Your Dividends Are Dead!

Are dividend stocks the new Beanie Babies? On the surface, you'd assume that stocks paying out cash have little in common with children's plush toys, but some of my colleagues would disagree. They'd call dividend investing a fad, just like the Beanie Babies of yesteryear.

Could that possibly be true? While investor interest in dividends is surely piqued, blue-chip companies like Procter & Gamble, Intel, and Microsoft continue boosting dividends at outsized levels, and come with pretty cheap price tags to boot.

So no, I don't think dividend investing is a fad. The real fad is a tightly clustered group of stocks hovering near the top of the dividend yield list. As evidence, look at this list of the highest-yielding stocks in the market today:

Company

Dividend Yield

American Capital Agency (Nasdaq: AGNC  ) 19.1%
Chimera Investment (NYSE: CIM  ) 17.7%
Annaly Capital Management (NYSE: NLY  ) 15.1%
Hatteras Financial (NYSE: HTS  ) 14.3%

Source: Capital IQ, a division of Standard & Poor's. Sorted by companies with more than $1 billion in market cap, traded on U.S. exchanges.

Or, if you wanted to limit your investing horizon to the popular S&P 500 index, here's a selection of the four highest-yielding stocks:

Company

Dividend Yield

Frontier Communications (NYSE: FTR  ) 8.2%
Windstream (Nasdaq: WIN  ) 7.7%
Diamond Offshore 6.8%
CenturyLink 6.8%

Source: IndexArb.com.

Notice something with each of these tables? In the top table, all the highest-yielding stocks are centered on real estate investment trusts. In the bottom table, all the highest-yielding stocks aside from Diamond Offshore are landline-focused telecoms.

This kind of high-yielding concentration around one industry is hardly unique. If we turn the clock back five years to look at the high yielders in 2005, a similar picture emerges.

Company

Dividend Yield

Frontline (NYSE: FRO  ) 14.5%
Genco Shipping 13.9%
Diana Shipping 13.3%

Source: Capital IQ, a division of Standard & Poor's.

Once again, we see the highest yielding stocks all concentrated in one industry! This time it's shipping, but the pattern of concentration remains the same. What's important to note is that while these shipping companies once paid eye-popping dividends, only one of them still pays a dividend today. While Frontline has managed to maintain (now far lessened) payouts to shareholders, both Diana and Genco's dividends were washed out to sea during the recession.

If you were chasing the best yields back in 2005, your dividends are now dead.

That's because unique events often conspire to create situations where one beaten-down industry offers yields that blow away those found anywhere else. Take the telecoms seen above; they're all focused on the declining landline market. That provides these companies with stable cash flows to pay out dividends today, but also gives them little growth. If these companies see faster customer defections than expected in coming years, investors can expect not only a slumping share price, but a sagging dividend payout as well.

As Foolish colleague Matt Koppenheffer said in his recent article on dividends-as-a-fad, "High yields aren't always good yields."

So should you avoid all high-yielding stocks? I don't think so. For example, I've advocated the merits of Annaly Capital before. It has several solid attributes, so long as investors are aware of the risk involved, and continue to monitor trends that could endanger its dividend.

Fools should generally keep a component of dividend stocks that can weather not only industry-specific calamities, but also further shocks to the broader economy. The list of Intel, Procter & Gamble, and Microsoft above is a good start, but it's just a start. To see a broader list of companies paying out strong dividends, click here to get The Motley Fool's five-page free report, 13 High-Yielding Stocks to Buy Today.

Eye popping dividends might be tempting today, but they're rarely built for the long-term. If you're looking for some stability from dividends, learn from the fallen high-yielders of the past. Make sure to diversify and keep a stable of companies with lower payouts -- and plenty of wiggle room.

Eric Bleeker owns shares of no companies listed above. Intel and Microsoft are Motley Fool Inside Value picks. Procter & Gamble is a Motley Fool Income Investor recommendation. The Fool owns shares of and has bought calls on Intel. The Fool owns shares of and has written covered calls on Procter & Gamble. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Annaly Capital Management, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (21) | Recommend This Article (117)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 30, 2010, at 4:16 PM, timlash wrote:

    Even a concentration of extreme dividend companies within a sector should not necessarily prohibit a purchase. Frontline, from your 2005 example, is considered by many to be the best company in its class. So potentially FRO was the smart purchase at that time. At the beginning of 2005 FRO was trading around $44. An investment then would have paid $35.15 (includes upcoming $0.25 payment) in dividends through 2010! Currently trading near $25, plus $35 in dividends, makes for a very attractive return while the S&P 500 was virtually flat over that time span with a mere 2% yield.

  • Report this Comment On November 30, 2010, at 4:47 PM, Alexinthebox55 wrote:

    Who are these companies? Anyone can use a stock screener and pick out companies with "strong" dividend yields.

    The key is to find a company with strong cash flows, a management team who knows when to change a dividend, and the sustainability to pay out shareholders in cash.

    Stay classy, Fools.

