Sure, it’s easy to let your eyes melt as you pore through lists of stocks with high dividend yields. But as they say, there’s probably more to the story.
More often than most investors might realize (until it’s too late), those high yields are on borrowed time, and/or are being paid by a cash flow that won’t exist in the future.
Here’s a closer look at four stocks that might have huge payouts, but still wave enough red flags to keep investors from initiating a position.
Dividend Yield: 8.9%
There’s no denying that PDL BioPharma (NASDAQ:PDLI) is conceptually one of the coolest biotech-esque ideas out there. The company buys rights to sell revenue-bearing drugs, and passes along a piece of its royalty income to shareholders. In fact, with a current dividend yield of nearly 9%, PDLI is one of the most income-oriented biopharma names out there.
There’s just one problem: That income stream is in serious jeopardy.
Like most other pharmaceutical companies right now, PDL BioPharma has too many of the drugs under its umbrella racing toward the patent cliff. Avastin, Herceptin, Lucentis and Tysabri make up 95% of the company’s total sales. Though most of 2013’s revenue should be decent, its four top-selling drugs will have lost their patent protection by 2014.
Yeah, PDL can always go out and buy or develop more revenue-bearing drugs. But that’s far easier said than done right now.
Penn West Petroleum
Dividend Yield: 10.1%
Even to those who know have been following it for a while, Penn West Petroleum (NYSE:PWE) — which operates as PennWest Exploration — is something of an enigma.
It was a trust, but became a corporation in early 2011. Even before (and after) the conversion, though, the company went through a few rounds of debt-based (and convertible-based) financings, and tapped bank-credit facilities. That matters, because to this day the market still isn’t entirely sure how to value — or evaluate — Penn West.
Be that as it may, it might be good that PWE still acts somewhat like a trust, in that it shares its capital spending plan for the year before that particular year starts. For 2013, Penn West reported it was going to reduce its capital spending from 2012’s $1.7 billion to $900 million this year (though it might spend another $300 million if crude prices behave favorably). It also has worked down $1.3 billion worth of long-term debt last year.
That’s the good news.
However, the reduced capital spending plans — even with the reduced debt load — plus the current dividend payout is still greater than Penn West’s cash flow. Some analysts even explicitly hope the company will ratchet down its double-digit yield.
Indeed, it might have to do so at some point in the near future — just to survive.
Dividend Yield: 12.5%
The good news is Pitney Bowes (NYSE:PBI) knows that businesses are going to rely even more heavily on automation and “big data” management in the future.
The bad news is Pitney Bowes doesn’t appear to be giving businesses what they want. Sales and operating income have been steadily declining since 2008, meaning PBI hasn’t been participating in the economic rebound, even though its peers have.
To give credit where it’s due, it’s still profitable — at least for the time being. The problem is, the difference between PBI’s per-share income and the dividend is quietly getting smaller.
For perspective, Pitney Bowes earned $2.78 per share in 2008 and paid out $1.40 in dividends. For 2012, the company will earned $1.99 per share, and has already paid out $1.52 in dividends. Translation: The payout ratio is getting larger, and if Pitney can’t stop bleeding revenue, that 12%-plus dividend yield could be the first thing to suffer.
Two Harbors Investment
Dividend Yield: 17.7%
As of the last look, Two Harbors Investment (NYSE:TWO) was paying out almost 18% of its value as a dividend. That’s quite high, even by non-agency-backed REIT standards. However — and despite the bullish chatter that so often accompanies the investment vehicle — it’s one of those “too good to be true” scenarios.
Many will dismiss the idea. After all, an investor only needs to look at the headlines to see that every media source directly or indirectly suggests Two Harbors is a great way to reap huge rewards indefinitely.
What’s not as blatant is the fact that the Federal Reserve is buying long-term mortgage securities with the ultimate goal of whittling their yields lower.
So far, none of the major mREITs (well, their investors) seem to care, as they haven’t been backing off on their buying efforts. In fact, TWO is the early leader in InvestorPlace‘s 10 Best Stocks for 2013 contest with 12% gains since Jan. 1. However, when the pendulum finally swings the other way (and it will — it’s the Fed), the leveraged nature of these REITS exaggerates the negative impact just as much as it exaggerates the upside.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.