Showing posts with label high-yield. Show all posts
Showing posts with label high-yield. Show all posts

Wednesday, April 17, 2013

High Yield Dividend Investing Misconceptions

One of the biggest misconceptions about dividend investing out there is that investors should change their strategy, depending on their age. I believe that this misconception comes from the traditional world of retirement planning, where advisers told clients to allocate higher and higher amounts to fixed income instruments as they got older.

Over the past 40 – 50 years, fixed income has tended to yield more than stocks. As a result, income hungry investors in retirement seeking current income purchased CD’s, bonds and other fixed income instruments. This chasing of yields exposed them to inflation risks. Unfortunately, investors who need yield at all costs typically do not have the foresight to look beyond the next five years. Had these investors simply followed the same investing strategy throughout their investing career, without adjusting for age, they should have done just fine. I believe that following the simple four percent rule should have been their benchmark for generating retirement income from a portfolio that includes stocks and bonds. As I mentioned in an earlier article, the four percent rule essentially relied on the dividend and interest income of a portfolio, which is what the traditional retirement industry has failed to understand. In another article I discussed that for my retirement I plan on relying on the dividend income from my portfolio, which yields around 4%. I would also rely on some interest income as well. I have followed the same investing principles for the past five years, and would follow them for the next fifty years ( hopefully).

Currently, I view the misconception that investors should invest differently depending on their age fully embraced by everyone. Any time I write an article outlining the dangers of focusing simply on yield, I always receive a backlash from a group of investors. The investors that always disagree with me are those who are anywhere between their 60s and 80s. It looks like these investors simply need the income, but it also seems that they are not giving much thought about whether this income is going to continue for the next 20 – 30 years. My article on the sustainability of Pitney Bowes (PBI) and Windstream (WIN) was not well received. I did notice that many investors were hopeful, although the factd spoke that these distributions are unsustainable.

Investors who make a mistake and get lucky are actually much worse off than investors who make a mistake and pay for it. If you leveraged yourself to the maximum in 1999 to purchase all the Altria (MO) stock that you could get, and you made money from this exercise, you learned a bad lesson. If you applied this lesson in leveraging your portfolio to purchase high yielding Canadian energy trusts in 2007, or US Banks in 2008, you would have lost everything. Investors who today are purchasing high yielding telecom stocks such as Frontier (FTR) or mREITS such as American Capital Agency (AGNC) without understanding their risks, might find out that they have been playing with fire in a few years.

These investments would likely generate high yields for the next five years. This might even continue for a longer period of time, if our yield starved investors get particularly lucky. However, I highly doubt that these companies would maintain their dividends for the next thirty years. If investors spend all the dividend income from these high yielding investments, they would be out of luck when the dividends are cut. However, looking at the brief history of these investments, I would much rather stick to traditional dividend paying stocks yielding 3 – 4 percent on average today. If a four percent yield is not sufficient for you, then chances are that you do not have enough money to retire. You might try to purchase some time by investing in securities yielding more than that, but you increase your risk of dividend cuts. If your portfolio consists of high dividend stocks yielding 8% on average, and dividends are cut by 50%, then you will need to find a job to cover the difference. Finding a job in your 70s and 80s is not an easy task however.

A company that cuts an unsustainably high dividend is usually punished by a steep decline in its stock price. Thus, investors experience the double whammy of lower income, and a depreciation in asset base. This is a problem, because if our investors need to replace the investment with something else, they would have less money to do so. This is a particular problem for situations where the dividend is eliminated completely. American Capital Strategies (ACAS) is a great example for this scenario. In 2008 the company cut dividends, which prompted a sell-off from $10/share to less than $1/share within 2 – 3 months.
Stocks are not inherently “bad investments” simply because they have high current yields. If these companies can afford to pay the dividend, and can grow earnings over time then these could be very good investments. However, high yielding companies which cut dividends over time, pay fluctuating dividends, have unsustainable payout ratios and are in declining industries are investments that should probably not be touched with a ten foot pole by individual yield hungry investors, without fully understanding what they are getting into.

The best way to invest your money is to focus on the best opportunities out there. The more experience I get with dividend investing, the more I realize that current yield should not be the most important factor in selecting investments. It should not even be in the top five reasons to select an investment. It is number six in my list of entry criteria. Investors who salivate over the high yields without understanding whether the business can grow revenues and earnings to pay for the dividend are committing a sin against their asset base. However, I am somewhat impacted by the four percent rule, in that I do believe that a portfolio that yields anywhere between three to four percent is the optimal solution in today’s market environment. I do own stocks whose yield is 1% such as Visa (V), as well as stocks whose yield is 6% such as Omega Healthcare (OHI). I just purchased the ones that made sense at the time.

In my portfolio, I screen the lists of dividend champions and dividend achievers every week, looking for attractively valued stocks to purchase or to research. I keep an open eye for attractively valued companies with room to grow distributions out of growing cash flow and earnings. After analyzing companies, I only invest in those ones where I can see earnings and dividend growth for the next two – three decades. For example, I expect that Coca-Cola (KO) would still be a company with recognizable brands that will be selling a product that customers desire and are willing to pay for.

Other companies that will be around over the next 20 -30 years include energy infrastructure plays such as Kinder Morgan (KMP) and Enterprise Product Partners (EPD). These companies create the infrastructure to store and transmit oil and natural gas across the US.

