Are ultra-high yield stocks a good investment or risky?
In response to my previous posting, a reader writes that he will not buy a stock that does not pay less than 8% in dividends. An 8% return on investment is stellar these days. But what does this really mean?
Since the market determines the price of the stock, the "dividend return" rate will vary with the stock price, as well as the dividend rate. If a company with sound financials consistently pays high dividends, the price of the stock will edge up until the dividend rate is about equal to market rates for other safe, bond-like investments.
If the market prices the stock so low that the effective dividend rate soars, then maybe you should listen to what the market is saying. Frontier Communications, for example, was paying a whopping 8% dividend when the stock was $10. But now that the stock has dived to less than $5 a share, the dividend rate is 15% or more.
Well, it will be, if they continue to pay dividends, and as I noted in an earlier post, they may be running out of money, due to their unfunded pension liabilities. The party may be over for Frontier, unless income increases in the 4th quarter of 2011. So if you buy this stock, far from a "guaranteed" rate of return, you are betting - gambling, on the future of a telcom stock that is a spinoff of land-line businesses that Verizon didn't want.
What could possibly go wrong?
For any dividend-paying company, the dividend ratio skyrockets the moment before it goes bankrupt. Bank of America will have a 100% dividend ratio when the stock drops to a penny a share. That does not mean it would be a good buy, only that it is on the brink of bankruptcy.
From This High Dividend Stock website, a list of some of the highest yield stocks out there:
| TNK | Teekay Tankers | 24.56% | 3.42 | 0.84 | 11/17 | 11/28 | |
| ALSK | Alaska Communications Systems Group | 20.38% | 4.22 | 0.86 | 9/28 | 10/19 | |
| AGNC | American Capital Agency  | 19.34% | 28.96 | 5.60 | 12/20 | 1/27 | |
| CPY | CPI Corp | 19.08% | 5.24 | 1.00 | 11/23 | 12/5 | |
| AINV | Apollo Investment Corporation | 18.70% | 5.99 | 1.12 | 12/13 | 1/4 | |
| RSO | Resource Capital | 18.15% | 5.51 | 1.00 | 12/28 | 1/27 | |
| SFL | Ship Finance International | 18.01% | 8.66 | 1.56 | 12/9 | 12/29 | |
| IVR | Invesco Mortgage Capital | 17.72% | 14.67 | 2.60 | 12/20 | 1/27 | |
| CEL | Cellcom Israel | 17.27% | 16.38 | 2.83 | 1/3 | 1/19 | |
| VOC | VOC Energy Trust | 16.74% | 20.55 | 3.44 | 10/27 | 11/15 | |
| CIM | Chimera Investment | 16.54% | 2.66 | 0.44 | 12/27 | 1/26 | |
| CPLP | Capital Product Partners L.P.  | 16.06% | 5.79 | 0.93 | 11/3 | 11/15 | |
| FTR | Frontier Communications | 15.54% | 4.83 | 0.75 | 12/7 | 12/30 | |
| CYS | Cypress Sharpridge Investments, Inc. | 15.47% | 12.93 | 2.00 | 12/15 | 12/28 | |
| SDT | SandRidge Mississippian Trust | 15.43% | 27.68 | 4.27 | 11/10 | 11/30 | |
| BFR | BBVA Banco Frances S.A.  | 15.02% | 4.81 | 0.72 | 4/20 | 5/6 | |
| PER | Sandridge Permian Trust | 14.82% | 19.50 | 2.89 | 11/10 | 11/30 | |
| NLY | Annaly Capital | 14.71% | 16.32 | 2.40 | 12/27 | 1/26 | |
| MFA | MFA Mortgage Investments | 14.58% | 6.86 | 1.00 | 12/28 | 1/31 | |
| VLCCF | KnightsBridge Tankers | 14.56% | 13.74 | 2.00 | 11/16 | 12/2 |
Note that the site I linked to is a for-profit site that wants you to join. Are these good, safe investments? Again, get out a calculator, go online to do the research, and then engage your brain and ask yourself the obvious questions.
1. If these were such great deals, why are the stock prices so low? In this market, a 5% return on investment is considered stellar. Why wouldn't the stock price of say, Teekay Tankers be bid up to the point where the rate of return was lower?
2. What is the stock history of the company? Is it trending down, and why? Teekay Tankers has "tanked" from a high of $25 a share to $3.48 a share today (yielding a fantastic 32.76% dividend ratio, and in this instance, I am using the term "fantastic" in the sense of "unbelievable" or "probably not going to happen").
3. What is the history of the company's market? What is going on the industry which would cause the share price to tank? In this instance, if we search online for Teekay Tankers yields some pretty expected data. Shipping companies are going bankrupt, and the market is nervous that the same could happen to TeeKay. Many shipping companies (like cruise companies) laid the keels on new ships before the market crashed. Now these ships are launched, the loan payments are due (often a Billion dollars or more) and the shipping market has dropped out. Overcapacity, just as in the housing industry.
4. It is possible this stock is a bargain? The Seeking Alpha guy seems to think so. He notes that TNK leases natural gas tankers, which are a specialty market and are leased for 3-5 year leases. Thus, even though shipping is down, the lease income is steady. For 3-5 years, anyway. What happens when these leases expire? For a ship launched in 2007, when does that lease expire (very shortly)!
5. Are you buying steady income or just gambling on a stock? You can gamble on a stock and win big. Buying Avis for 75 cents a share and selling for $10 a share is great - if you win. Most times you lose. Bear in mind with an example like TNK, it will still take three years to earn your money back. If they declare bankruptcy before then, well, you lost money on the deal - assuming they still pay these great dividends.
And so on, down the line. Ultra-high yield stocks are really no different than tech stocks. They are a risky gamble and they could go bankrupt in a heartbeat. And in fact, most of the market is betting on this, which is why the stock price has been hammered.
Again, it is not that the company is "paying" 16% dividends, but rather the stock price has been beaten up until a normal dividend appears to be very high. Don't forget this point, as it is key!
I am not saying to invest in this stock or NOT to. That choice is up to you. But one reason the rate of return is so high is that the risk factor is fantastic (and again, I am not using the term "fantastic" in the American sense of "hey, it's great!" but in the British sense of "Holy Shit!").
Note that another tanker company appears on this list, a host of REITs - once the darling of Wall Street, now viewed as risky in this day of overbuilt commercial space ("Space Available" is the most popular store in my town!), and smaller telcoms.
People a lot smarter than you and me have thought about it and decided to run away from these stocks. Maybe they are wrong - once in a while the market values things poorly, as it did in February 2009. But for the most part, when the market screams "run away" at least listen to their arguments before you invest.
Would I buy some of the stocks on this list? I might gamble a few hundred bucks on one or two. But I realize that I am gambling, nothing more.
UPDATE 2014: I gambled a bit on Teekay and made some nice dividends and then sold the stock when it went up in price. Another tanker stock, Kinghtsbridge Shipping, didn't do as well. It tanked, if you'll pardon the pun - but has a P/E ratio (at today's prices) of 9.44 and a Dividend yield of 4.42%. Frontier communications went up 40% and has a dividend yield (at today's stock price) of 6%. How they do this with a P/E ratio of 35 is beyond me. Gamble is the operative word. Overall, in this market basket of high dividend stocks, I am not sure I really came out too far ahead.