Wednesday, July 29, 2020

Are Storm Clouds Gathering For These 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:

Altria Group Inc. (MO) is the largest U.S. cigarette producer. It spun off Kraft Foods in 2007 and its international cigarette operations in 2008. Given the health risks associated with tobacco products, catastrophic lawsuits are always a risk along with declining consumption as populations become more educated. Yield: 8.0%

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 (BDC). BDCs heavily use leverage and target small or distressed companies, which makes them relatively high-risk investments. Like REITs, profits are not taxed at the corporate level, but passed to shareholders. Yield: 8.0%

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. Due to legal requirements of REITs to distribute profits, their free cash flow payout is usually very high, often approaching, or exceeding, 100%. Yield: 8.6%

Enterprise Products Partners LP (EPD) is an integrated provider of natural gas and natural gas liquids services, including processing, fractionation, storage, transportation and terminalling. As a MLP, EPD does not pay income taxes which are passed directly to its unit holders. 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: 9.8%

Magellan Midstream Partners LP (MMP) is engaged in the transportation, storage and distribution of refined petroleum products primarily through its 9,600-mile pipeline system. MMP is also a MLP as such does not pay income taxes which are passed directly to its unit holders. The decline in oil prices has put pressure on all companies in the supply chain. Yield: 9.7%

ONEOK, Inc. (OKE) is an Oklahoma-based natural gas utility with substantial midstream operations through its 2% general partnership interest and large limited partnership interests in a master limited partnership. OKE is also a MLP as such does not pay income taxes which are passed directly to its unit holders. Yield: 13.0%

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 150+ 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 MAIN, OHI,

Related Articles
- Warren Buffett's Two Investing Rules For Dividend Investors
- Dividend Stocks vs. Dividend ETFs
- Managing Risk With Dividend Stocks
- If Only I Had Known About These Dividend Stocks...
- 12 Dividend Stocks and 3 ETFs To Balance Your Asset Allocation