Full Disclosure: Long V, OHI, KO, KMP, EPD

Relevant Articles:

Dividend Champions - The Best List for Dividend Investors
Are these high yield dividends sustainable?
Don’t chase High Yielding Stocks Blindly
Four Percent Rule for Dividend Investing in Retirement
Dividend Investing Misconceptions

This link was featured in the latest Carnival of Wealth

Monday, April 8, 2013

Five Things to Look For in a Real Estate Investment Trust (REIT)

Real estate investment trusts (REITS) represent a unique opportunity for dividend growth investors. They provide exposure to real estate, without the hassle of direct ownership. REITs are structured as trusts for tax reasons, and as a result, they do not pay federal income taxes at the entity level. The dividends they pay to shareholders are typically treated as ordinary income, and do not qualify for the preferential rate on qualified dividends. However, because income is taxed only at the shareholder level, there is more money for distributions to shareholders. In addition, a portion of your typical REIT distributions is non-taxable and it is treated as return of capital for tax purposes. This decreases shareholder's basis in the stock. The return of capital portion is caused by depreciation expense. By law, Real Estate Investment Trusts have to distribute at least 90% of income to shareholders, in order to maintain their preferential tax status.

There are five factors I analyze at a REIT, before putting my money to work in the sector. I used three REITs I own in this exercise - Realty Income (O), Digital Realty Trust (DLR) and Omega Healthcare Investors (OHI):

Funds from Operations (FFO)

Earnings per share are not an adequate way to look at REITs. Instead, analysts use Funds from Operations (FFO). FFO is defined as net income available to common stockholders, plus depreciation and amortization of real estate assets, reduced by gains on sales of investment properties and extraordinary items. I like to look at the trends in Funds from Operations per share over the past five or ten years, in order to see if there is any fuel for dividend growth. The slow growth in FFO led me to sell my position in Universal Healthcare Realty Trust (UHT) in March.

I usually prefer to see growth in FFO/share over the past five and ten years. REITs are pass-through entities, which means they return almost all of their free cashflow to shareholders. As a result, they sell shares and bonds each year in order to fund their expansion projects. These projects usually cause an increase in total revenues and FFO, but because of the dilution to existing shareholders, I want to see growth in FFO/share. This shows me that new projects are accretive to the FFO for all the shareholders. In the table below, I have placed the trends in FFO/share for three REITs I own:


FFO Payout

For REITs, I use FFO Payout Ratio, which is calculated by dividing the dividend payment over the FFO/share. I usually prefer to see a REIT whose payout ratio is below 90%. While REIT revenues are typically stable, I want to have some margin of safety in the form of a lower FFO Payout Ratio. Ideally, it would be flat or trending down over time. An FFO ratio above 90% couple with slow growth in FFO/share could jeopardize distribution growth. In the table below, I have summarized the FFO payout trends in three REITs I own:

Occupancy and Tenant Diversification

Diversification is an important thing to have in any portfolio, as it offers some level of protection to the company when something unexpected happens. I usually scan through the list of top tenants, and make sure that they do not account for an extremely large portion of revenues. I define extremely large as somewhere above the range of 50% - 66% of revenues. In addition, I also want to see stable and hopefully growing occupancy percentages over time. The occupancy ratios vary somewhat for different REITs. For example, Realty Income has an occupancy ratio of 97%, Digital Realty Trust has an occupancy of almost 94%, whereas Omega Healthcare Investors has an occupancy rate of 84%. The top ten tenants account for 64% of Omega Healthcare Investors revenues, but 35% for Digital Realty's revenues. The top ten tenants of Realty Income account for 37% of revenues.

Plans for growth

The fuel behind future distributions growth is growth in FFO/share. The growth in FFO/share is one of the factors that will determine whether distributions grow above the rate of inflation, stay flat or even worse - get cut or eliminated. I usually like to see a company that can manage to deploy capital raised in the public markets into projects that have attractive rates of return, have signed long-term leases and have escalation clauses that would allow them to charge higher rents over time. In terms of growth, Digital Realty Trust, Omega Healthcare and Realty Income all rely on strategic acquisitions of quality properties. Realty Income went one step further in 2012, when in completed the acquisition of American Realty Capital Trust. As a result, it was able to boost monthly distributions by 19.20%.

Debt, Cost of Capital and Risks

Understanding leverage is an important part of understanding REITs and risks behind REITs. Most Real Estate Investment Trusts pay for new projects either by issuing stock or issuing debt. If they issue too much debt and the projects do not work out as expected, the interest costs might eat into the profit. If it is difficult to renew the debt, or it gets more expensive, this could eat into the profit as well. This is why it is important to review the maturity schedules for the REITs you are interested in analyzing. Currently, issuing debt is very cheap, which should bode well for various projects. When the debt has to be refinanced in ten years however, it would likely cost much more to renew it. Realty Income, Digital Realty Trust and Omega Healthcare Investors do not seem to have problem accessing capital markets, nor do they have steep amounts of debt maturing soon. Omega Healthcare sold 12 year bonds in 2012 at 5.875%, while Realty Income managed to sell $450 million notes maturing in 10 years at 3.25%. Realty Income also sold 5 year notes, which yielded 2%. Digital Realty Trust sold 12 year, 400 million British Pound notes at 4.25%. Digital Realty, also managed to sell 300 million in ten year notes at 3.625%.

Dividend Growth

The table below shows the dividend growth for Realty Income, Digital Realty Trust and Omega Healthcare Investors.

