High Yield Stocks for Those Who Need Income Now

The typical stocks that I currently focus on and own are ones that spot current low dividend yields which are pretty close to what I would get right now if I bought one of the most popular ETF’s such as SPY or DIA. The main difference is that based off the recent history of the stocks that I analyze, I have concluded that my selections have a chance of increasing their dividends above the rate of inflation, effectively doubling my yield on cost after a maximum period of 10 years. This sounds even more exciting as most of the dividend stocks I follow tend to increase their stock prices over time as well, thus effectively keeping their current yield low. At the end of the day this provides for a great total return experience as well as a stable and increasing dividend income.

Many readers of my column on my blog as well as Seeking Alpha have concluded that low current yields are not enough for them to live off of, and that the likelihood of future dividend increases does not seem as likely to them as it looks to me.

The yield hungry investors find refuge in high-yielding special treatment entities such as Real Estate Investment Trusts, Business Development Companies, Canadian Income Trusts, Master Limited Partnerships as well as some of the oil tanker stocks. The current yields on most of these stocks ranges from 4-5% for some REIT’s to over 20% for some BDC’s and tanker companies.
The reason why most of these companies are able to pay such a high dividend is because they use their cash flows rather than earnings per share in order to determine the payout to shareholders. Thus they add certain items like depreciation expense back to the earnings per share number and are able to increase the payout. Depreciation expense is basically an accounting term which means that the company is recognizing a charge to its fixed assets based off an amortization schedule. Thus if a building had a useful life of 30 years depreciated using a straight line method, and it sold for 30 million dollars, then for this example the company would have an annual depreciation expense of 1 million/year. The main problem is that on year 30 the building is no longer useful, and could be sold for a very small amount relative to what the REIT paid for it 30 years earlier.

In my understanding of this procedure, it seems that what most of these companies reward their stockholders is a return of capital, as opposed to a return on capital. That’s why most of the above mentioned typed of entities need to constantly sell more stock to investors or increase their leverage exposure in order to grow. As long as these stocks also have the ability to generate earnings however, which are directly proportionate to the returns on assets that the company typically generates, there shouldn’t be a worry for investors.

If that type of company stops growing however by issuing stocks and fixed income to investors, then the end result is that investors would not get a good total return at the end of the day.
Another risk with those entities mentioned in the second paragraph is that the government could change the regulations that govern certain aspects of these special entities like taxation for example. I tried explaining this in my article on Canroys several months ago.

So should investors invest in these higher yielding instruments? I would say go for it if you really need the high yield now, but remember that bad diversification and extreme concentration to the financial sector would have been detrimental to your portfolios in 2008. Thus, in order to maintain a balanced stream of income, one needs to have a diversified portfolio of stocks which includes as many industries as possible, without being overly exposed to any. If you can afford to wait for several years before needing the dividend income stream, then I would strongly suggest investing in stock with moderate current yields but good dividend growth potential.

And last but not least, even though dividend growth policies could always change, the dividend payments could always be cut. Thus always try to understand the business of the stock you plan on investing in as well as the reason behind the above average yield.

Comments

[d_teller:]

Firstly, I really enjoy your articles...and have some of your "picks".

Most of our family's stocks are in sheltered accounts, wherein the yrly MRD's are based upon age and prior yr-end balance..so declining principals (over a short = 2-5 yr period) is not too terrible, if the company's are reasonably sound. As long as the deferred "dividends" are greater/yr than the MRD required, there's no need to sell at a irrecoverable loss. And there have been some total wipeouts...but we don't commit more than 2-4% of any portfolio to a single security...and most pay out >8%. This also is true for closed-end funds.

However, for a youngster like yourself, I really congratulate you on your prudence. I remember some years ago, purchasing AYE (Allegheny Energy) when it was recommended by Kiplinger's retirement newsletter as a good dividend-paying ute. It was a disaster.

On the other hand, HCP, SNH and HRP have been great dividend payers...they are >15 years in our portfolio. Others, such as SO and ERF, have also been reasonable for us over the last 20 years.

Some of the CanRoys, such as ATP/UN.TO (ATPWF) have been naked short-selling targets, because of their cash flow, U.S. holdings (unaffected by the proposed Cdn tax hike) and small enough to be seriously affected in a thinly-traded market. Perhaps the new ban on naked shorting will stop this nonsense for these smaller securities, as it may stop the credit-seizure in the larger financials.

So, from the other side of the age divide, good luck and I wish you well.

(P.S. For the years leading up to normalization in the world's GDP...perhaps 2009... the infrastructure funds originated, but not indebted to Macquarie Bank, such as MGU, MIC, MFD and MCQPF, which lease roads and income generating infrastructural businesses, may recover a reasonable price...they're so cheap now because few govt.'s and investors can afford to deploy income to much-needed infrastructure.) An interesting example of the decline can be seen with Veolia (VE) whose price has declined from the mid 50's to mid-forties, pays a now hefty 4+% dividend, and is in water infrastructure...and isn't a weenie.

2008 Sep 18 09:28 PM

[notsosmart:]

i own many high yield stocks like FRO & NAT.i ow them in 200-300 sh ranges so if something goes wrong im not hurt too badly. my avg. return is 8-9%.not the greatest but reasoable.

2008 Sep 19 12:08 PM

[edtheincome...:]

excellent article and explanation of why high cash flow. REITs specifically use FFO (Funds from Operations) as the key metric. Brought O, FR, NLY for 6-10% income, even got $10K gain yesterday after negative for 2 months. Also got ALD and ACAS at the bottom for 20% yield. Both REIT and BDC must pay out most of their income by law. Yes, when evaluating these and any closed end income funds (favorites NRO, BIF, AGD ...) watch out for return of capital which really means shrinking of assets and therefore future income/growth. Be sure the dividends are sustainable in the long term by income and CGs.

2008 Sep 19 02:24 PM

[edtheincome...:]

forgot one more favorite REIT: HPT - its the only one with investment grade. Easiest way to get idea on whether 'return of capital' is involved in payout is look at Tax information or Rule 19A-1 alerts (SEC requires closed-end investments companies to disclose sources of distributions)

2008 Sep 19 04:07 PM

[rcraig:]

REIT's and trust have an expensive tax form that go with them. If you are just getting into them make sure you can pay for the form to be done for you or complete by yourself.
Just working small potatoes when I first got involved with them and ended up loosing money on them the first year, even though I was tickled pink over the dividends they paid throughout the year. Learned my lesson the hard way.

2008 Sep 22 06:13 PM