  • Report this Comment On November 30, 2010, at 7:09 PM, canadacomments wrote:

    @Alexinthebox55

    I think you missed Eric's point. There is nothing wrong or unFoolish about buying one of the REIT's listed BUT you must watch their risk areas. None of these are hold till you die stocks, but I like a 15%+ dividend for a few years, at least until US government interest rates start to rise. But I haven't bet the farm on them. Diversify and prosper!

  • Report this Comment On November 30, 2010, at 9:08 PM, dlomax77 wrote:

    Mr. Bleeker is missing the point. Beanie babies are trading below their intrinsic value right now. They are a great value play, unlike all this worthless stock he's touting.

  • Report this Comment On November 30, 2010, at 9:19 PM, Acorn17 wrote:

    Wouldn't a faddish trend result in low dividend yields because people would be jumping on the bandwagon and buying these stocks up, hence raising the share price and driving down the yield? I would look into areas where yields are lower than would be merited to find a fad.

  • Report this Comment On November 30, 2010, at 10:17 PM, FutureMonkey wrote:

    I think any investment decision based on anything other than the underlying business is foolish (small f).

  • Report this Comment On November 30, 2010, at 10:27 PM, lebaresq wrote:

    Wealth preservation investors need only seek out 'best in breed' companies regardless of sector. These days, prices are driven by 'sector rotation (herd mentality) along with fundamentals.

  • Report this Comment On December 01, 2010, at 12:55 AM, mikecart1 wrote:

    Another poorly researched article. Winstream's dividend is like cement. It will never go away.

  • Report this Comment On December 01, 2010, at 4:34 PM, bzhayes wrote:

    @mikecart1

    you should consider investing in the pony express.

    @Acorn17

    I agree. I've often wondered if dividend investing is a fad, then I realized if a bubble forms the dividend returns will disappear.

  • Report this Comment On December 01, 2010, at 6:29 PM, jm7700229 wrote:

    A comment and a question. The comment is that a low (or no) growth company that throws off cash used to be known as a "cash cow," a term that I believe was coined by Boston Consulting Group and that has been co-opted by so many people who didn't understand it that it has become kind of meaningless. There is NOTHING WRONG WITH A CASH COW. Cash is sometimes called money. This is a good thing. We generally like money.

    A Cash Cow with a secure market (and the good ones generally do have a secure market) can be a lot better than a bond. Remember: bonds don't grow either, and their interest is not tax privileged. I expect some of the rural telecoms to be generating cash for some years, yet.

    My question -- anybody? Why are the yields of Hatteras and Annaly so high? Their margins seem to be pretty secure for the next couple years. Why haven't the yields been driven down? I've done all the research I can, and it seems to me that the risk puts the yield in the range of 8-11%, not 15% plus. Anyone have any comments on this? I have put significant cash into both of these guys (I'm not risking my retirement, though) and I watch them and the Fed rate daily, but feel pretty confident about my returns. Anyone think I'm nuts?

  • Report this Comment On December 02, 2010, at 10:23 AM, timlash wrote:

    @jm7700229

    I'd say the mortgage REITS have been able to maintain their yields due to the uncertainty surrounding interest rates. Rates will rise again. Rising rates will pressure margins on future investments for those firms and put their hedging strategies to the test. A likely scenario in such an environment would be shrinking dividends and falling share prices - i.e. high risk. Hence high yields. The real question is: when will interest rates begin to rise?

  • Report this Comment On December 03, 2010, at 12:22 PM, Metaworld wrote:

    Mortgage REITs have to return 95% of profits in dividends to qualify as one. So, I guess the driving factor is how much profit they generate. I thought the key was spread. So my question is how do higher rates negatively affect the spread?

  • Report this Comment On December 03, 2010, at 12:33 PM, Canuck2010 wrote:

    As a Canadian investor, US stocks paying dividends are actually rather unattractive. US dividends are taxed at the full rate as normal income. US capital gains (even short term gains) are taxed at 50% of the normal rate. So I'd rather have a stock that appreciates in value and can put it's cash flow to work rather than returning cash that gets taxed at twice the capital gains rate.

    (Note Canadian dividends do get a preferential tax rate)

  • Report this Comment On December 03, 2010, at 1:03 PM, PositiveMojo wrote:

    @FutureMonkey. I agree 100%

    I'm not sure if investing for dividends is the best strategy. Would you think it's a good deal to buy a house for $100K with rents of $1500 a month and then have the value of the house drop to $80K - even though you continue to get the $1500 per month?

    That is the scenario I've seen with many dividend stocks so I don't make my investment decisions based on dividend along. In fact it is one of the lesser reasons I buy or sell a stock. I trade on the technical indicators and have done pretty well during the turbulent times.

  • Report this Comment On December 03, 2010, at 1:32 PM, derbyrm wrote:

    I moved my REITs to my IRA. That's all "ordinary income" anyway, so cash is cash to reinvest.

