Wednesday, January 25, 2017

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:

Sunoco Logistics Partners (SXL) is a master limited partnership (MLP) that was formed by Sunoco Inc. to acquire, own and operate a group of refined product and crude oil pipelines and terminal 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. Yield: 8.6%

Alliance Resource Partners LP (ARLP) produces and markets coal primarily to utilities and industrial users in the United States. It offers low-sulfur coal, medium-sulfur coal, and high-sulfur coal. Another Master Limited Partnership. Yield: 8.0%

Genesis Energy LP (GEL) is a limited partnership transports crude oil for others; it owns and operates a 235-mile Mississippi System, a 109-mile Texas System, and a 135-mile Jay System (AL). Another Master Limited Partnership. Yield: 8.0%

Buckeye Partners LP (BPL) is one of the largest independent U.S. pipeline common carriers of refined petroleum products, with over 6,000 miles of pipeline. Another Master Limited Partnership. Yield: 7.6%

Omega Healthcare Investors Inc. (OHI) 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. Yield: 7.6%

Plains All American Pipeline LP (PAA) is a limited partnership that engages in interstate and intrastate crude oil transportation, terminalling and storage, as well as crude oil gathering and marketing. Another Master Limited Partnership. Yield: 7.1%

Vector Group, Ltd. (VGR) manufactures and sells cigarettes in the United States under various brands; and has real estate interests worldwide. Cigarette companies face three major obstacles: 1. Product liability litigation, 2. Anti-smoking laws/culture and 3. Excessive taxes. Yield: 7.1%

TC PipeLines LP (TCP) has interests in more than 5,550 interstate natural gas pipelines, including a 46.5% stake in Great Lakes Gas Transmission LP. Another Master Limited Partnership. Yield: 6.5%

W. P. Carey Inc. (WPC) is a leading global net-lease REIT that provides long-term sale-leaseback and build-to-suit financing solutions for companies worldwide. Another REIT. Yield: 6.4%

Main Street Capital Corporation (MAIN) is a business development company specializing in equity, equity related, and debt investments in small and lower middle market companies. MAIN is a business development company. Like real estate investment trusts (REITs), BDCs are not taxed at the corporate level as long as they pay out to shareholders at least 90% of their taxable annual net income each year and derive 90% or more of their gross income from dividends, interest, and capital gains on securities. As such, they can pay higher dividends. Yield: 6.1%

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 approximately 250+ 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 and MAIN. See a list of all my Dividend Growth Portfolio holdings here.

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