Author: Jason Hall | July 25, 2019
A plethora of payouts
Dividends are an amazing thing. All you have to do is invest in a company, and sit on your hands while the checks roll in. For people looking for income, higher-yield -- dividend yield is the percentage of the stock price you earn in dividends -- stocks have proven a god-send over the past decade, with bond yields spending much of the period near historical lows following the rate cuts during the Global Financial Crisis.
Yet at the very same time, plenty of investors have gotten burned, making the mistake of buying a stock based on the yield they expected to get, only for the company to cut -- and in some cases actually eliminate -- the dividend. Adding further injury, a share price drop often accompanies the dividend cut, leaving you with a big loss too.
After filtering out the smallest stocks, starting with companies worth at least $1 billion, here are 10 stocks that offer investors some of the highest yields in the world; all pay double-digit rates based on recent share prices and dividend amounts. But several of them have questionable abilities to maintain the current payouts, and their high yields aren’t the product of raising the dividend, but sharp drops in their stock prices. Keep reading to learn more.
1. Norbord Inc
Over the past year, Norbord Inc (NYSE:OSB) has indeed paid out CAD 5.90 (Canadian dollars) per share in dividends, putting its trailing yield at 25.1% (adjusted to about 20% for U.S. investors). Moreover, the company does continue to generate solid cash flow, and should prove to remain a pretty decent income stock for the foreseeable future.
But capturing a 20% yield isn’t likely on the table. That’s because the massive yield its has paid over the trailing 12 months is a product of an “exceptionally strong free cash flow” quarter it experienced about a year ago that allowed the wood panel maker to pay a massive CAD 4.50 last August.
The two quarterly dividends that followed were CAD 0.40 per share each, not only lower than last September’s gigantic dividend, but also the smallest quarterly payout Norbord has paid since mid-2017. Moreover, there’s the potential the dividend falls further, and falling demand for its products tied to a slowdown in residential construction in North America, weakens cash flow.
2. Vector Group Ltd
Vector Group Ltd (NYSE:VGR) is the fourth-largest cigarette manufacturer in the U.S., through its Liggett Group subsidiary which owns a number of popular discount cigarette brands. Moreover, the company’s manufacturing agreements give it a strong cost advantage, which it has leveraged to gain market share in recent years, primarily by promoting its low-cost brands.
For investors this has resulted in relatively steady cash flow, which it has then regularly returned a substantial portion of back to investors. The company has also awarded investors with a 5% stock dividend every year since 1999. That’s on top of the 17% cash dividend yield investors have enjoyed over the past year.
Can it keep the checks -- and free stock -- coming? On one hand, the tobacco business is in decline, and it’s hard to imagine it remaining a stable source of income in perpetuity. One only has to look at Vector’s cash dividend of $0.40 per share each quarter -- a level it’s been at since 2016 -- as evidence that it’ll be hard to grow cash flow in the tobacco business.
Vector is taking two actions to address this. One is the focus on heavily-discounted brands. In 2018, retail tobacco shipments declined 5% in the U.S. overall, but Vector was the lone national cigarette maker to grow shipments. Second -- and likely the more sustainable path forward for the company -- is its move into the real estate business. Vector’s New Valley subsidiary owns a collection of both real estate properties and brokerage businesses which generated $761 million in revenue over the past 12 months. Included in its real estate portfolio are more than a dozen properties in New York City, as well as multiple properties in Los Angeles, Las Vegas, and Miami Beach.
Its real estate business doesn’t come close to matching the cash flow of its cigarette business just yet, but if management can continue to build that business, eventually Vector could make the improbable transition from a tobacco cash cow to real estate titan.
Bauxite mining and alumina refining giant Alumina (NASDAQOTH:ACWMY) is another natural resources-driven company that paid investors a larger-than-usual dividend recently that it isn’t likely to repeat in the near future. In Alumina’s case, it paid investors $0.5414 per share in March, substantially higher than it has paid out in recent history. That comes on the back of the $0.34 per share it paid in September 2018, pushing its 12-month payout past $0.88 per share. That puts the trailing yield at 13.7%.
Unfortunately for investors, alumina and bauxite prices have come down after reaching the three-year peak in 2018 that drove Alumina’s strong results that funded its recent big dividends:
Since Alumina’s dividend policy is to pay out excess cash after paying debt and corporate expenses, the dividends it pays based on its future results will almost assuredly be smaller than it has paid over the past year.