I prefer to look for consistent dividend growth over time. A long streak of dividend increases for at least ten years is important. A company that manages to maximize existing investment opportunities for the benefit of growing distributions to shareholders is the right company for my money. Although dividend cuts in the past cause a red flag, if the company has managed to build a ten year streak of dividend increases, and has FFO growth coupled with adequate levels of debt, I would take a chance on it.

Relevant Articles:

- High Dividend Growth REITs: Digital Realty Trust (DLR)
- Realty Income (O) – The Monthly Dividend Company
- Three High Yielding Dividend Machines Boosting Distributions
- Four High Yield REITs for current income
- National Retail Properties (NNN) Dividend Stock Analysis
- Spring Cleaning My Income Portfolio, Part II

Tuesday, March 19, 2013

Are these high yield dividends sustainable?

When I analyse dividend paying companies, I always look for strong competitive positions. This is because a company in a strong competitive position might be able to enjoy rising profits for several decades. As a result, it might be able to boast a long streak of regular dividend increases. However, changes in technology can jeopardize a company’s economic moat. This could mean that the company might be unable to not only afford to keep raising dividends. In addition, such companies might find themselves in a precarious position, where the dividend has to be sacrificed, in order to maintain the business.

The dividend rate is usually determined by the company’s Board of Directors, who take a look of near term prospects for the business. If the Board expects that the company would be able to generate a higher amount of earnings over the next two, five and ten years, they are much more likely to boost distributions. As a result, sometimes there might be a short term disconnect between current year earnings per share and dividends per share. In this article, I have highlighted two high yield dividend stocks, whose dividends are at risk of a dividend cut. I have always argued that dividend investors should avoid chasing yield at all costs.

Over the past 20 years, we have seen plenty of companies fall victims to the rapidly changing world. Even some boring companies with strong moats have been victims of the process. Examples include newspapers, photography, mail and fixed line telecoms. These industries would have to adapt very well to the new world of technological innovation, or they would be extinct. Even if these companies can support the current high dividend payments for the next one or two years, their long-term prospects are grim.

Windstream Corporation (WIN) provides communications and technology solutions in the United States. The company derives its revenues from wireline operations. The long term trend is for erosion in wireline revenues, given the wide adoption of wireless technology. The company has managed to plug the hole in its dwindling customer count by making acquisitions. That being said, the dividend payment has not been covered for several years. Windstream’s peer CenturyLink (CTL) recently cut distributions in February 2013, which led to steep declines in shares of other fixed-line telecoms such as Windstream (WIN) and Frontier (FTR).  Given the expected erosion of the company’s customer base, and the competition from wireless, cable and VoiP technology, it seems like it is only a matter of time before the firm would find that it has to cut the dividend.

Most analysts are using cash flow payout ratios when analyzing telecom firms such as Windstream. Their calculation adds non-cash items such as depreciation expense to the net income amounts as the denominator in the cash flow payout ratio.  While using a cashflow payout ratio is appropriate for a real estate investment trust, it clearly shows a lack of basic understanding behind the wireline telecom model. A REIT owns a building with a useful life of 30 years, which would probably would still be there for a few decades after it stops accounting depreciation, and would still be a useful asset for generating revenues. A company like Windstream on the other hand, needs to continuously invest in its technology and equipment simply to keep its operations functioning normally. The telecom equipment that you had purchased even five or ten years ago would likely need some improvement or replacement. In addition, the company is also trying to invest in its future in order to still be able to generate revenues after the wireline segment dies off. As a result, analysts should be looking at earnings only, and those who ignore this logic have an increased likelihood of suffering devastating losses in dividend income and principal investment amounts. A look at the company’s ratio of capital expenditures to depreciation over the past four years shows that for every dollar in depreciation, the firm had to invest almost one dollar in new capital projects.

In Millions of $
2012
2011
2010
2009
Depreciation/Depletion
1,297.60
847.5
693.7
538.3
Capital Expenditures
1,206.60
723.7
412
286.9
Ratio
92.99%
85.39%
59.39%
53.30%

At the same time, the dividend payout ratio has been increasing over the past four years, and has reached stratospheric levels:

2012
2011
2010
2009
Diluted EPS Excluding Extraordinary Items
 $0.28
 $0.32
 $0.66
 $0.90
Dividends per Share - Common Stock Primary Issue
 $1.00
 $1.00
 $1.00
 $1.00
Dividend Payout Ratio
357%
313%
152%
111%

As a result, I find that the dividend is at a risk of a cut at present levels.

The second company I will profile today is Pitney Bowes Inc. (PBI), which provides software, hardware, and services to enable physical and digital communications in the United States and internationally. This dividend champion has raised dividends to shareholders for 30 years in a row. The company has slowed down on the rate of increase in dividend payments in recent years. The dividend has been increasing at 2 cents/year since 2008. Currently, the stock yields an above average 9.70%, and has a dividend payout ratio of 70%. The forward dividend payout ratio is 77%. The stock is trading at a forward P/E ratio of 8, which is low. The yield is very high and the P/E is very low. This could be the market’s way of saying that the current dividend payment might be difficult to maintain, and that it could be at risk of a cut. A company’s stock price could be temporarily pushed down by shareholders who do not believe in the long-term outlook for a company. If the stock price goes up, the yield and P/E would return to normal levels. The low P/E ratio could signal a stock that is undervalued, or it could be the market’s way of saying that future earnings would be much lower going forward. Overall, a dividend yield of 10% is something that you do not see every day. In most cases of common stocks of your typical corporation, this high yield is a warning sign of an impending dividend cut.

