3 Popular High-Yield Stocks I Don’t Recommend Owning

| November 14, 2016 | 0 Comments

warningWhile these three high-yield stocks are popular among many income investors, for Tim Plaehn’s rigorous standards, they don’t make the cut. See why Tim doesn’t recommend these three seemingly attractive stocks and his recommended replacements. 

For The Dividend Hunter recommendations list of high yield stocks, I follow and analyze the financial results from several hundred companies. I then weed the list down to a portfolio of about 20 stocks because I owe it to my subscribers to recommend only the best high yield stocks I can find. But on a regular basis, I receive questions about other high-yield stocks.

Before I discuss a few individual stocks that came up short, let me review some of my investment criteria. With the Dividend Hunter recommended stocks, the primary criteria I require is the safety of the dividend with a secondary goal of dividend growth. For a safe dividend, you need a company that generates free cash flow that is greater than the dividend, providing a cushion over the dividend payment. In the high yield world, different companies and sectors have their own terms for free cash flow. These terms include funds from operations (FFO), distributable cash flow (DCF), and cash available for distribution (CAD). To ensure continued dividend safety, a company’s business should show growth in the free cash flow per share over time. I want to see steady growth of cash flow, year after year. If that growth stops or reverses, that is a very big danger signal and I will give a company very little time to reverse the lack of growth. Finally, I only recommend stocks of companies which have business models that I understand, especially pertaining to how they turn revenues into the cash needed to pay dividends.

To build a portfolio of higher-yield stocks, I want to diversify across a range of attributes. I pay close attention to the current yield vs. dividend growth projections of companies. In a portfolio, I want some high-yield stocks where the dividend may not grow much paired with lower yield stocks with strong dividend growth potential. I also want to diversify across the types of high-yield stocks, including real estate investment trusts (REITs), energy infrastructure companies, business development companies (BDCs), and offshore domiciled corporations.

I then try to further diversify among the subsectors of these larger groups of companies. To build a complete high-yield portfolio takes months of analyzing individual companies to build a list of the highest quality, high-yield dividend-paying stocks and then picking from that list to end up with a diversified portfolio that will balance the ups and downs of the different sectors of the economy.

I have found that after going through the above process, which is continuous and ongoing, some very popular high-yield dividend stocks do not make the cut to be included in The Dividend Hunter recommendations list. Some of these are companies that I like and would not mind seeing on the list. But for one reason or another, they come up a bit short. Here are three that you may know and my reasons why they don’t currently make the cut.

Apollo Commercial Real Estate Finance Inc.Apollo Commercial Real Estate Finance Inc. (NYSE: ARI) is a commercial mortgage finance REIT. The finance REITs divides into two subsectors. The residential mortgage REITs tend to use lots of leverage and make big interest rate bets, which can blow up if they bet wrong. On the other side, commercial mortgage REITs have real, easy to understand businesses that have good growth potential in the current banking regulation environment. Apollo Commercial Real Estate Finance has some attractive qualities, including a high current yield and recent dividend growth. I do not include it in my recommendations list for two related reasons. There are already two commercial mortgage REITs on my recommendations list. I don’t need a third. ARI is significantly riskier in its business operations compared to the two I currently recommend. If one of those two did falter, I would again be taking a very close look at ARI. This stock currently yields 10.8%.

Omega Healthcare Investors Inc.Omega Healthcare Investors Inc. (NYSE: OHI) is a healthcare properties sector REIT that is very popular with income investors. That’s understandable since the company has increased its dividend every quarter for 17 straight quarters and yields 8%. Omega Healthcare Investors is the largest Skilled Nursing Facility focused REIT and it owns over 950 operating facilities in 42 states. The problem with this REIT is a concentrated focus in a type of healthcare facility where 91% of the revenues come from Medicaid and Medicare payments. For me, that is too much of a concentration on government programs where cuts in payment rates are a distinct possibility.

W.P. Carey Inc. REITW.P. Carey Inc. REIT (NYSE: WPC) operates as a triple-net lease REIT. This type of REIT owns free standing properties that are on very long-term leases with built-in rent escalators. Net lease REITs are viewed as one of the safest groups of REITs when it comes to dividend payments. I was a big fan of W.P. Carey from 2010 through 2014. During that period, the company had very strong dividend growth combined with an attractive yield. Then in 2015, the dividend growth slowed dramatically. WPC had a history of quarterly increases, with the dividend going up by 2 cents to 5 cents or more each quarter. In 2015, the increases dropped to 1/10th of one cent each quarter. This showed me that W.P. Carey had lost its growth momentum and was just increasing the dividend by a very small amount to not break its record of quarterly dividend growth. I continue to watch this company closely with the hope they can restart their growth machine. It hasn’t happened yet.

Note: This article originally appeared at Investors Alley.

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Category: Dividend Stocks To Buy?

About the Author ()

Tim Plaehn is the lead investment research analyst for income and dividend investing at Investors Alley. He is the editor for The Dividend Hunter, an investment advisory delivering income investments with double digit growth in share price and dividend payments, and 30 Day Dividends, a specialty income service that takes advantage of opportunities for relatively fast, attractive profits around potential dividend payouts.

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