When it comes to double-digit yields, there's always a
Some investments, such as the
Sandridge Mississippian Trust I (NYSE:
Whiting USA Trust II (NYSE:
offer dividend yields in excess of 20% simply because the market
clearly understands that projected income streams will soon peter
out. After accounting for the present value of future cash flows,
these investments can make sense to investors who want to
front-load the timing of income streams.
Other high-yielders, such as oil refiners
Alon USA Partners LP (Nasdaq:
CVR Refining (NYSE:
, each of which offers a yield in the 15% range, offer erratic
dividends (thanks to unpredictable refining profit margins), but
can still be suitable for yield-seekers who can stomach that kind
of bumpy dividend performance.
Yet in many other instances, a double-digit yield can simply
be a trap for unwitting investors. They may have the appearance
of steady dividend production, but face tremendous challenges
that likely spell a reduction -- or outright elimination -- of
the dividend. Here are two examples of the kind of double-digit
yielders that you should avoid.
1. Javelin Mortgage (NYSE:
This company is structured as a real estate investment
trust focused on mortgages (mREIT). It borrows at a low
cost and buys mortgage bonds that carry relatively higher
yields. The difference creates income for investors. But
as we get ever closer to the eventual rise in interest
rates, this strategy will start to wither away. It's not
a risk for 2014, but could start to impact company cash
flows (and the dividend) by 2015. The trouble is that
investors are already looking ahead to the era of smaller
dividends for Javelin, and they are starting to see an
Analysts at Citigroup, for example, expect Javelin's
stock will settle near $11 once the market digests the
impact of rising interest rates on this business model.
In effect, the current downside of 18% is even greater
than the current 13% yield, implying you'd actually lose
money on this yield play over the next 12 month.
It's hard to pinpoint how much Javelin's $1.80 a share
annual dividend would need to be reduced to reflect any
change in rates, but a drop down to $1 or $1.50 might be
a suitable range. An even bigger headwind: The value of
Javelin's existing mortgage assets will lose value as
interest rates rise, as less risky fixed-income
investments start to diminish the after-market price of
mortgage bonds. So investors may flee this stock before a
dividend cut or an asset value writedown.
2. NTELOS Holdings (Nasdaq :
This wireless service provider is already feeling the
heat of tough national competition. It's had to heavily
invest in its network, which has zapped free cash
NTELOS generated $55 million to $70 million in annual
free cash flow in 2009, 2010 and 2011, which supported a
robust dividend in excess of $2 a share. Yet over the
past two years, free cash flow has averaged just $6
million. The dividend has already been cut to $1.68 a
share, which still consumes about $35 million in company
cash each year.
Trouble is, NTELOS has nearly $500 million in
long-term debt to service and needs to make sure that
enough cash flow is kept in reserve to meet future bond
obligations. A lack of pricing power in an industry
dominated by larger rivals will likely lead management to
cut the dividend anew in coming quarters. This is an
instance where the current 13.5% dividend yield
implicitly suggests such a move is coming.
Risks to Consider:
Many high-yield stocks have benefited from an era of low
interest rates and a resulting low cost of capital. But that
pillar is slowly going to disappear, and a wide range of today's
high-yielders won't be offering such robust yields a few years
from now. The market always looks ahead, and these stocks may
lose as much on terms of share price drops as they produce income
from their dividends.
Action to Take -->
Before you look at any high-yield stocks, you need to assess the
potential impact of changing interest rates or industry dynamics.
Also, take a close look at any high-yield stocks' payout ratios.
Whenever a company is paying out more in dividends than it is
generating in cash flow, a dividend cut appears almost
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