A High Yield Doesn't Always Equal a High Return

Even with payouts at relatively low levels compared with the past, dividends are very popular right now. There are numerous companies out there with astronomical yields, led by companies such as Invesco Mortgage Capital (NYSE: IVR  ) and Chimera Investment (NYSE: CIM  ) , both currently yielding more than 18%. As mortgage REITs, they are a part of the market's hottest dividend sector, required to pay out at least 90% of earnings as dividends every year. But these large dividends don't guarantee great returns from these stocks, and an investment in these companies could lose you money overtime.

Invesco vs. the S&P 500
The S&P 500 Index represents 500 companies of various sizes. According to IndexArb, the average estimated forward yield of the 395 companies that pay dividends from the index is 2.57%. If you include the other 105 companies, the average yield drops to 2.03%, which in and of itself isn't that bad. However, these yields pale in comparison with the 21.3% yield of Invesco, prompting many investors chasing a high yield to purchase the stock.

With the benefit of hindsight, though, we can judge how wrong those investors might have been. If you'd bought $10,000 worth of shares of three stocks a year ago -- Invesco, Hershey (NYSE: HSY  ) yielding 2.43%, and Caterpillar (NYSE: CAT  ) yielding 1.91%, an interesting pattern would now emerge:

Name

Initial Shares*

Initial Price (11/16/2010)

Shares Purchased Through Dividend Reinvestment / Total Price

Current Value of $10,000 Purchase and Dividends

Total Return

Invesco Mortgage 450 $22.21 89 / $1,794.17 $8,095.72 (19%)
Hershey 215 $46.40 5.63 / $294.34 $12,373.13 24%
Caterpillar 127 $78.60 2.35 / $230.12 $12,485.97 25%

Sources: Yahoo! Finance and author calculations.  Current value as of Nov. 14.
*Whole shares only.

Even though you'd have more Invesco shares at the end of the year because of its higher yield, the miserable performance of the stock over that year -- along with the varying prices at which you reinvested your dividends -- would adversely affect your return. If you chose not to automatically reinvest the dividends, the initial 450 shares would be worth $6,759, a loss of 32%! Conversely, the return of the "average" companies is primarily driven by an increase in share price over the year, with both companies' share prices increasing by more than 20%.

Chimera vs. the Dow
The Dow Jones Industrial Index (INDEX: ^DJI  ) is made up of 30 leading companies, all of which pay a dividend. The average estimated forward yield of these 30 companies is around 3%, or about one-sixth of the current yield of Chimera Investment. The "average" company from the Dow we'll use in comparison is a refreshing one: Coca- Cola (NYSE: KO  ) . Coke's current yield is slightly below the average at 2.76%, but for comparison's sake, it's close enough.

Name

Initial Shares*

Initial Price (11/16/2010)

Shares Purchased Through Dividend Reinvestment / Total Price

Current Value of $10,000 Purchase and Dividends

Total Return

Chimera Investment 2,506 $3.99 423.79 / $1,506.73 $7,470.97 (25.2%)
Coca-Cola 161 $62.08 4.59 / $301.08 $11,260.15 12.7%

Sources: Yahoo! Finance and author calculations.  Current value as of Nov. 14.
*Whole shares only.

As with our previous example, a higher yield does not equal a better return, as Chimera's large price fluctuation over the year and 36% loss in share price affect its overall return. Coke doesn't have the same return as Caterpillar or Hershey, but it is truly a rule maker as the leading beverage producer. If it were to continue on the pace it established over the past year, an initial $10,000 investment would be worth $20,000 in just less than six years. That's a better proposition than losing a quarter of your initial investment, as Chimera would have done last year.

High yield can equal solid returns
Don't think that a high yield automatically equals a less-than-stellar return. In fact, I've found one company with a 20% dividend yield that puts Invesco and Chimera to shame. Like the other two, American Capital Agency (Nasdaq: AGNC  ) is a mortgage REIT, and as such it's dependent on a favorable rate spread to maximize its yearly profits. Luckily for us, its spread dipped only a little in the most recent quarter, which has helped the stock maintain its value. In our purely hypothetical situation, let's see how well it would have performed for us last year.

Initial Shares*

Initial Price (11/16/2010)

Shares Purchased Through Dividend Reinvestment / Total Price

Current Value of $10,000 Purchase and Dividends

Total Return

351 $28.44 75 / $2,115.02 $11,923.85 19.5%

Sources: Yahoo! Finance and author calculations.  Current value as of Nov. 14.
*Whole shares only.

