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World Wrestling Entertainment, Inc. (NYSE:WWE) is an integrated media and entertainment company that leverages its brand in generating revenue from live events, television rights, advertising sales, pay-per-view and related products. It recently hit a 52 week low after weak guidance coming in at roughly half the consensus estimates. Despite this, the company pays a dividend yielding in excess of 11%, making it a tempting target to many income-driven investors.

Unfortunately, the high dividend yield may illustrate the problem of income investing. High payout ratios (dividend/eps) may be attractive, but are they sustainable? In WWE’s case, for each of the last four years, the company has had a payout ratio in excess of 1, meaning that it is paying out more cash than it has earned. How can it do this? WWE has non-cash charges like depreciation which bring cash flow from operations up above net income. The company has had few capital expenditures over the last few years and very low debt, allowing the company to use the cash remaining for dividends. In the long-run, this isn’t sustainable. Depreciation is a reserve for the ultimate replacement of assets. By running such a high payout ratio, the company risks being cash-poor when it comes time to replace its assets.

Another pitfall for investors looking at the dividend yield only is that it is just one aspect of total return. The other aspect is capital gains (or losses). In 2008, Saj Karsan wrote an article about WWE’s payout ratio exceeding its net income going back to at least 2006. At that point, the company was trading for $17. Investors at that point would have lost $4.50 in share price, but received nine $0.36 dividends for a total of $3.24, a net loss of $1.26 or 7.4% of the purchase price. This illustrates the perils of investing for yield. The situation would be different if WWE’s payout ratio was only a small amount of net income, thus signifying a more sustainable dividend.

Investors can protect themselves against losses like this by focusing on companies trading at a discount to their intrinsic value. Dividends should be considered a pro-shareholder bonus, but should never be the sole reason for investing.

Disclosure: No Position.

Source: World Wrestling Entertainment's Payouts Illustrate the Problem of Income Investing