We have noted that dividends are becoming increasingly important. We expect yields from bonds to be limited, inflation is an ever present threat and many need income on which to live. With an increasing focus on dividends, there is a concern that dividends may hide fundamental weakness and lead investors astray. Jim Royal of the Motley Fool takes up this thread. He comments that a sky-high yield is one of the first warning signs that a stock or bond could be in real trouble. The market doesn't usually offer up megayields unless the security is judged to be extremely risky. In general, the higher the potential reward, the higher the risk. He then outlines six companies offering high yields that he recommends again.
Not Recommended Because
|Annaly (NLY)||14.6%||The high yield will last only as long as the bad times|
|Chimera (CIM)||18.2%||(See: Annaly)|
|Telefonica (TEF)||10.9%||More than half of revenue comes from Europe and more than a quarter from beleaguered Spain|
|Banco Santander (STD)||10.3%||More than half of assets are in Europe and a third in continental Europe.|
|Frontier Communications (FTR)||12.8%||It runs fixed-line telecom in a mobile world.|
|CVR Partners (UAN)||9.5%||It IPO'd in April, so little dividend track record. Its growth relies on capital markets. Major finance sites reported no dividend for a while.|
I think that Jim's caution is warranted. It is all to easy for companies to boost dividends in the short term in the hopes of boosting desirability and price of a stock. We are going to start tracking his selection to see how they perform and whether this is a group of stocks to avoid. We will benchmark is against our dividend ETF portfolios. The benchmark ETFs are:
|Asset||Fund in this portfolio|
|REAL ESTATE||(ICF) (iShares Cohen & Steers Realty Majors,|
|FIXED INCOME||(TIP) (iShares Barclays TIPS Bond,|
|Emerging Market||(VWO) (Vanguard Emerging Markets Stock ETF,|
|US EQUITY||(DVY) (iShares Dow Jones Select Dividend Index,|
|US EQUITY||(VIG) (Vanguard Dividend Appreciation ETF,|
|INTERNATIONAL EQUITY||(IDV) (iShares Dow Jones Intl Select Div Idx,|
|High Yield Bond||HYG (iShares iBoxx $ High Yield Corporate Bd,|
|INTERNATIONAL BONDS||EMB (iShares JPMorgan USD Emerg Markets Bond,|
- High Dividend High Risk Equities -- Total of $10K invested equally in each stock
- Retirement Income ETFs Tactical Asset Allocation Moderate -- Above funds using TAA (40% fixed income, 30% for each of the top two asset classes,
- Retirement Income ETFs Strategic Asset Allocation Moderate -- Above funds using SAA (40% fixed income, 12% for each of the five asset classes -- funds selected based on price momentum,
Portfolio Performance Comparison
|Portfolio/Fund Name||1Yr AR||1Yr Sharpe||3Yr AR||3Yr Sharpe||5Yr AR||5Yr Sharpe|
|Retirement Income ETFs Tactical Asset Allocation Moderate||2%||20%||10%||79%||8%||60%|
|Retirement Income ETFs Strategic Asset Allocation Moderate||-1%||-5%||14%||81%||2%||7%|
|High Dividend High Risk Equities||-14%||-68%||10%||37%|
The chart gives a hint that the good times are coming to an end for these stocks and that dividends may well hide a poor return for the investor.
The graphs tell the same story, and while the three year window shows good returns, over the lifetime of the portfolio, it is net negative. Jim has provided a salutory warning for those who are just looking at dividends. We will continue to track this selection and see where it goes. Full details
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Disclaimer: MyPlanIQ does not have any business relationship with the company or companies mentioned in this article. It does not set up their retirement plans. The performance data of portfolios mentioned above are obtained through historical simulation and are hypothetical.