One of the most important lessons of dividend investing is: If the yield looks too good to be true, it probably is. When a company is paying out far more per share than its peers in the sector, it's probably because the market doesn't think it can last, and it's pricing in a cut.
The coronavirus pandemic has driven up dividend yields as it's crushed stock prices, but with companies' earnings forecasts thrown into disarray, the same guideline applies -- a high yield is more likely to be a mirage than an opportunity.
Here are three stocks with yields that signal a possible dividend cut.
A big decline in book value means a dividend cut is coming
Annaly Capital Management (NYSE:NLY) is one of the premier mortgage real estate investment trusts (REITs). But the first quarter was absolutely hideous for the entire industry as interest rate volatility spiked and mortgage-backed securities underperformed Treasuries. This caused a wave of margin calls, which resulted in forced deleveraging. Mortgage REITs were forced to sell assets at fire-sale prices in order to raise capital. Every mortgage REIT out there has either cut or suspended its dividend.
Annaly did pay its $0.25 quarterly dividend on April 30 after announcing it just as the COVID-19 crisis began. The annualized $1.00 dividend works out to a nearly 16% yield at Friday's closing prices. Book value per share has fallen from $9.66 at the end of 2019 to $7.50, and investors should expect to see a dividend cut next quarter.
If the tenants aren't paying, the stock probably won't, either
Simon Property Group (NYSE:SPG) is a mall REIT that has been slammed by the coronavirus crisis. Social-distancing regulations and stay-at-home orders have meant that malls are largely closed, and if Simon's tenants are closed, then nonperforming leases are a concern. The company has withdrawn guidance for the year.
Simon paid a $2.10 dividend in February and has said that it will announce the second-quarter dividend by the end of June. Simon has committed to pay the dividend in cash and will pay 100% of taxable income. First-quarter earnings per share were $1.43, and funds from operations (the REIT equivalent of earnings) came in at $2.78 per share -- before Simon was bearing the full brunt of the pandemic. The chance of Simon maintaining its $2.10 dividend in the second quarter is slim, as its 15% yield suggests.
The price for government aid may be a dividend suspension
The pandemic has put an incredible strain on the financial system. If there is one thing that makes Washington politicians seethe, it is when banks pay management and shareholders while getting government aid. Even though just about every bank has suspended share buybacks, that isn't enough for some. Enter Wells Fargo (NYSE:WFC), the bank that Washington loves to hate.
As one of the largest mortgage servicers in the U.S., Wells is a target. Given the sheer number of incoming phone calls from borrowers looking for forbearance, hold times and response times are going to fall short of Consumer Financial Protection Bureau guidelines. There have been reports that servicers were demanding immediate repayment of missed mortgage payments upon exiting forbearance. Mortgage servicing is like being an umpire: The only time you are noticed is when you mess up. There will be complaints galore for the entire industry, and Wells is probably going to be the face of it.
And don't forget: Wells Fargo is still under a cloud from the fake-account scandal. The pressure from Washington to suspend its dividend will only increase as the crisis drags on (it is an election year, after all). The stock's yield over 8% tells you that the Street senses a cut is coming.
All three of these stocks are trading with elevated dividend yields, which tells you the market is assigning some probability of a cut. The entire mortgage REIT sector has cut or suspended dividends. The mall REITs are almost certainly going to follow. For the banks, lower earnings will increase pressure to cut dividends, along with pressure from Washington. Don't count on that fat yield. It's probably too good to be true.