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Don’t Get Caught Chasing a Dividend!

Exceptionally high dividend yields often are death traps

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It is the second category where investors tend to get themselves in trouble, both in stock investing and bond investing. Alas, your humble correspondent was one of the hapless souls who bought shares of Thornburg Mortgage in 2008 because it had a yield of over 10% and a “solid” portfolio of super-prime jumbo mortgages. That 10% yield didn’t get me very far when the company filed for bankruptcy. How many other investors were seduced by the 20%-30% yields offered on General Motors (NYSE:GM) bonds? Again, we know how that worked out.

Investors can avoid these traps by setting reasonable expectations. If a yield seems too high to be true, it probably is. Roll up your sleeves, take a look at the company’s financials and make that judgment call with a sober mind.

Income seekers currently have their pick of the litter of safe, moderately high-yielding stocks with room for dividend growth and price appreciation. As an asset class, master limited partnerships are attractively priced, and several — including Williams Partners (NYSE:WPZ) and Kinder Morgan Energy Partners (NYSE:KMP) — yield more than 5%.

REITs are more expensive as an asset class, buy here too there are bargains to be found. National Retail Properties (NYSE:NNN) and Realty Income Corp (NYSE:O) yield 5.7% and 4.5%, respectively, and I consider both to be safe.

Investors willing to accept modest risk of a temporary dividend cut should consider Spain’s Telefonica (NYSE:TEF). Telefonica currently yields over 10%, and its share price has taken a beating along with the rest of the Spanish stock market. I consider a dividend cut to be unlikely, though the board might opt to conserve cash if the European capital markets seize up again. Still, any cut in this case would be temporary. And unlike, say, RadioShack, Telefonica has a healthy business with excellent long-term prospects, particularly in Latin America. Use any weakness as a buying opportunity.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. KMP, NNN, O and TEF are all holdings of Sizemore Capital’s Dividend Growth Portfolio. Sign up for a FREE copy of his new special report: “Top 3 ETFs for Dividend-Hungry Investors.”

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