The trick with high-yield dividend stocks is that they sound great on the surface, but they can be oh so dangerous … and the high yield could actually be the warning sign.
High dividend yields can often be a product of a severely reduced stock price, and while quick dips can happen on market sentiment, monster gaps down usually happen for a reason.
Also, sometimes that dividend yield isn’t sustainable … so drawing a 15% yield from a dividend stock is small consolation if the company either cuts the dividend or loses more than 15% in market cap in a hurry.
Today, we’re looking at three dividend stocks with sky-high dividend yields to see whether they’re safe.
Western Asset Mortgage Capital Corporation (WMC)
First up is Western Asset Mortgage Capital Corporation (WMC), a mortgage real estate investment trust, or mREIT. These entities invest in mortgage-backed securities.
The great thing about Western is that the mortgages that it invests in are often secured by the federal government. WMC, however, buys some securities that are not guaranteed. The risk with mREITs are that they borrow money at low rates over the short term to finance long-term purchases. If near-term rates rise, that squeezes the company’s margins.
WMC also declared an unexpected dividend bonus at year-end because the company had hedged interest rates with various derivatives that resulted in additional net income.
The issue with Western’s dividend yield is simple: Is it sustainable? I think so, because WMC always reports funds from operations that allow the company to make good on its dividends. And that’s great, because right now, the dividend yield is a whopping 20%.
As long as we don’t get a massive increase in interest rates — which doesn’t appear to be in the offing — WMC should be safe for at least the next year.
CYS Investments (CYS)
CYS Investments (CYS) is a bit more diversified in the mortgage securities market than WMC. It’s aiming to reduce its NAV volatility by reducing exposure to longer-term securities. CYS management doesn’t seem concerned about the fact that the Fed won’t buying up as many of their instruments as the QE taper continues. The yield curve is steep, financing has actually gotten cheaper, and although hedging costs are high, the spread remains attractive. CYS also feels the Fed taper has been priced into the market, so risk has declined.
CYS seems to be approaching the business carefully and is on top of things. That makes me feel a little bit more secure about its 15% dividend yield.
Chesapeake Granite Wash Trust (CHKR)
Chesapeake Granite Wash Trust (CHKR) has nothing to do with granite counters in your bathroom. It is a royalty trust, meaning it pays out royalties to shareholders from its energy holdings. In this case, it represents royalty interests in 69 Chesapeake Energy (CHK) natural gas wells and 118 wells that are in development. CHKR also is a relatively new trust, just more than two years old.
The trick with royalty trusts is that you don’t overpay for the value that the underlying trust actually holds. Royalty trusts also have dissolving dates. So you don’t want to pay a price that is way above the total distributions the trust will make before it dissolves. Trusts also are subject to concerns (not necessarily realities) over energy oversupply and if drilling doesn’t yield the results that are expected.
CHKR’s nearly 25% yield is outstanding, but I’m a little concerned with how fresh the trust is. Plus, two-thirds of the wells are in development and not producing.
Two-I am concerned that Chesapeake is too new for results to be proven. Two-thirds of the wells are in development, not producing, and that’s just too much unknown for me. None of this is to say that CHKR is a bad holding … it’s just too risky for my blood.
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.