4. New Residential Investment Corp
Since initiating a dividend, New Residential Investment Corp (NYSE:NRZ) has rarely seen its yield fall below 10%, so the 13% its shares yield today isn’t particularly unusual. That’s because its core business comes with a certain amount of risk.
New Residential is a REIT -- real estate investment trust -- but not the kind that owns property. The company is a so-called mortgage REIT, investing in a mix of real estate-related financial instruments, including residential and consumer loans, mortgage backed securities (basically big bundles of mortgages), and mortgage servicer rights, or MSRs.
About half its business is investing in residential debt, while the other half is its MSR business. The risk of the residential debt portfolio is two-fold. First, it requires people continue to pay their loan notes; if the economy were to weaken, the company could be exposed to higher rates of default, resulting in big losses. Second, rising interest rates could put a squeeze on the company, since it uses a substantial amount of debt to raise capital to invest in the mortgages on its balance sheet. The risk is that rising interest rates could cause its cost of capital to go up faster than the rates on the mortgages it owns, cutting its profits along the way.
As an MSR, New Residential is obligated to make advances to the mortgage holder to fund missed payments from borrowers, taxes, insurance premiums, and even foreclosure-related costs. In other words, the company takes on further risk from economic weakness that could affect mortgage delinquencies simply by acting as a servicer.
5. New York Mortgage Trust
New York Mortgage Trust (NYSE:NYMT) is another mortgage REIT, and more typical of its peers with a focus on owning residential and commercial real estate loans and securities. Yet even it has a bit of a twist, which is a big reason why its yield makes this list at a sky-high 13%.
New York Mortgage Trust’s portfolio includes a large amount of investments it purchased from so-called “distressed markets.” This includes delinquent loans it purchased at a discount, taking on the risk of default and bankruptcy.
The company has generally proven adept at navigating the distressed markets, but it bears the same interest rate and economic risks as other mortgage REITs that can quickly turn positive cash flow into losses and wipe out any dividend payments.
The company’s own dividend history is an example of how rising rates and other factors can impact its cash flow. The company paid a $0.27 per share quarterly dividend from 2012-2015, cutting the payout to $0.24, and then the current $0.20 in 2017. As a matter of fact, the long-term trend hasn’t been in shareholders' favor:
Interest rates are expected to be flat -- and maybe even fall a bit -- in the near-term. That would be good for the company if it lowers its cost of capital, but the falling-rate environment and the days of super-cheap capital of the past decade don’t look likely to return. Moreover, if rates were to fall sharply from here, it would be due to serious economic weakness, and that wouldn’t be good for New York Mortgage Trust or investors counting on its dividend.
6. FS KKR Capital Corp
Like REITs, business development companies, or BDCs, get favorable tax treatment in exchange for passing along at least 90% of taxable income to shareholders. That’s why, in general, BDCs pay higher yields than other categories of stocks.
At the same time, there are other factors that make them riskier investments, pumping up the yield they generally command even further. FS KKR Capital Corp (NYSE:FSK), with its 14.4% yield at recent prices, is an extreme example.
So what makes BDCs higher-risk? They make (and sometimes lose) money by investing in the debt of and lending directly to other companies, often businesses that don’t meet investor-grade credit ratings.
The benefit of owning non investment-grade debt -- sometimes called “junk” debt) is that it pays higher interest, and FS KKR’s management has proven adept at navigating the risks of the market and limiting the losses as much as identifying the successes (though it’s also worth noting that default rates have been low industry-wide for the better part of a decade).
The risk? Historically, default rates for junk debt are far higher than investment-grade companies, and to maintain its payout, FS KKR will have to navigate the down-cycles too. That’s something we haven’t really seen in a decade, so be conscious of that downside risk if you decide to buy.
7. Two Harbors Investment Corp
Our third mortgage REIT, Two Harbors Investment Corp (NYSE:TWO) has paid out dividends equivalent to a 12.3% yield to shareholders over the past year. However, investors should also note that the $0.40 per share it paid out, was down from $0.47 per share it paid the two prior quarters. That’s because, like many other mortgage and hybrid REITs (Two Harbors invests in real estate debt and MSRs, similar to New Residential) its cash flows and taxable earnings can fluctuate far more than that of equity REITs.
