One of the dangers of high yielding dividend paying investments is the uncertainty that the lofty annual income payouts will be sustained. How can we find blue chip stocks and REITs with over 10% annual payouts that have a decent chance of maintaining this?
Is Low Dividend Payout the Key?
Some income investors look to the payout ratio. The payout ratio is synonymous with the amount of earnings paid out as a dividend. If the ratio is low, this gives the company room to increase the payout percentage to maintain the yield. However, out of the 76 companies on my stock screener that payout at least 10% yields, only 6 were listed with a payout ratio of less than 90%.
It would make sense that if a company is payout out very high dividend ratios, little if any of the earnings are likely to be retained by the company. As well, REITs are under obligation to payout 90% of their earnings in dividends, leaving only 10% to re-invest or for capital appreciation.
If analyzing dividend payouts is not the answer, then what is?
Net Profit Margins
The net profit margin is a ratio of net income compared with sales. A low ratio means that a company retains a very small amount of its sales as profit. This could be due to a host of reasons from production costs, taxes, marketing, and so forth.
Companies with very high profit margins have larger reserves to fall back on when times get tough. Of course, these figures will vary from industry to industry; we will weed out any companies with less than a 50% profit margin. Our list of 76 high yielding companies is whittled down to 14.
Growth and Sustainability
Net profit margins only provide us with a relative number. Even if your net profit margin was 100%, declining sales would still erode your dividend income over time. To know if our investment is sustainable we need to track overall growth of earnings. We will screen out any investment product that has not improved its bottom line EPS for this year. This knocks our list down to 10 companies.
Stocks paying out hefty dividends typically trade closer to their intrinsic value than do speculative high-growth stocks. Still, if we remove any publicly traded product that is valued over 1.5x its book value, we will be left with investments priced very close to their ‘liquidation’ value.
This can provide protection. For example, imagine you purchased a stock at $10 per share with a yield of 10%. The price to book ratio is quite high and the price drops to bring share value closer to intrinsic value. The share price is now $5 per share with a 10% yield payout of 50 cents. Because you purchased shares during its ‘overvalued’ time frame, your yield is only 5% of what you paid into this investment, not to speak of capital losses.
Long-Term Debt to Equity Ratios
Another consideration should be given to long-term debt to equity ratios. As the market improves, interest rates will rise accordingly. If long-term debt ratios are high, this could severely impact the amount of earnings in the future.
Long-term debt is any debt that will not be paid off in the next year. A long-term debt to equity ratio over 1 means that the company has more long-term debt than assets. We will screen out companies with a LTD to equity ratio greater than 0.4.
The High Yielding Dividend List
A quick review of our criteria:
- Dividend Yield > 10%
- Net profit margins > 50%
- Positive EPS growth this year
- Price to Book Ratio < 1.5
- LTD ratio < 0.4
It is of little surprise that our list of 8 investments is comprised mostly of REITs and mortgage products. The investment products that made the final cut are as follows:
1. RiverSource LaSalle International Real Estate Fund, Inc. (SLS) is a closed-end fund. Being involved in foreign investment there are of course added risks. It is not FDIC insured, or insured by any federal government agency. As well, there is no bank guarantee. Also to be considered is a special shareholder meeting date on February 15, 2011 where a proposal will be considered to be acquired by the Columbia Real Estate Equity Fund which is an open-end fund. The perks have been a 17.61% dividend yield.
2. Cornerstone Progressive Return (CFP) is another closed-end fund with a trailing 15.89% dividend yield. They pay monthly. Not everyone agrees with their methods which amount to dividend-stripping, or dividend capturing. The concept is to hold income stocks and sell them shortly after the ex-dividend date, to get into another upcoming dispersion of dividends. In theory, this should not work since capital share appreciation is reduced by the amount of dividends paid out. Still, you should compare long-term income payouts and share price movement and make the call yourself.
3. Invesco Mortgage Capital (IVS) has a forward annual dividend yield of 17.1%. Their year over year growth is outstanding with quarterly revenue up 243% and quarterly earnings up 322%! Still, the company is still in its infancy stage being founded in 2008, so making long-term assumptions about this mortgage product is more difficult. Also keep a close eye on the relationship between the NAV value for over-hyped prices.
4. Hatteras Financial Corp. (HTS) is a residential REIT with a forward dividend yield of 13.8%. But not everyone is happy with management that offered an additional 10 million shares at $28.75 a piece to dilute former shareholders. As short interest climbs on this one, it could be interesting.
6. MFA Financial (MFA) is another diversified REIT expecting to give out 11.7% annually. There seems to be more than a little disagreement on whether this is still a buy as FBR Capital reiterated in early 2011, or a neutral downgrade by Credit Suisse in December 2010.
7. ING Global Equity Dividend and Premium Opportunity Fund (closed-end foreign fund) (IGD) has a trailing annual dividend 12.2%. They are paying out a monthly dividend of about 10 cents per share which is about an 11% forward looking yield. Although it is currently trading below book value, certain precautions are in order for foreign investments.
8. BlackRock Kelso Capital Corporation (BLK) is a private equity firm specializing in middle market companies. With a 10.9% yield with an 87% payout ratio, this is an attractive play.
Of course, it is of utmost importance that each investor performs his own scuttlebutt of these companies as it is just the beginning of quantitative analysis. Note too that you need to carefully look at the growth number of each stock; some companies have increased year-over-year quarterly growth but down when looking at the entire year, some are the flip side of that scenario. Still others have declining growth but positive future expectations. Its up to each person to look at which growth numbers are positive and if you are comfortable with it.
This also speaks absolutely nothing of qualitative investigation that has made such value investors as Warren Buffett famous. Still, by analyzing a few key financial figures and ratios, we have a higher chance of sustainability of these high yielding dividend paying investment products.