High Yield Dividend Stock Disaster

| December 15, 2014 | 1 Comment

disasterSorry, Gordon Gekko.

Greed is not good.

And when you’re looking for a high yield dividend stock, here’s a number that’s definitely not good.

10%.

When you see a stock paying a dividend of 10%, walk away.

Chances are you’re looking at nothing but heartbreak. Here’s why.

High Yield Dividend Stock Disaster Waiting To Happen

Good companies don’t need to pay a 10% dividend. It’s overkill. Take a look at the S&P 500 Dividend Aristocrats. Not one of them pays a yield of more than 6%.

Why?

They don’t have to. These companies don’t need to lure investors who don’t know any better into buying their stock with the enticement of a fat dividend.

Good companies have better things to do with their money than shill their stock. Their stock has underlying value that goes well beyond a dividend. There is no need for window dressing.

Most of the time, the only reason a company will pay a 10%+ dividend is to pull in a greedy investor who thinks that he’ll take the money and run. He thinks that maybe he’ll hold the stock for a quarter or two and then get out while the going’s good.

Well, it usually doesn’t work out that way. Timing the market is virtually impossible, and so is timing the sell date for a high-risk dividend stock.

Let me show you a few stocks that pay high yields, so you can see exactly what kind of trouble you’re setting yourself up for if you invest in one.

And let’s also look at a stock that pays a 13.93% dividend where the problems are more carefully hidden, but just as serious.

High Yield Dividend Heartbreakers That Will Love You And Leave You

Here are the four of the highest paying dividend stocks you’ll find on the NASDAQ. Each one pays a dividend of more than 20%.

And remember… you want to run for cover from any dividend stock that pays more than 10%. These stocks are like crazed panhandlers on the sidewalk of a seedy neighborhood that lunge at anyone unfortunate enough to walk by.

Stock Yield Annual Payout Payout Ratio
Niska Gas Storage Partners LLC (NKA) 40.70% $1.40 NM
SandRidge Mississippian Trust II (SDR) 37.18% $1.61 84.7%
Chesapeake Granite Wash Trust (CHKR) 36.06% $2.03 84.6%
Newcastle Investment Corp. (NCT) 25.00% $1.20 50.0%

The first thing you’ll see is we’re dealing with a different animal.

The high dividend stocks on this list are Master Limited Partnerships, which are traded just like a regular stock.

But the MLP has a special financial structure. The MLP is set up to bypass corporate taxes. This means the dividends you’re paid usually aren’t taxed at a lower dividend income rate, but at the higher ordinary income rate.

Because of the taxes investors will usually have to pay, the dividends are higher.

But don’t let this distinction pull you in.

Lurking behind the attractive dividends, chances are you’re going to see something ugly.

Four Problems A High Dividend Usually Tries To Hide 

Look at the trend of net income. Is it going up or down? When income starts to slip, and dividends either stay the same or increase, this is a warning sign.

And when there isn’t any income at all… when a company is losing money and dipping into its savings to pay a high dividend… you’re dealing with a ticking time bomb.

Look at debt. There’s trouble when you see a high debt to equity ratio that’s heading higher.   The amount of debt a company carries compared to its equity should be going down over time. The company should be making money, paying down its debt, and growing its assets.

Big fat dividends get in the way of this.

You should also take a look at the return on equity. Return on equity measures the rate of return. It shows you how efficient the company is at making money. Look at the recent return on equity and compare it to the ROE from previous quarters. If it’s not growing, you’ve got a problem.

Then there are profits. Are there any? If so, is the profit margin going up or going down?

Look at both the gross and the net profit margins to see what’s happening.

But not all the warning signs that keep you safe show up on the balance sheet.

The dividend payout ratio shows you what percentage of profits goes to pay investors a dividend. This number shouldn’t be too high, and it should never be over 100.

Why?

When a dividend payout ratio is over 100%, this means the company is paying more money in dividends than it has coming in. This obviously isn’t going to last long. It’s the best signal you can get that a dividend cut is in the cards.

Let’s take a look at a stock that’s like the dashboard of your car where every possible warning light is flashing. The dividend payout ratio is so high it’s not considered meaningful.

The stock is Niska Gas Storage Partners (NKA).

Net income has plunged by a stunning 268%.

Debt equity ratio is at 1.68.

Return on equity is down.

The gross profit margin of 13.39% is down from last year. So is the net profit margin of -136.70%.

And the stock’s performance over the past 52 weeks… check out this chart.

high yield dividend stock dive

Ugly, isn’t it?

