Who wouldn’t like a piece of a juicy double-digit yield?
Of course, the issue you come across in dividend stocks with big yields is that they often also have some big risks associated with them. High volatility and murky growth prospects are two common tradeoffs for high-yield stocks.
So, I decided to see if I could wade through the prospects and find an enormous dividend that might be worth the risk. A couple mega-yielders I’ve examined are junkers and to be avoided, but I’ve also come across a couple real investment possibilities.
Whiting USA Trust II
Dividend Yield: 18.5%
Whiting USA Trust II (NYSE:WHZ) is a royalty trust associated with the company Whiting Petroleum (NYSE:WLL).
Royalty trusts pay royalties on the energy sources that are drawn from the ground. The underlying value of the trust, however, declines over time because those resources eventually deplete. You also have to factor in how oil and gas prices affect the trust, since falling prices are obviously bad.
… actually, I’m going to stop right there.
I don’t care if the trust is yielding in the high-teens if depleting assets and commodity volatility could kill me.
Distribution Yield: 20%
PetroLogistics (NYSE:PDH) is a master limited partnership that owns and operates propane dehydrogenation facilities. (For us chemistry geeks, that means it converts propane into propylene.)
The chemical is a starting product for chemical reactions — a raw material used for things like films, packaging and caps. Profit depends on the spread between the commodity pricing between propane and propylene.
Personally, I don’t like being tied to commodities like this. But if you’re willing to ratchet down your holdings in commodity baskets (in a diversified portfolio), and replace it with this company, then PetroLogistics might be worth the risk. The company’s last distribution of 67 cents annualizes out to a whopping 20% yield.
Just remember that PDH falls into the speculative category of investments.
Dividend Yield: 14%
Portugal Telecom (NYSE:PT) would scare me off if the company only handled telecommunications in Portugal. Luckily, it provides all kinds of infrastructure and communications services in emerging markets across Asia, Africa, and most notably, booming Brazil, so the stock has lots of potential.
However, I’m not sure the 14% dividend is sustainable.
Last year, the company generated net income of $304 million, and free cash flow of only $75 million — but paid out $847 million in dividends. That was down from $1.56 billion in 2011 and $1.94 billion in 2010. The company has $4 billion of cash on hand, but this is a capex-intensive business.
Sorry, but if the dividends are falling, not rising, I’m staying away.
Western Asset Mortgage Capital Corporation
Dividend Yield: 17.5%
Western Asset Mortgage Capital Corporation (NYSE:WMC) is an mREIT, meaning it invests in residential mortgage-backed securities for which principal and interest payments are guaranteed by the government. So I like that Uncle Sam is on the hook here.
The way mREITs make their money is via arbitrage, so they borrow money at a lower rate than their portfolio yields. As long as interest rates remain low — and that will be the case for a long time — that arbitrate should hold firm. They carry more leverage than I’d ideally like, but then again, they’re paying 17.5% dividend to offset that risk.
I think this is also worth looking at but, again, only as the speculative part of a diversified portfolio.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at firstname.lastname@example.org and follow his tweets @ichabodscranium.