Two Harbors’ portfolio is 80% so-called “agency” mortgage and mortgage-backed securities, meaning they’re guaranteed by a federal agency, 13% non-agency -- making them higher-risk -- loans, and MSR assets which made up 7% of its $27 billion portfolio at the end of the first quarter.
Going forward, Two Harbors’ strategy to manage interest rate uncertainty is to pair agency mortgage-backed securities with MSRs. In the latest earnings presentation, the company said it expects “...the combination of these two assets results in a higher return with a lower risk quotient.”
But investors should be conscious of the long-term interest rate environment; what it has meant for Two Harbors over the past few years is a steadily shrinking dividend:
The company’s strategy to increase its MSRs could help stabilize income to some degree, but the trend isn’t exactly Two Harbors’ friend anymore.
8. Transportadora de Gas del Sur
Argentina’s biggest natural gas transporter, Transportadora de Gas del Sur SA (NYSE:TGS) is also the largest gas transportation company in Latin America. It’s hard to overstate how dominant the company’s pipeline and distribution network is, with approximately 59% of all natural gas consumed in Argentina traveling through the company’s 5,700 miles of pipelines. The importance of this business to the country’s economy and society is enormous, and that helps ensure steady cash flows as it supplies a key component in its energy needs to everyday people and businesses alike. The cash flow resulted in a nearly-11% yield as the dividend was increased sharply over the past year. Moreover, Argentina’s economy is improving, helping lift its prospects.
However, TGS, as the company is known, can be hard to follow and understand. It reports almost all of its financial numbers in Argentine pesos, making the translation to U.S. dollars difficult (that’s before remembering to adjust for the value of ADRs, which are worth five common shares).
Lastly, TGS doesn’t have a formal dividend policy, and the massive increase in the payout that drove the current yield so high may not be sustained; moreover it’s about double the company’s historical yield average and I’d expect we see some reversion to the mean.
9. Global Net Lease
Our first and only equity REIT, Global Net Lease (NYSE:GNL) is set to pay $2.13 per share in annualized dividends based on its most-recent payout. That works out to an 11.1% yield at recent share prices.
Global Net Lease focuses mainly on so-called “sale-leaseback” transactions, meaning it buys property from an organization and then leases it back to the same entity on a long-term agreement.
The benefit to the entity is it can generate a large amount of capital up front by selling the property to Global Net Lease, while then continuing to utilize it by leasing it over the long-term. For Global Net Lease, it gains a long-term source of cash flow, making money on the spread between what it can charge for rent, and its cost of capital to buy the property.
This can be an excellent business, generating steady, dependable long-term income and cash flow. It’s why equity REITs can make for some of the very best high-yield dividend investments out there.However, investors should be hyper-aware that Global Net Lease pays out an enormous amount of cash; actually it has paid out more than it brings in from its operations. FFO -- funds from operations, the best metric for profits from an equity REIT -- in the first quarter was $0.44 per share, while the company’s quarterly dividends during the period were $0.53 per share. Sure, a company can pay out more than it earns for a short period of time, but at some point, something has to give. If Global Net Lease can’t boost its FFO, then the dividend could get cut.
10. Alliance Resource Partners
Coal supplier Alliance Resource Partners (NASDAQ:ARLP) may seem like it has all the sustainability of Vector Group, the cigarette manufacturer featured on an earlier slide. Moreover, there’s plenty of good reason to view both with an ethical eye: Using coal for energy production causes environmental harm, including both the particulates that pollute waterways and cause harm to people and animals which breathe them in, and the carbon that’s behind global warming.
But that eye-popping 12% dividend yield is hard to ignore, no? From an economic perspective, Alliance is a different animal than most of its big coal peers, many of which have gone bankrupt over the past half-decade. Alliance has some of the best low-cost coal reserves in the world that have allowed it to generate sizable positive cash flow, even as coal demand falls, driving prices lower.
Moreover, there’s reason to predict the payout will stay high. Even after increasing it each year for the past few years, Alliance pays out less than 60% of cash flow, making it ultra-secure. The bigger question: Can investors count on that remaining the case as coal demand weakens further over the next decade?