Many novice investors get in the world of dividend investing because of the belief that it is possible to generate double digit current yields. They purchase these securities in pursuit of current income, only to see these distributions cut after a few months. The truth is that few companies can afford to pay high dividends, unless they are pass-through entities such as master limited partnerships or real estate investment trusts to name a few.
I have highlighted the top 20 yielding stocks in the S&P 500 index below:
Right off the bat investors could notice that most of these issues are from the telecom, utilities and tobacco sectors. The reason why these companies yield so much is because they are sharing almost all of their profits to shareholders in the form of dividends. This is clearly unsustainable, particularly in the case of telecom carriers, which have high capital expenditure requirements in an industry with high competition. Another risk facing telecom investors is that the wireline (landline) portion of their businesses is destined to decline over the years until its extinction a few years from now. Few households have both a cell phone and a fixed line anymore, and those that still pay for both are beginning to question the benefit of the extra landline phone charges. This dying business would generate less and less in profits, which cannot be offset against cost cuts. The main bright spots for telecom providers is data and cellular phones.
Tobacco is also a dying business, where companies direct all of their cash flows to investors in the form of dividends and stock buybacks. The one positive for tobacco companies is that because of the ban on advertising, it is virtually impossible for new companies to enter the market. In addition to that the product is addictive, and the price increases have so far offset the declines in the number of smokers in the US. The major risk is legislation banning the use of tobacco in the US, which seems to already be priced into the shares of tobacco companies such as Altria (MO). The states need revenues, and the steep excise taxes generated by tobacco products make it very unlikely that these products would be banned in the next decade.