Despite a slight dip in share price over the year, American Capital would have returned nearly 20% last year, nearly in line with its lofty yield. Like my colleague John Maxfield, I am a bit wary of mortgage REITs in general, but in American Capital's case, the dividend may be too good to pass up. If I were to invest in this company going forward, I would pay close attention to quarterly reports of the changes in the all-important interest-rate spread and abandon the stock if it started to trend downward.

Other options abound
This handful of companies represents a very small percentage of the more than 2,000 publicly traded companies currently paying dividends. If you're interested in income investing, we have a new special free report titled "13 High-Yielding Stocks to Buy Today," which has 13 great-yielding stocks not even mentioned in this article. Get it while it's still available.

Fool contributor Robert Eberhard likes dividends but has no shares in any company mentioned here. Follow him on Twitter, where he goes by @GuruEbby. The Motley Fool owns shares of Coca-Cola and Chimera Investment. Motley Fool newsletter services have recommended buying shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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 (10) | Recommend This Article (8)

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 17, 2011, at 11:24 PM, cliffkemp wrote:

    What is the point of this article??? The aurthor is picking a moment in time to justify an article that has no merit except timing. Why do you people write this junk????

    How about if the person bought a Reit stock, such as CIM the week of March 2nd, 2009 @ 2.50/share... The held that stock for the last 2.5 years....Do the math on that one and even with the loss to the stock, itself, the investor would be miles ahead of Coca Cola, Hershey, and most others.

    My point is, these articles have no merit as they pick a point in time that favors the argument. They cannot be used as advice for investing in any shape, form, or fashion the prove anything or, show anything of value to the people reading this.

    Please write something of value in these articles and not scare-the-investor-that-doesn't-know-any-better.

    Point....If you go back to 2008 when shares were 15+ per share, you could argue that CIM is a very bad investment...Stop picking a moment in time and look at the current facts and always, always remember...

    Past performance does not predict future performance.

    This article is worthless to investors.

    Sorry to sound harsh but, it is what it is.

  • Report this Comment On November 18, 2011, at 3:02 AM, XMFTheGuruEbby wrote:

    While I do believe that "past performance does not predict future performance," I don't feel the article is worthless. You can grab any random stock from any random point in time and make an argument one way or the other.

    That said, I urge you to run the numbers on your argument. While it is true that $10,000 of CIM purchased on March 2, 2009 (at $2.81 a share) would be worth over $13k today (dividend reinvestment included), the same amount invested in either KO or HSY would be worth nearly $17,000... and I didn't even factor in two and a half years of dividends for either company.

    To reiterate the point of the article, an average yield can often beat an extremely high yield. The examples given here are but a few of many.

    Since we cannot predict the future, sometimes it is important to look at the past, but not to try and predict the future. Past lessons, even learned using hindsight, can help us develop an investment philosophy going forward, as running the numbers here did for me.

    Thanks as always for reading!

    TMFGuruEbby

  • Report this Comment On November 18, 2011, at 8:15 AM, okiedivot wrote:

    And when SA authors don't pick time spans to calculate returns, readers gig them for being too vague.

    One thing that has changed is the myriad of automated tools available to the investor (some you can rent monthly instead of buying). All of those complicated formulae we learned in B school are pre-programmed and very precise. Past performance can be combined with future economic trends in order to run a wide array of scenarios. Takes away all the excuses except laziness.

  • Report this Comment On November 18, 2011, at 9:06 AM, cliffkemp wrote:

    You may want to check your quote price. It was 2.50/ share.... In saying this, you can chose any point in time to prove that it is either a good investment or a bad one. KO and HSY may or may not be 'as good' depending on when you buy, dividends reinvested, and when you sell. My point is, I could have taken the same arguement and invested 10k in FCX when it was selling at 17/share and, even when they suspended dividends, It could be turned into over 50k in just over 2 years just before the split at 114, earlier this year.

    I can pick all kinds of points.

    As far as economic trends go...That is not even valid as no one know what will happen. That same FCX stock dropped even though copper and gold have gone through the roof and FCX is miles ahead of its forecast. Is there a reason it is down to around 40 (around 80 pre split)...not as far as economic trends go...according to that, it should be around 60-80....

    The real key for investing is knowing what the market is....excess money. It moves based on risk, potential return and, in many cases, intuition based on a perceived guess on how a business will operate based on past, current, and future business cycles.

