Tuesday, January 29, 2013

Are The Dividends Safe For These High-Yielding Stocks?

Everyone wants to earn more. For investors in dividend growth stocks, the quick way to earn more is to select dividend stocks with higher yields. Swap those 2-4% yields in for stocks earning 6-10%, or more. Before making the trade, you should ask yourself the following two questions:

1. Why is the yield higher? and
2. Are these higher yields sustainable?

Structure Driven Yields

One variation in yields can be attributed to the entity's tax structure. For example, Master Limited Partnerships and REITs do not pay income taxes. Instead, earnings are passed to investors who pay the taxes. Yields on these types of investments tend to be higher. Since the entity doesn't have to pay income taxes, there is more cash to distribute. Also, since earnings from these investments don't qualify for preferential dividend tax rates, the market adjusts the price of the investment down, which increases the yield, to compensate for the additional taxes owed.

Risk Driven Yields

The most significant determinant of yield is risk. In a world where risk is equal across all investments, yields within the same industry and investment vehicle would tend to be homogeneous with very little variation. When yields dramatically increase compared to the company's peers, this is a sign that there is increased risk with that investment. Before investing, you need to understand this risk to determine if you are willing to accept it.

This week week, I screened my dividend growth stocks database for the highest yielding stocks, not considering any other factors. The results are presented below:

Pitney Bowes Inc. (PBI) | Yield: 12.3%
Pitney Bowes Inc. is the world's largest maker of mailing systems, and also provides production and document management equipment and facilities management services. The U.S. Post Office is in financial trouble. PBI's revenue stream from its mailing business will continue to shrink. To offset this, the company has focused on less profitable business segments which will likely yield lower returns than its core postage-meter business. PBI's last three quarterly dividend increases have been an anemic $0.005 per share.

Vector Group, Ltd. (VGR) | Yield: 10.3%
Vector Group, Ltd. manufactures and sells cigarettes in the United States. It produces cigarettes in approximately 118 combinations of length, style, and packaging under various brands. Cigarette companies face three major obstacles: 1. Product liability litigation, 2. Anti-smoking laws/culture and 3. Excessive taxes. Although product liability litigation has been quite in recent years, in April 2009 the federal excise tax on cigarettes jumped to $1.01 per pack from $0.39. Tobacco will likely continue to be a target for additional state excise taxes. In June 2009, President Obama signed the Family Smoking Prevention and Tobacco Control Act into law giving the Food and Drug Administration (FDA) the power to regulate both the manufacture and marketing of tobacco products.

Nustar Energy (NS) | Yield: 8.8%
Nustar Energy L.P. is a leading independent operator of crude oil and refined products pipelines as well as terminal storage facilities. Limited partnerships yields tend to be significantly higher since they don't pay income taxes. Instead, the partnership's investors are responsible for the taxes (which could include multiple state tax returns.) Each year the entity issues a K-1 tax form to its unitholders to be incorporated into their tax returns. K-1s often run late (March/April delivery) and include potentially complex tax issues.

Below are other similar partnerships making the list:

Buckeye Partners LP (BPL) | Yield: 7.9%
Buckeye Partners LP is one of the largest independent U.S. pipeline common carriers of refined petroleum products, with over 6,000 miles of pipeline.

Suburban Propane Partners LP (SPH) | Yield: 7.3%
Suburban Propane Partners LP is a limited partnership that markets propane gas and other refined fuels to residential, commercial, industrial and agricultural customers.

TC PipeLines LP (TCP) | Yield: 7.3%
TC PipeLines LP has interests in over 5,550 interstate natural gas pipelines, including a 46.5% stake in Great Lakes Gas Transmission L.P.

Inergy, L.P. (NRGY) | Yield: 5.8%
Inergy, L.P.'s assets include incentive distribution rights in Inergy, LP, operates a retail and wholesale propane supply, marketing and distribution business.

Omega Healthcare Investors Inc. (OHI) | Yield: 6.9%
Omega Healthcare Investors Inc. is a real estate investment trust (REIT) that invests in income-producing healthcare facilities, mainly long-term care facilities located in the United States. REITs enjoy high yields since they do not have pay taxes if they distribute 90% of their earnings. Unlike partnerships, their income is reported on a 1099 for tax purposes. Low interest rates and reduced vertical competition has benefited REITs. Both will diminish at some point in the future.

As with past screens, the data presented above is in its raw form. Some of the the companies would be disqualified for poor dividend fundamentals. However some of the others may be worth additional due diligence.

My database, D4L-Data, is an Open Office spreadsheet containing more than 20 columns of information on the 220+ companies that I track. The data is sortable and has built-in buttons and macros to make it easy to use. Companies included in the list are those that have had a history of dividend growth. The D4L-Data spreadsheet is a part of D4L-Premium Services and is updated each Saturday for subscribers.

Full Disclosure: Long OHI in my High-Yield Portfolio. See a list of all my dividend growth holdings here.

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