Tuesday, July 8, 2014

Are Storm Clouds Gathering For These 5 High-Yielding Securities?

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 7-10%, 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:

Vector Group, Ltd. (VGR) manufactures and sells cigarettes in the United States. It produces cigarettes in approximately 117 combinations of length, style, and packaging under various brands. Given the health risks associated with tobacco products, catastrophic lawsuits are always a risk along with declining consumption as populations become more educated. Yield: 7.5%

Kinder Morgan Energy Partners LP (KMP) is one of the largest pipeline master limited partnerships (MLPs) in the U.S. Partnerships dominated this screen. As a MLP, KMP does not pay income taxes which are passed directly to its unit holders. Yield: 6.9%

TC PipeLines LP (TCP) has interests in over 5,550 interstate natural gas pipelines, including a 46.5% stake in Great Lakes Gas Transmission L.P. In addition to not paying income taxes, MLPs also carry a stigma of complicated taxes. Instead of a 1099-DIV, unit holders are issued a K-1 which in its simplest form is a pro rata tax form that includes all the items you would expect to see on a complex corporate tax form such as depreciation, amortization, investment tax credits, etc. In some cases the K-1 can run over 100 pages, depending on the complexity of the MLP and the number of states it operates in. Yield: 6.6%

Senior Housing Properties Trust (SNH), a real estate investment trust (REIT), primarily invests in senior housing properties. Due to legal requirements REIT's free cash flow payout is usually very high, often approaching 100%. SNH free cash flow payout is 337%, a rate that is not sustainable. Yield: 6.4%

Universal Health Realty Income Trust (UHT) is a real estate investment trust (REIT) that invests in healthcare and human service related facilities. The Obama administration has created a great deal of uncertainty around the U.S. Healthcare system. It will likely take many more years before everything is sorted out. Yield: 5.8%

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 240+ 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 UHT in my Dividend Growth Portfolio and SNH in my High-Yield Portfolio. See a list of all my dividend growth holdings here.

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Tags: [VGR] [KMP] [SNH] [TCP] [UHT]