    Complicated formulas do not do much good when articles are written to appeal to senses and not common sense. Go back and look at most of the 1 year projections on stock prices and there are 100s that are no where near what they were projected to be....not even close. Look at the projections now,...we will look at this again in about a year. I have been following the market since 1990 and, unless you are talking about AT&T, and food producers and stocks like Southern Co....it is hit or miss and singling out a time frame to compare stocks does not make sense at all.

    I read so many of these articles that say this stock is good, this is bad, this will go up, this will go down....Daytraders may find this useful but, it is still down to supply/demand based on the market being excess money. I do hope they teach that in B school these days and not make things so complicated.

    have a great day and best of luck to you all.

  • Report this Comment On November 18, 2011, at 11:48 AM, chaseriley wrote:

    Robert, in your 3rd paragraph you say "If you bought $10,000 worth of shares 3 years ago". Yet, in your graphs you use 11/16/2010. This sounds like 1 year to me. Dividend Growth stocks have outperformed over time.

    The mReits with their high yields are high for a reason. They are hard to understand their accounting procedures, they keep issuing more shares, interest rate and political risk.

    Try comparing apples to apples.

    PG and CL in 2008 to 2011. LLY to BMY.

    CTL and T in 2008 to 2011. BAC to MTB.

    Try non-dividend payers vs dividend payers since 1907.

    I'm just sayin'

    Thanks for your time and efforts!

  • Report this Comment On November 18, 2011, at 12:36 PM, XMFTheGuruEbby wrote:

    chaseriley,

    The sentence you reference says "If you'd bought $10,000 worth of shares of three stocks a year ago." The word order makes it a bit confusing at first glance.

    As for your second point, I normally would compare similar companies. I just thought it would be interesting comparing companies based on nothing but yield. The special treatment the gives REITs higher yields is definitely unique and worth mentioning.

    Thanks for reading!

    TMFGuruEbby

  • Report this Comment On November 18, 2011, at 1:15 PM, cliffkemp wrote:

    I would just like to point out one more thing...The government thinks it can 'help' the housing market by using 'Operation twist' and 'Harp' as well. This is all junk as well. They do not even know what the root of the problem is and what it is going to take to fix it.

    Than being said, the scare tactic that these 2 programs create, have created a scare in MREITs and, the result, short term is a downtrend, more so than others, in these stocks. Since the aurthor picked this moment in time to do a comparo on these kinds of stocks compared to the chocolate, beverage, and heavy equipment segments, my point still stands....it is useless information....Sorry for my forwardness but, it is what it is.

    If the government had not tried to 'fix' the housing market, these stocks would be doing 'better' than they are...

    My point is still the same....compare like things....do not assume that past performance will be anywhere close to future gain/loss. Just as the market has cycles, so do businesses....ANY article that focuses on a time frame to favor the arguement, be wary. The best advice to give anyone is to use common sense and do your homework on financial factors such as over-head and how cash is spent. Business is complicated due to people wanting to take advantage of the system....to an extent, it is good as it makes the mind work but, it also, creates excuses for people to do things that do not make sense and waste money. Dig as deep as you can on a company and make an educated decision...something doesn't add up, do not buy into the hype whether good or bad. Look at enron and lately, netflix...no one saw it coming, for the most part. Above all, question everything and listen to the explaination...evaluate and learn.

    good day to you all.

  • Report this Comment On November 19, 2011, at 6:17 PM, 1caflash wrote:

    Great Stuff!! My 14,000 plus Chimera shares in my DRIP will compound no matter what CIM pays each quarter. You need to Gut-It-Out sometimes; take the Bitter with the Better. There is no Law which states that any Company has to pay shareholders dividends. Feel blessed when You receive them each Quarter or Month.

  • Report this Comment On November 25, 2011, at 4:14 PM, renfool100 wrote:

    My 'foolish'(?) question i.r.t. American Capital Agency : how to pay close attention to quarterly reports of the changes in the all-important interest-rate spread ?

  • Report this Comment On November 29, 2011, at 2:20 PM, XMFTheGuruEbby wrote:

    renfool100,

    Most mREITs will publish this spread as part of their quarterly 10-Q report with the SEC. For AGNC, I simply did a search for "interest rate spread" in the document and found that its spread was 2.14% last quarter, down slightly from the previous year. You can also compare the spreads quarter over quarter for dramatic changes.

    Thanks for reading!

    TMFGuruEbby

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