Apr 16
Gold Bullion vs Gold Miners - 28th Apr 16
OECD Suggests BrExit Would Cut Net Migration by 1.2 Million by 2030 - 28th Apr 16
MP Naz Shah Punished for Tweets Made During Israel's Genocide of Gaza Palestinian People - 28th Apr 16
Global Recession in 2016 and Beyond - The Obvious Evidence - 27th Apr 16
Why Gold Bugs Need to Stop Listening to The Fear Mongers and Start Thinking for a Change - 27th Apr 16
BlackRock’s Fink: Fed to Raise Interest Rates by Quarter Point ‘at Best’ - 27th Apr 16
Gold More Productive Than Cash?! - 27th Apr 16
Donald Trump Will Fire Janet Yellen and Be Trapped - 27th Apr 16
Money Saving Gardening by Propagating Roses From Cuttings - Propagating Rose Plants Over 2.5 Years - 27th Apr 16
Facebook Censors Pro Trump and Negative Hillary News - 27th Apr 16
This is the Era of the Democrats and Your Taxes are Going Up - 27th Apr 16
Long Awaited Gold Price Breakout - 26th Apr 16
Crude Oil Price Double Top or Further Rally? - 26th Apr 16
Madness in the Crimex Gold and Silver Trading Pits - 26th Apr 16
Britain's Prospects: GBP and BREXIT - MAP Wave Analysis - 26th Apr 16
CRB, Gold, Oil, Cotton, Coffee - 7 Must See Commodities Charts - 26th Apr 16

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

Catching a Falling Financial Knife

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