Sustainable Dividend Plays for a Difficult Market

Blue-chip bellwether General Electric (NYSE:GE) cut its dividend for the first time since 1938. Prior to cutting its payout, the stock yielded nearly 14% -- a sign that the market thought a cut may have been imminent. Turns out, the market got this one right.

Income investors know that chasing the highest yield often turns out to be a recipe for disaster. The market, after all, is a forward-looking mechanism, and oftentimes, a stock's yield is highest right before a dividend cut -- because the stock price declines in anticipation of the cut, but the dividend is still running at the old rate.

Take, for example, Bank of America (NYSE:BAC), which for a few short weeks had a dividend yield in the high teens during the fall of 2008. As of September 2008, Bank of America was still paying a $0.64 quarterly dividend, which resulted in an annual payout of $2.56 (the company paid that rate for a total of five quarters). Of course, the credit crisis really went into overdrive in the fall, and Bank of America was forced to cut its dividend once toward the end of 2008 and then again in 2009, when it reduced the quarterly dividend to 1 cent.

Get this: Bank of America's stock traded as low as $2.53 last month -- less than its annual payout as of October 2008! As the examples of GE and Bank of America show, simply chasing high yields can turn out to be a complete disaster.

A different kind of bank
Wells Fargo (NYSE:WFC), on the other hand, shocked markets in 2008 by hiking its quarterly dividend 10% to $0.34 a share. Recent statements from management indicate that they plan to maintain the dividend.

Wells' dividend yield is now about 11%, but in mid-February, when the stock hit a low of $8.81, Wells was yielding 15.4%. Yet while it looked like another Bank of America situation for a few brief moments, I think Wells is in a much stronger position now.

Warren Buffett, who owned 290 million shares of the stock as of Dec. 31, apparently isn't selling. Wells Fargo is increasing lending and taking away market share as capital-constrained rivals pull back from the market. In the end, Wells Fargo may turn out to be the biggest winner of this banking crisis by literally getting Wachovia for free -- thanks to a juicy tax write-off. As scary as the decline looks, Wells does not appear to be another B of A.

Shipping blues
The Baltic Dry Index, which measures shipping rates, plummeted 92% in the second half of 2008. If you are a ship operator that works on spot market rates, 92% of your revenues disappeared in six months. Would you venture to guess if those spot ship operators are generating profits or losses?

But there's a smarter type of a shipping operator -- Teekay LNG Partners (NYSE:TGP) -- which has seen no variability in revenues and is actually increasing distributions to investors as the rest of the industry is in a free fall. That's because this publicly traded master limited partnership leases most of its ships under very long-term (15-20 years) fixed-rate contracts, so the huge volatility in spot rates doesn't affect its income. That was a problem with record high spot prices in the first part of 2008, but a blessing in the second part. The shares currently yield 12.4% and show no danger signs of seeing a dividend cut anytime soon.

At the speed of light
You've probably heard it before: Landlines are a dying business and there is no future in telecom stocks. Yet, some telecom companies keep reinventing themselves. One such survivor is Verizon (NYSE:VZ), whose stock yields 6.4%. Operational performance has been messy, with the company losing landlines but gaining customers in its wireless and FiOS business, and the stock has not done much. But with healthy free cash flow, the dividend does appear to be sustainable.

When looking for income investments, remember that the highest dividends are not necessarily sustainable. You have to do more homework than just chasing a high yield. The stocks above are a good place to start.

More on dividend plays:

• Defensive Stocks That Work Right Now
• Real Estate Plays for Right Now
• Are Your Dividends Safe?