The issue with the company is that it is providing postage processing equipment such as postage meters to organizations. Revenues have been declining, and the outlook for the business is not very bright. The company has tried to reposition itself in the new digital document environment, and eliminate costs from its structure, but the truth of the matter is that physical mail processing by organizations is destined to decline over time.

Full Disclosure: None

Relevant Articles:

Seven wide-moat dividends stocks to consider
Highest Yielding Dividend Stocks of S&P 500
Dividend Cuts - the worst nightmare for dividend investors
Don’t chase High Yielding Stocks Blindly
Dividend Champions - The Best List for Dividend Investors

This article was included in the Carnival of Personal Finance # 403

Wednesday, June 20, 2012

Dividend Investors – Do not forget about total returns

Dividend investors often get into the strategy because the dividend component of total return is more stable. This makes it an ideal strategy for retirees to live off dividends and not be dependent on short term market fluctuations.

Some dividend investors however focus exclusively on yield, which could result in sub-par performance. Choosing a utility yielding 5%-6% today with a high payout ratio and low or no earnings and dividend growth over a dividend growth stock such as Johnson & Johnson (JNJ) might lead investors disappointed down the road. Even if retirees are looking for high dividend stocks for current income, they should not ignore the fact that they would likely remain retired for two or three decades. A stock yielding 6-8% today that does not grow distributions would deliver the same amount each year. The purchasing power of these dollars would be much lower however. In fact even a 3% inflation would decrease purchasing power by 50% over 24 years. This means that a Coca Cola can selling for 75 cents today would likely cost $1.50 in 24 years. On the other hand, a company which yields 3% today, but grows distributions at 6% would pay a yield on cost of 12% in 24 years. Even if the purchasing power is cut in half by inflation, this is still a respectable inflation adjusted yield on cost of 6%.

Utilities are dividend staples, which investors usually purchase in their search for current income. Utilities typically provide above average yields, although their dividend payments do not grow much over time. As a result the purchasing power of these high yields decreases each year. Most of these utilities also pay most of their earnings out in the form of dividends. This means that if these companies could easily cut distributions if cost of capital increases or regulators are not willing to increase rates to provide for sufficient return on new investment. If this happens, investors would suddenly realize a much lower yield on cost on their original investment which would also have much lower purchasing power. Of the 15 companies included in the Dow Jones Utilities index, only a handful have not had dividend cuts over the past 2 – 3 decades.



It is evident, that utility dividends are highly cyclical. In essence, the best time to purchase utility stocks might be right after a dividend cut.

Investors should focus on total returns as well, because increases in share prices would protect the purchasing power of the principal over time. By focusing solely on obtaining the highest current yield, investors could actually risk depleting their principal and suffering from dividend cuts at the worst times imaginable.

The types of companies which are suitable for all investors, no matter what their age, are dividend growth stocks. The types of companies investors should look for include:

The Procter & Gamble Company, together with its subsidiaries, provides consumer packaged goods and improves the lives of consumers worldwide. The company operates through six segments: Beauty, Grooming, Health Care, Pet Care, Fabric Care and Home Care, and Baby Care and Family Care. The company has raised dividends for 56 years in a row, and has managed to boost them by 10.90%/year over the past decade. Yield: 3.60% (analysis)

The Coca-Cola Company (KO), a beverage company, engages in the manufacture, marketing, and sale of nonalcoholic beverages worldwide. The company has raised dividends for 50 years in a row, and has managed to boost them by 10.10%/year over the past decade. Yield: 2.70% (analysis)

McDonald’s Corporation (MCD), together with its subsidiaries, franchises and operates McDonald’s restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. The company has raised dividends for 35 years in a row, and has managed to boost them by 27.40%/year over the past decade. Yield: 3.10% (analysis)

Chevron Corporation (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. It operates in two segments, Upstream and Downstream. The company has raised dividends for 25 years in a row, and has managed to boost them by 8.80%/year over the past decade. Yield: 3.50% (analysis)

Philip Morris International Inc (PM)., through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends since 2008, and has managed to boost them each year since. Yield: 3.50% (analysis)

Full Disclosure: Long ED, KO, PG, MCD, PM ,CVX

Relevant Articles:

Investors Get Paid for Holding Dividend Stocks
Living off dividends in retirement
Don’t chase High Yielding Stocks Blindly
Capital gains for dividend investors

Wednesday, September 7, 2011

Two High Yield Dividend Growth Stocks I am buying

When it comes to dividend investing, many investors tend to be either yield chasers or pure dividend growth investors. The real world however is not black and white. As a result, a more nuanced strategy where at least some minimum yield is requested before one purchases a stock that regularly raises distributions should deliver solid income over the long term.

