When examining a stock's dividend yield you need to go behind the numbers. A fantastic dividend yield on the surface may be masking some significant underlying issues. The dividend yield is simply a calculation that compares the annual dividend distribution to the current price per share. The dividend yield can look artificially inflated if the stock price has taken a recent hit; that's why investors need to examine the fundamentals of the company first and look at the dividend yield later.
There are a number of companies out there with prodigious yields that for one reason or another - challenging economic conditions or poor company-specific performance - warrant caution. Chasing the dividend in any one of these stocks could end up leaving you with a loss on your investment.
This is probably a spot where you could drop in the name of many telecommunications and utility stocks but we'll pick on AT&T here.
AT&T is one of corporate America's bellwethers that has been around for decades and is a very popular choice for dependable slow growth and dividend income. AT&T has a long history of paying and raising its dividend and the current yield on the stock stands at about 5%. It's a great choice for conservative and retirement investors. The company itself isn't the issue here. It's the economic environment that the company is soon to face.
We've been in an unprecedented low interest rate environment for some time now but indications now are that this environment along with the Fed's accommodative policies could soon be coming to an end. Utilities like AT&T could find themselves especially susceptible to the tapering of the Fed's economic stimulus program that's expected to begin around March 2014. Tapering could fuel higher interest rates and increased volatility in the markets and both of those would be bad news for utilities like AT&T. A trailing 12 month P/E ratio of 25 compared to the Utility Sector SPDR (XLU) ratio of 17 doesn't help matters either.
The dividend is on solid ground but the stock price could be coming up on volatile times.
Southern Company (SO)
Southern is a holding company for several Gulf area utility companies that also carries a 5% dividend yield. Unlike AT&T, Southern faces headwinds not just from economic conditions but from its own operations as well.
Troubles relating to upgrades of the company's infrastructure and construction of developing nuclear power options has been a drain on Southern's financial resources. These projects have faced schedule delays and costs have gone over budget with no immediate end in sight. These issues have hit the bottom line as the company missed on both earnings and revenue forecasts for the third quarter.
The stock price peaked at $48 earlier this year but is hovering around $40 today so shareholders have already felt the pain of Southern's issues. Southern is a stock that has a several year history of steadily growing the dividend, so for income investors looking for yield it's understandable that they'd look to Southern. But the issues the company is having with its capital expenditures might make you consider sitting on the sideline until they get sorted out.
Apollo Residential Mortgage (AMTG)
Apollo is a good example of the risks involved with investing in mortgage REITs.
REITs in general have much higher than average dividend yields than most stocks due to their structure but there are times when these dividend payouts simply can't be maintained by the net interest income the REIT earns. Apollo, like many of its REIT peers, cut the quarterly dividend that it paid in September to $0.40 per share. That's down from $0.70 per share just a quarter earlier. Share prices for REITs like Apollo began dropping like a rock in May in anticipation of the eventual dividend cut.
The yield on Apollo back then was well above 10% and based on the lower dividend and the lower stock price is still over 10%. A 10% yield might sound like a great thing but a dividend payout that's been reduced, coupled with a stock price that's tumbled in the last several months, is generally a good sign that, unless you're a bit of a gambler, you might want to look elsewhere for dividend income.
Each one of the stocks listed above is a bit of a different case study. AT&T is a great company with a great dividend history but could be adversely affected by the economy. Southern is a company with a great dividend history but that's facing internal challenges. Apollo is a company that's dealing with issues both internal and external.
All have solid dividend yields but all could deliver a loss on a total return basis. Southern and Apollo already have year-to-date. Dividend stocks tend to make great long term investments but you can't buy blindly based solely on dividend yield or you could find yourself swimming in red.