In the endless hunt for dividends, one must always be careful not to jump into a security that pays a really high dividend just because it has a big number before the percent sign. Some companies pay out more than they can afford, and when that dividend gets cut, the stock will fall, wiping out whatever quarterly payments you’d been collecting in the form of capital losses.
Today, I’ve found four stocks paying sustainable dividends over 7% that are unlikely to suspend or cut those payments.
Annaly Capital Management
Annaly Capital Management (NYSE:NLY) is a mortgage real estate investment trust, or REIT. These companies are able to borrow money at low interest rates, then use the proceeds to invest in securities that are known as Government-Sponsored Entity Mortgage Backed Securities, or GSE-MBS. These securities pay a very healthy interest rate themselves, thus Annaly profits from the spread between the two rates. It then throws the income off to its shareholders.
NLY’s dividend yield currently is 14.9%, and it’s trading at about 25% below where it normally does on a book-value basis. Sounds too good to be true? For the moment, no, but Annaly is worth keeping an eye on. If interest rates start to rise, you’ll want to sell out, since the spread will decline.
Fifth Street Finance Co.
Fifth Street Finance Co. (NYSE:FSC) is known as a Business Development Company. These entities operate under special rules that allow them to invest in middle market, bridge financing, first and second lien debt financing, expansions, acquisitions, add-on acquisitions, recapitalizations and management buyouts in small and mid-sized companies. They often charge interest in the low- to mid-teens and take an equity kicker in the form of warrants to purchase the company stock. These entities also spin out much of their income to shareholders — in FSC’s case, 13.1%.
The trick here is that Fifth Street does its due diligence and doesn’t invest in risky operations that end up defaulting. Fifth Street has more than $1 billion invested in companies and is only 30% leveraged, so FSC has a wide margin for error should investments have to be written down.
Medallion Financial Corp.
Medallion Financial Corp. (NASDAQ:TAXI) is exactly the kind of oddball investment I love. In this case, the governments of various cities, such as New York, have decreed that one must have a special license, or “medallion,” to operate a taxi. By limiting the number of medallions, a city artificially puts a cap on the number of taxis (now you know why you can’t get one in the rain) operating within its limits.
Consequently, because demand for medallions exceeds supply, the medallion cost is very high ($450,000) and must be financed. Enter Medallion Financial. This is a business with no real capital expenditures and no cost of revenue. Thus, net margins are 23%. TAXI just has a lot of cash and no business to expand, so it pays it out in the form of a 7% dividend.
France Telecom
Finally, we have a foreign telecom provider, France Telecom (NYSE:FTE). Does this seem like an odd choice? Not when you consider it’s the country’s largest telecom provider and third-largest in Europe. France Telecom routinely generates billions in free cash flow and pays much of it as a dividend, currently at 7.5%.
Telecoms often pay high yields because their model is one of regular subscribers, so revenue can be relied upon. France Telecom is not growing — it much resembles our own AT&T (NYSE:T) in that regard, and FTE stock is down because of Europe’s financial turmoil. However, France Telecom seems like a solid company that pays you well to hold its stock.
Remember to keep an eye on the financial health of any dividend-paying stock. If interest rates rise, you’ll want to sell Annaly. If another liquidity crisis should hit, you’ll want to bail on Fifth Street. And if Godzilla attacks New York — well, you’ll want to hop in a cab and get out of town.
As of this writing, Lawrence Meyers did not own a position in any of the aforementioned stocks.