I follow a similar strategy in my income portfolio. I purchase stocks with rising distributions which can afford to pay the dividend but I also have a minimum yield requirement of 2.50%. I tend to be skeptical over stocks which have high current yields, unless my individual company analysis proves otherwise. My analysis of the two income plays listed below has identified them as companies with sound business models. The recent downturn in the stock market has made the following dividend growth stocks with high yields attractive at the moment:

Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The company generates most of its revenues from outside the US, where the legislation is not as draconian. The company will be able to increase earnings by generating cost efficiencies in its cost reduction programs, acquiring companies internationally as well as innovating in growing markets in order to position itself favorably. Last but not least, tapping into the growth of emerging markets such as China and India, where it has a low presence could provide another opportunity for future growth. The company has raised distributions in every year since the spin-off from Altria Group (MO) in 2008. Phillip Morris International will be able to keep increasing dividends at the high single digit percentage points in the foreseeable future, while yielding 3.70% today. (analysis)

Kinder Morgan, Inc. (KMI) owns and operates energy infrastructure in the United States and Canada. Kinder Morgan owns the general partner and limited partner units in Kinder Morgan Partners (KMP). KMI also owns 20 percent of and operates Natural Gas Pipeline Company of America (NGPL), which serves the high-demand Chicago market. Another valuable asset behind KMI is the Incentive distribution rights behind the general partner, which entitles it to 50% of the distributions above certain thresholds. This is why any growth in KMP distributions would really accelerate growth in KMI dividends. KMI is set up as a corporation, which is why investors should receive a form 1099- DIV at the end of the year and have their dividends taxed at no more than 15%. The company will likely raise distributions at the low double digits for a few years, and currently yields 4.60% (analysis)


Owning these two high income dividend growth stocks makes sense for investors looking for high yield and a rising income stream. Investors should however always understand the risks behind each investments they purchase and try to spread it by obtaining allocation to different sectors in their diversified dividend portfolios.

Full Disclosure: Long PM, MO, KMI

Relevant Articles:

Wednesday, April 27, 2011

Highest Yielding Dividend Stocks of the S&P 500

The S&P 500 is one of the most followed stock market index in the world. Mutual fund managers benchmark their returns against it, yet somehow studies show that the vast majority underperforms the index in any any given year. There are many ways to invest in the S&P 500, including mutual funds (VFINX), exchange traded funds (SPY) or even stock index futures. I benchmark my dividend income against the S&P 500. Many of the best dividend stocks in the world have a substantial weight in this important stock market barometer. With its average yield of 1.70% however, many dividend investors choose to ignore the index, and instead focus on its components.


It is interesting to note that 386 companies included in the index pay dividends. The average yield on those is 2.30%. Below I have highlighted the ten highest yielding dividend stocks of the S&P 500:

Altria Group (MO) engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. This dividend champion has raised distributions for 43 years in a row. The company has a forward dividend payout ratio of 76%. Yield: 6.10% (analysis)

AT&T Inc. (T) , together with its subsidiaries, provides telecommunication services to consumers, businesses, and other service providers worldwide. This dividend champion has raised distributions for 27 consecutive years. The high dividend payout ratio, and the fact that the company is in a highly competitive industry cast a shadow on the sustainability of the distribution payment. Right now the dividend payout ratio is 72% based off forward 2011 EPS. If the acquisition of T-Mobile goes through, the payment of $25 billion dollars in cash could potentially jeopardize the current dividend. (analysis)

Frontier Communications Corporation, (FTR) a communications company, provides regulated and unregulated voice, data, and video services to residential, business, and wholesale customers in the United States. Between 2004 and 2010 the company paid a quarterly dividend of 25 cents/share. Last year however it cut the distribution rate by 25% to 18.75 cents/share. The company has been unable to cover its dividend out of earnings since 2006. More than two-thirds of its distributions are non-taxable as they are essentially a return of capital. Yield: 9.40%

Windstream Corporation (WIN), together with its subsidiaries, provides various telecommunications services primarily in rural areas in the United States. Since 2006 the company has paid 25 cents/share every quarter. Windstream has been unable to cover its dividends from earnings in every year since 2008. One the bright side cash flow from operations has been relatively stable, although the company has ramped up capex spending in recent years. Yield: 7.90%

CenturyLink, Inc. (CTL), provides a range of communications services, including local and long distance voice, wholesale network access, high-speed Internet access, other data services, and video services in the continental United States. The company is a member of the elite dividend aristocrats index, and has raised dividends for 37 consecutive years. In comparison to the previous two telecom players, CenturyLink has been able to cover its distributions from EPS, although its payout ratio is a scary 92.70%. Yield: 7.20%

Reynolds American Inc. (RAI), through its subsidiaries, manufactures and sells cigarette and other tobacco products in the United States. The company has raised dividends for 7 years in a row. The company has managed to double EPS over the past decade, and raise dividends by 9% per year as well. The forward dividend payout ratio is 79.70%. Yield: 6.20%

FirstEnergy Corp (FE) is involved in the generation, transmission, and distribution of electricity, as well as energy management and other energy-related services. The company has maintained its dividend payment since 2008. It’s dividend payout ratio however is at 69.40%, which is sustainable for a utility company. Yield: 5.90%

Pitney Bowes Inc. (PBI) provides mail processing equipment and integrated mail solutions in the United States and internationally. The company is a member of the dividend aristocrats index and has raised distributions for 29 years in a row. Yield: 5.90%

Pepco Holdings, Inc. (POM) operates as a diversified energy company. It operates in two divisions, Power Delivery and Competitive Energy. The company cut dividends by 40% in 2001 to 25 cents/share, and has since raised them by 8& to 27 cents/share. Based off forward 2011 EPS, the payout ratio is over 85%. Yield: 5.80%

Lorillard, Inc (LO), through its subsidiaries, engages in the manufacture and sale of cigarettes in the United States. The company has paid a rising dividend since becoming a separately traded company in 2008. It yields 5.40% and has a high dividend payout ratio as well.