  • Report this Comment On December 03, 2010, at 3:49 PM, dragonshon wrote:

    jm7700229,

    I don't think you're nuts, rather the opposite actually. Why not take advantage of a good opportunity when you can--either it be a few years or even a few quarters...! It's good that you have an eye on them like a hawk. I would add that instead of owning just 2, I would spread that "significant [amount of] cash" into AT LEAST a handfull of these MREITs as to further balancing risk on top of watching "them and the Fed rate daily."

    Metaworld,

    The key is the spread--the difference between the borrowed rate and the rate lended out. Thus, if the rate you lend out is a fixed number, then the variable/the unknown/the risk is the Fed Fund rate, which is a negative affect to the spread when rates go up because your are having to borrow at a higher rate but still lending at the same fixed rate (due to competition, etc.). Hope this helps...

    PositiveMojo,

    I do agree with you and FutureMonkey, in part. When investing, it is most important that ALL investors should consider wealth/capital preservation first and foremost, because "You can't finish first [place] if you don't first finish." Nonetheless, depending on the conditions of your example ("Would you think it's a good deal to buy a house for $100k with rents of $1500 a month..."), it may be or become a good deal. For instance, let's say if the rent/lease is for 3 years, then you would get almost the entire $20,000 loss within the first year (simply calculations, taxes and etc. not factored in), then gain almost $40,000 after the third year, and during this time, look for other tenants/options for after the 3-year lease.

    I am not advocating excessive risk-taking, but just trying to see the big picture and the whole story, instead of just one side.

    Toa`n

  • Report this Comment On December 03, 2010, at 5:37 PM, possumkiller wrote:

    SFL check this one out workin pretty good for me

  • Report this Comment On December 04, 2010, at 6:30 AM, infiniti01 wrote:

    This article mentions telecom stocks as being similar to the shipping stocks from 5 years ago. Currently, I own the Reeve's Utility Income Fund (UTG) as one of my top holdings; however, the top holdings are mostly telecom's including about 5% staked in AT&T and Frontline. I've read all the financial statements and prospectus of this fund, but knowing more doesn't hurt. I've owned this fund for about 5 years now and it has actually held up fairly well, even during 2008 and 2009. The dividends still kept rolling in every month, but I want to know if there is anything I need to know or should worry about with this fund?

    Anything anyone thinks is a better opportunity?

  • Report this Comment On December 05, 2010, at 2:26 PM, busterbuddy wrote:

    A sound investment strategy should have a solid foundation. Even hedge funds do this. Jim the mouth Cramer did this. So REIT, Oil and GAS partnerships, Preferred stocks, and solid dividend stocks should be the foundation. Then you go up the ladder and invest in dividend paying stocks with overwhelming cash flows. And then you limit your risk to companies like Ford and Citigroup.

    And of course 10% in Gold.

    But note above Realty income, O, has been a REIT you can buy and keep for ever.

    My notes say if a stock/REIT ext is yielding 2 times,T, or a oil and gas MLP then be careful you are really getting back capital.

  • Report this Comment On December 06, 2010, at 3:36 PM, surfgeezer wrote:

    @dragonshon

    Agree with most of your answers to the others, but as primarily a Real Estate guy, let me add.

    Many of the views are basic differences in investing style. I am a landlord, I have many friends that made big money flipping properties. This thinking is transferred to stocks pretty easily IMHO. Stocks, of course, have a much lower transaction cost and can be moved in and out much quicker and I think this clouds some people's basic way they think. I keep my rentals and divvy stocks for my retirement income. In the 100k/1500 mo example, I see absolutely NO reason to either sell or be concerned. That is a 18% ROI. The supposed 20k loss DID NOT HAPPEN. The ONLY thing that matters is, as you point out the sustainability of the rent. This is the same for my divvy stocks. Even if you did NOT have a long term lease, it depends on the market conditions for competing rentals ONLY. If rents are staying the same who cares what other people want to buy it for? My rentals have dropped in price, but my RENTS haven't. Price varies and with the stock market their plenty of traders that DEPEND on price movement for profit, in fact landlords/divvy stocks take most of the trading game away, IF you have the conviction your rents are safe. I look at my divvy stocks as THE renters and do a financial analysis/FICO check just like my renters. Mt rentals have a ZERO cost basis now and in fact the loans are paid off, it is PURE monthly cash that we live off of. Landlord model takes the strength to wait thru temporary price changes that only affect traders.

    Having said that I do not have telco's because they have to much debt and they are in a dying business, I do not feel confident in holding them long term.

    The mortgage REIT's ( Have AGNC) are simply not a long term hold, but are high enough return to warrant the risk IMHO. The key, as you state is the yield spreads. Sustainability is also in the % of their holdings that are in variable loans and gov backed securities. Each company has a different mix, I like AGNC's. Part of the high yield is definitely that people will not touch anything that says mortgage now. Opportunity IMHO. That said I would also watch when the FED changes what it charges to these financial institutions, as that will probably happen before the general rate hike.

  • Report this Comment On December 07, 2010, at 9:58 PM, mkj1928 wrote:

    @ Truthisntstupid

    Man, I couldn't of said it any better. So much truth in that.

    Mike

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