No wonder Niska Gas Storage Partners is dangling the lure of a 40.7% dividend.

Why Dividends Above The 10% Mark Flash Warning Signs 

Niska is an obvious poster child for a dividend stock disaster waiting to happen.

But there are plenty of stocks that pay dividends between 10-20% that don’t come with this balance sheet baggage. They might seem like a good deal.

Be careful. Check out the trend of net income, the debt to equity ratio, and return on equity.

And don’t limit your thinking just to the numbers. Ask yourself why the company’s management would pay such a high dividend, instead of paying down debt. Why isn’t management investing in the research and development, or simply building up savings for a rainy day?

More often than not, when you size up a high yield dividend stock this way, you’ll uncover some desperation.

High yield dividends are just like Hail Mary passes. The quarterback in a football game throws this long shot pass as the clock winds down because there’s no other way to win the game.

Theses passes are fun to watch and full of drama. But the chances of a Hail Mary pass being caught aren’t that great.

And the chances of dividend yield over 10% being paid for the long haul are virtually nil.

Are There Exceptions To The 10% Rule?

Not very often.

But now and then you’ll stumble across a dividend stock that pays more than 10%. On the surface, it actually looks pretty good.

An example is KCAP Financial Inc. (KCAP).

KCAP Financial, Inc. is a business development company that invests in middle market companies. It makes loans and investments.

Net income is up quarter to quarter, and there’s not a debt problem.

But when you look at return on equity, you’ll see what’s wrong with KCAP Financial.

When it comes to spending money, KCAP is like a drunken sailor.

It pays too much for its assets. Take a look at the balance sheet and you’ll see that at the end of Q3, 2014, it had assets on the books with a fair market value of $442.5 million.

The problem… it paid $486.6 million for them.

And the dividend payout ratio for KCAP isn’t good. It’s 103.1%.

Remember… when you see a dividend payout ratio that’s over 100%, you’re looking for trouble.

How High Is Safe?

Dividend stocks with yields of 10% or more are dicey.

And the 5-10% range is not exactly where you’ll get a good night’s sleep. Stick with stocks that pay lower yields, down below 5%.

You’ll find plenty of them on the lineup of the S&P 500 Dividend Aristocrats.

Here’s how to find the best stock for dividend income.

Better to have a dependable dividend that’s paid – and growing – than a high flier that’s ready to crash and burn.

Avoid the heartbreak. Steer clear of the appealing high yield dividend stock that’s usually going to break your heart and poison your portfolio.

……………………………………………………………………..

Niska Gas Storage Partners LLC (NKA)

Dividend Yield: 1.00%
Annual Payout: $1.10
Payout Ratio: 31.1%
P/E: NA

KCAP Financial Inc. (KCAP

Dividend Yield: 13.93%
Annual Payout: $1.00
Payout Ratio: 103.1%
P/E: 9.57

SandRidge Mississippian Trust II (SDR)

Dividend Yield: 34.48%
Annual Payout: $1.61
Payout Ratio: 84.7%
P/E: 2.61

Chesapeake Granite Wash Trust (CHKR)

Dividend Yield: 34.18%
Annual Payout: $2.03
Payout Ratio: 84.7%
P/E: 3.10

Newcastle Investment Corp. (NCT)

Dividend Yield: 24.2%
Annual Payout: $1.20
Payout Ratio: 50%
P/E: 4.37

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Michael Jennings writes and edits DividendStocksResearch.com. Sign up for our free dividend reports and dividend newsletter at https://dividendstocksresearch.com/free-sign-up. We’ll show you how to create regular income by investing in dividend stocks, easily, step-by-step.

 

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Category: Dividend Yield

About the Author ()

Michael Jennings writes and edits DividendStocksResearch.com showing how you can profit from dividend stocks. His passion for stocks and especially Dividend Stocks began at an early age. Now he shares his knowledge and wisdom with anyone who asks... He shows beginning investors, retirees, and even trading pros how to create regular income by investing in dividend stocks, easily, step-by-step! You can Sign up for his free Dividend reports and dividend newsletter at http://www.dividendstocksresearch.com/free-sign-up

Comments (1)

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  1. Don Chase says:

    Hi Michael,
    Really enjoyed your article and signed up for more like it.
    Your article high-lighted stocks to avoid, but, do you know of any high-yielding (around 10%) that you would consider buying?
    I am buying a house with financing at 3.75% and would like to use some free cash (as a result of no down payment) to generate more income than using that money to pay-down a 3.75% loan. So your response is really important to my future.
    Thanks, Don

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