It is evident that the highest yielding stocks in the S&P 500 include sectors such as telecom, tobacco and utilities. All of the top ten companies have very high dividend payout ratios. This increases the risk of a dividend cut, as any decline in earnings would make it impossible to maintain the high distributions. Of particular concern are the telecom companies, since the cash cow businesses of telephones is a dying one. The cell phone industry is highly competitive and is becoming a basic commodity, since customers could expect similar levels of service, and similar prices as well. The only differentiator could be phones offered, but this is a short-lasting advantage, as new phones are introduced and it is impossible to tell which ones would be embraced by consumers.

The tobacco business is also in decline, as more people are starting to realize the health effects of smoking on their well-being. In contrast with telecoms however, tobacco companies have strong pricing power and a loyal customer base, which is addicted to its products. While taxes are raised each year on cigarettes, the levels of price increases that cigarette makers generate more than offsets the decline in consumption by customers. In addition, while there might be speculation that unfavorable court rulings could potentially make all tobacco companies bankrupt, this is highly unlikely. The taxes that tobacco products generate fill in government coffers with billions of dollars worldwide, and tax increases are favored by the electorate. It would be difficult to replace the tax revenues from tobacco products if they were banned.

Full Disclosure: Long MO

Relevant Articles:

Monday, January 3, 2011

High Yield Stocks in 2010: Slow and Steady Wins the Race

Back in 2009, I selected four high yield dividend stocks in order to participate in a stock picking competition. The companies selected have diversified income streams, high dividend yields and were characterized by stable revenues. Three of the companies had recession proof products or services. This ensured that investors would keep receiving their dividends and earn a return on their investment throughout all market conditions.

The companies I selected include Realty Income (O), Con Edison (ED), Kinder Morgan Energy Partners (KMP) and Philip Morris International (PM).

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company has long term leases with tenants, which ensures stability of revenues over time. In addition to that, the properties it collects revenues from are located in 49 states. This real estate investment trust is one of the few which didn’t cut distributions during the financial crisis. Yield: 5% (analysis)

Consolidated Edison, Inc. (ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States. Utility revenues are stable even during recessions, but don’t increase by much during expansions. Utility companies are natural monopolies in their geographic areas, and typically earn a return on their capital investment that is set by the state they are operating in. Yield: 4.80% (analysis)

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets in North America. Pipelines are regulated by the FERC and the transportation rates for oil and gas that flow through them typically increase at the rate of inflation and are not dependent on the volatile price of the underlying. While energy prices are highly volatile, the amount of oil and gas consumed in the US typically changes by a few percentage points every year. Yield: 6.30%(analysis)

Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The number of smokers is decreasing in Western Europe, although the price increases have been able to offset any declines in revenues. In addition to that, growth in emerging markets for the brand products the company is producing should boost profitability in the long run. Strategic acquisitions should also add to the bottom line, as would synergies and strategic cost efficiencies are realized over time. Yield: 4.30% (analysis)

2010 could be characterized by the lowest bond yields in several decades. This has caused some investors to shift their portfolios toward dividend stocks. The positive side of most dividend stocks is that unlike fixed income, they could increase their distributions over time. As a result some high dividend stocks such as the ones I selected in 2010 had a very good performance this year. The positive fact of dividend stocks with strong fundamentals is that investors receive a growing stream of dividend income in all market conditions. With even modest capital gains and regular dividend reinvestment, investors could achieve consistent returns over the long haul, which could compound their original investment for many years.

Two of the companies, Con Edison (ED) and Realty Income (O) seem to be trading a little ahead of themselves. As a result I find it difficult to commit new money to them at this moment. The other two companies, Kinder Morgan (KMP) and Philip Morris International (PM) look attractively valued at the moment given their bullish growth prospects and attractive fundamentals. As parto f 2011’s stock picking competition I selected Philip Morris International (PM), Johnson & Johnson (JNJ), Procter & Gamble (PG) and PepsiCo (PEP). You can read the article explaining the reasoning behind these picks here.

Overall, the four stocks delivered a total return of 26.10% in 2010. In comparison, the S&P 500 delivered a total return of 14.60% in 2010. This placed me third in the competition. You could find the results for the other bloggers below:

The Wild Investor +27.15%


Zach Stocks +20.87%

My Traders Journal +10.39%


Intelligent Speculator -0.45%

The Financial Blogger -1.64%

Four Pillars -35.25%

While I own all of the stocks mentioned above, this stock picking competition is not representative of how investors should invest money. I believe that in order to be successful at dividend investing, one has to build a diversified portfolio of stocks, representative of as many sectors as possible. I would also add geographic diversification as a plus, as well as the need to build positions slowly over time, by dollar cost averaging.

Full Disclosure: Long ED, KMP, O, PM

Relevant Articles:

- Best Dividend Stocks for 2011
- Dividend Aristocrats list for 2011
- 2010’s Top Dividend Plays
- The case for dividend investing in retirement

Wednesday, October 20, 2010

High Income Stocks for a Dividend Growth Portfolio

Most of my articles on dividend investing contain a fair bit of warning about the dangers of high dividend stocks. This has caused several readers to question whether I should include high yielding stocks in their portfolios or not. In this article I would try to explain the advantages and disadvantages of these securities, and let readers decide for themselves whether they suit their investment objectives.

