The only big risk for dividend investors is a company that
reduces or eliminates its dividend. It's something you need
to avoid at all costs, because falling dividends mean less
income, and always sparks a stock selloff. It's bad enough
to forego income, but worse still when the stock tumbles too.
Do you know a risky dividend when you see one?
The easiest way to identify a risky dividend is to look at the
cost of the dividend compared with the operating income and cash
flow. Specifically - companies that aren't earning enough to pay
the cost of their dividend are extremely risky.
When I invest for income, I want a safe and reliable dividend.
If I wanted to speculate for big capital gains, I would just buy
some highflying growth stocks.
Today, there are over four hundred large companies paying high
yields. Now, big dividends alone aren't risky. But in my
experience, many high yield stocks are downright risky.
Income & Prosperity
readers asked me to check out their dividend stocks.
I selected two stocks that illustrate exactly how to spot a risky
The two stocks are similar in some ways. Both are what I
call "tax advantaged" dividend stocks. That means they
avoid corporate taxes by guaranteeing to pay shareholders at
least 90% of their income. And both pay a high yield.
But that is where the similarities end. The first of
these stocks has fallen considerably, and its dividend at risk.
On the other hand, the second company operates in a growing
sector and has plenty of cash to fund its dividend.
In this inaugural issue of the
Income & Prosperity
reader mailbag issue, I'll give you my opinion on the two stocks
Don't Bet on Mortgage REITs
Two readers - Elliott and Mark - wanted to know more
American Capital Agency (
This stock has been crushed in recent weeks, down 22% since
early May. That drop has sent the yield soaring, and the $5
dividend translates into a 19.6% yield.
That kind of yield should immediately set off alarm bells.
American Capital Agency operates as a REIT. But unlike
many REITs, the company doesn't own and operate buildings.
Instead, it invests in residential mortgages. That makes the
business a bit more complicated.
However, this stock plunged along with the entire sector last
month. The reason is that Bernanke may curtail bond buying
by the Federal Reserve. I've been talking about this
Why I want the Fed to Raise Interest Rates
Rising interest rates aren't good for mortgage REITs like
American Capital. That's because this business is extremely
sensitive to changes in interest rates. And rising rates aren't
good for business. At a recent conference, the company's
CEO admitted that the company may be forced to write down its
Perhaps the biggest thing haunting American Capital is the
dividend itself. Credit Suisse recently reported that most
mortgage REITs like American Capital will be forced to cut their
The fall in share price for this stock likely reflects that
reality. The bottom line is that the dividend is at
risk and a rising interest rate environment isn't good for
business. This stock is complicated and difficult to
evaluate. And rising rates aren't good for business. My
advice is to steer clear.
The Affordability Factor
In 2006, many American's were living beyond their means.
They were buying McMansions, getting a new SUV every other year,
and using the home equity loan to finance a highflying lifestyle.
The Great Recession gave many Americans all a healthy dose of
When it comes to dividend stocks, I always want to make sure
that the company can actually afford its payments to
shareholders. And I want to invest in a company that lives
within its means.
Maria wrote in to ask me about
Energy Transfer Partners (
with a 7% dividend yield. If you're not familiar with the stock,
Energy Transfer Partners is a MLP operating over 23,000 miles of
natural gas pipelines.
I'm bullish on MLPs like Energy Transfer Partners, thanks to
the growing U.S. energy sector. The company profits by
transferring oil and natural gas through their vast network of
One great aspect of this investment is that it isn't directly
tied to commodity prices. The pipelines get paid the same amount
to transfer natural gas at $4 or at $8.
One of the first things I look at is the cost of the dividend,
relative to the company's earnings.
Energy Transfer Partners pays an 89-cent quarterly dividend.
The cost of the dividend is equal to the operating profits of $2
billion a year. Like all MLPs, this stock pays out at least 90%
of its operating income to shareholders.
I also like that this company is growing. Last year, the
company acquired Sunoco. The result is that revenues surged
7x. And operating income has doubled.
Healthy companies mean stable dividends. With my income
investments, my primary concern is safety and consistency.
MLPs fit nicely into that strategy, allowing me to capture
healthy and stable income.
I'm not specifically recommending shares of Energy Transfer
Partners. But I would much rather own this MLP yielding 7%,
instead of American Capital Agency with its 19% dividend.
Chasing stocks like American Capital can lead to investments
in companies with unsustainable dividends. And stocks that reduce
their dividends get punished.
Stick with safer dividend stocks that can afford to pay their