First, I find stocks with above average yields helpful for retirees or future retirees who expect to start living off dividends up to the next 10 years. While dividend growth stocks are a great investment vehicle for the long run, it might take some time for them to start generating a sufficient yield on cost. For example it might take over a decade for a stock like Wal-Mart (WMT) with a current yield of 2% that raises dividends by 12% annually to reach a yield on cost of 8%. For the investor who needs to put food on the table for the next decade, Wal-Mart will likely be ignored due to its low yield in favor of a higher yielding stock such as Kinder Morgan Energy (KMP) or Royal Dutch Shell (RDS.B). A stock with a higher current yield which raises dividends minimally or not at all would provide the best yields for the next few years, provided that the company generates strong cash flows to support the distribution. If the investor simply chases high dividends without checking for their sustainability, they will be better off in cash and short –term maturities, rather than risk their principal on untested investments. If the distributions are sustainable, then the high dividend stock could be bought and held for current income.

Second, it is imperative to understand that a high dividend stock that doesn’t raise its distributions for a long period of time would result in lower inflation adjusted income over time. This is particularly concerning in the event that the investor spends their whole income, and doesn’t reinvest a portion of distributions. That’s why investors should hold only a portion of their income portfolio in high yielding stocks. They should invest the other portion in dividend growth stocks which offer consistent dividend increases. This dividend growth should be supported by a solid business model that generates sufficient cash flows to grow and maintain the business and also return excess cash to owners. The dividend growth component of the portfolio should be quietly working in the first decade or so in order to reach higher yields on cost. This is the component that will ensure that the income stream maintains its purchasing power for the whole retirement, no matter whether it last for one decade or half a century.

As a result, if you look at dividend yield from the viewpoint of your dividend portfolio, one could realize that individual company yields do not matter as much, as long as overall portfolio yield is enough to generate sufficient initial income stream. After that knowing that the addition of a 2% yielder that grows distributions at 15% annually won’t affect overall yield too much, the decision to add a stock like Becton Dickinson (BDX) or Family Dollar (FDO) is much easier that before.

The high dividend stocks which I currently own to supplement my current dividend income, until my future growers increase dividends enough include:

National Retail Properties, Inc. (NNN) is a publicly owned equity real estate investment trust. The company is a member of the dividend achievers index, and has raised distributions for 20 years in a row. The stock yields 5.70% ( analysis)

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The company is a member of the dividend achievers index, and has raised distributions for 16 years in a row. The stock yields 5.00% ( analysis)

Royal Dutch Shell PLC (RDS.B)operates as an oil and gas company worldwide. The company explores for, and extracts crude oil and natural gas. The stock yields 5.40% ( analysis)

Kinder Morgan Energy Partners, L.P. (KMP)owns and manages energy transportation and storage assets in North America. The company is a member of the dividend achievers index, and has raised distributions for 14 years in a row. The stock yields 6.20% ( analysis)

Universal Health Realty Income Trust (UHT)operates as a real estate investment trust (REIT) in the United States. The company is a member of the dividend achievers index, and has raised distributions for 22 years in a row. The stock yields 6.80% ( analysis)

Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The company has consistently boosted distributions to stock holders since it was spun out of Altria Group (MO) in 2008. The stock yields 4.50% ( analysis)

Altria Group, Inc. (MO), through its subsidiaries, engages in the manufacture and sale of cigarettes, wine, and other tobacco products in the United States and internationally. This dividend champion has raised dividends for 43 consecutive years. The stock yields 6.20% (analysis)

Consolidated Edison, Inc. (ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States. This dividend aristocrat has raised distributions for 36 consecutive years. The stock yields 4.90% ( analysis)

Dominion Resources, Inc. (D), together with its subsidiaries, engages in producing and transporting energy in the United States. The stock yields 4.10%

At the end of the day, investors should determine what they are trying to accomplish with their dividend portfolios. The stocks mentioned above are just a piece of the puzzle and not the solution to building a dividend portfolio for the long run.

Full Disclosure: Long WMT, FDO, D, ED, MO, PM, NNN, O, KMP, UHT, RDS.B

Relevant Articles:

- A dividend portfolio for the long-term
- Living off dividends in retirement
- Three Dividend Strategies to pick from
- Dividend Investing Works in All Markets

Monday, October 4, 2010

Top Dividend Stocks for 2010, 3Q Update

The third quarter of 2010 was characterized by a rebound in global equity markets, which lead to rising stock prices. Income hungry investors are starting to realize that certain safe-havens such as US Treasury bonds do not look as attractive as dividend stocks. This has pushed many dividend stocks higher, particularly the ones with sustainable and growing distributions.

Back at the end of 2009 I selected four dividend stocks as part of a competition. The stocks that I selected were representative of the tobacco, real estate, master limited partnerships and utilities sectors. The main characteristic of these sectors was that they consist of stocks with above average yields. The higher yield not only softened investor losses during the second quarter of 2010, but also produced very good performance over the third quarter.

The stocks that I selected were not only attractively valued at the time, but also had sustainable and growing distributions. The companies include:

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. The monthly dividend company has paid rising dividends for 16 years in a row. Right now this dividend achiever yields 5.10% ( analysis)

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets in North America. The second largest master limited partnership in the US has raised distributions for 14 years in a row. This dividend achiever yields 6.40% (analysis)

Consolidated Edison, Inc. (ED), through its subsidiaries, provides electric, gas, and steam utility services in the United States. The New York based utility company has raised dividends for 36 years in a row. This dividend aristocrat current yields 4.90% (analysis)

Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. This global tobacco powerhouse has raised dividends every year since it was spun out of parent Altria Group (MO) in 2008. It offers not only a high yield, and a sustainable dividend, but also solid dividend growth potential. Yield: 4.50% (analysis)

Some of the companies such as Realty Income and Con Edison look overstretched at the moment. The hunt for yield has pushed these companies to levels of relative yield not seen for a while. Furthermore, given the slow dividend growth that they have experienced, I do not find them worthy of adding new money to these positions. The price you pay today would affect your total returns in the future. As a result, investors putting in new money in stocks like Realty Income (O) and Con Edison (ED) might not generate the same level of total returns as investors who bought the stocks at the end of 2008 for example. This being said however, these stocks are still at least a hold, as their dividends appear to be safe. But if you are in a DRIP plan in one of those stocks, you might be better off allocating the dividends in something more attractively valued.

Overall the picks I selected outperformed the picks of the other bloggers in the competition for a second quarter in a row. Here’s the ranking:

Blogger Performance

Dividend Growth Investor +21.34%

The Wild Investor +8.35%

Zach Stocks +0.84%

My Traders Journal -1.31%

WheredoesallmyMoneygo -2.90%

Intelligent Speculator -7.86%

Million Dollar Journey -10.46%

The Financial Blogger -15.24%

Four Pillars -27.07%

While I own all of the stocks mentioned above, this stock picking competition is not representative of how investors should invest money. I believe that in order to be successful at dividend investing, one has to build a diversified portfolio of stocks, representative of as many sectors as possible. I would also add geographic diversification as a plus, as well as the need to build positions slowly over time, by dollar cost averaging.

Full Disclosure: Long ED,PM, KMR, O

Relevant Articles:

- Reinvest Dividends Selectively
- Four Characteristics of The Best Dividend Growth Stocks
- 2010’s Top Dividend Plays
- Dividend Investors are getting paid for waiting

Thursday, July 1, 2010

Best High Yielding Stocks for 2010, Q2 Update

When it comes to dividends, investors either immediately grasp the concept or dismiss it altogether. After all dividend payments are more stable than price returns. In addition to that, dividends have accounted for 40% of average annual total returns since the 1920s. Reinvested dividends on the other hand have accounted for over 90% of total stock market returns since 1871. As a result, it is no surprise that income investing is gaining support at a time when stock markets have been mostly flat for over a decade.

Back in 2009 several stock bloggers and I chose four stock picks each in a friendly stock contest. The companies I selected have low earnings volatility and as a result have stable dividend payments. In addition to that, the four companies were representative of four sectors of the economy – real estate, tobacco, utilities and energy. The companies include Realty Income (O), Con Edison (ED), Philip Morris International (PM) and Kinder Morgan Energy Partners (KMP).

Kinder Morgan Energy Partners, L.P. (KMP) owns and manages energy transportation and storage assets in North America. This dividend achiever has raised distributions to unit holders for fourteen consecutive years. The last distribution increase occurred in 2010, when this master limited partnership increased quarterly distributions from $1.05 to $1.07/unit. Yield 6.50%. (analysis)

Realty Income Corporation (O) engages in the acquisition and ownership of commercial retail real estate properties in the United States. This dividend achiever has raised distributions for sixteen consecutive years. Since the end of 2009, Realty Income has raised distributions from 0.1426875/share to 0.1433125/share. Yield 5.50%. (analysis)

Consolidated Edison, Inc., (ED) through its subsidiaries, provides electric, gas, and steam utility services in the United States. This dividend aristocrat has raised distributions for 36 consecutive years. Earlier this year the company raised distributions from 59 cents/share to 59.5 cents/share. Yield 5.40%. (analysis)

Philip Morris International Inc. (PM), through its subsidiaries, engages in the manufacture and sale of cigarettes and other tobacco products in markets outside of the United States. The company has increased dividends twice since the spin-off from Altria (MO) in 2008. The last dividend increase was announced in September 2009. Yield 5.00%. (analysis)

The above mentioned stocks are good additions for current income. They should only be a part however of a diversified income portfolio, whose goal would be to produce income until the dividend growth component of the portfolio kicks in and starts generating enough cash flow. I would expect slow distribution growth from these stocks over the next few years.

Overall, this portfolio has achieved a 6.39% total return so far in 2010. I outperforming the stock selections of the other market newsletters for a second quarter in a row. (see results below)

Dividend Growth Investor: 6.39%

WildInvestor: -7.60%

My Traders Journal: -11.90%

Where does all my money go: -14.16%

Zach Stocks: -17.24%

Intelligent Speculator: -19.06%

Four Pillars: -20.11%

The Financial blogger: -22.65%

Million Dollar Journey: -23.65%

The lesson to learn is that "boring" dividend stocks are less volatile in comparison to the overall market. The regular dividends paid also make shareholders hold on to their shares through thick and thin, without panicking. As long as dividends are being paid, income investors realize a positive return even in a flat or down market.

Full Disclosure: Long all stocks mentioned above

Relevant Articles:

- Top Dividend Stocks for 2010, 1Q update
- 2010’s Top Dividend Plays
- Best High Yield Dividend Stocks for 2009
- Five Consumer Stocks for 2010

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