Chasing Yield Is Fraught With Risk

This suggests that some of its tenants which operate in the traditional bricks and mortar environment have likely been unable to adapt to the changing retail environment. As a result occupancy levels have dropped off thus resulting in certain properties no longer being attractive long-term investments.

This couple looks at the company’s recent dividend history (2012 – 2017) and notices the quarterly payments on the units have remained unchanged for several years. They also take a gander at the 2003 – 2011 dividend history and notice distributions used to be made monthly. They further notice that in March 2012 RPAI:

  • triggered a ten to one reverse stock split (this is not a good sign);
  • redesignated all its common stock as Class A common stock and paid a stock dividend whereby each outstanding Class A common stock received one share of Class B-1 common stock, one share of Class B-2 common stock and one share of Class B-3 common stock.

This couple realizes the dividend history is unattractive and then becomes more disenchanted with RPAI when they look at the company’s stock’s performance.

This couple decides RPAI is definitely not a suitable investment.

Other Shortcomings

This couple is starting to understand the bigger picture. They perform a similar rudimentary analysis on other 5%+ dividend yield companies. What they find is that in some cases, the yields reflected on stock screeners are not entirely a ‘return ON capital’. In some cases, the yield is also comprised of a ‘return OF capital’.

The more this couple delves into this list of companies the more they uncover! There are actually companies out there that are raising debt to sustain their dividend. In other cases, more shares are issued for ‘general purposes’. Who is to say some of these proceeds are not being used to sustain the dividend?

Yikes! Most of the companies on this 5%+ dividend yield list are far from suitable investments. This couple now suspects their neighbors who told them ‘It is like fishing in a barrel’ really have no clue what they are investing in. It is as if their neighbors have no common sense. Perhaps common sense isn’t common!

What Will Happen When Interest Rates Rise?

One evening while watching the evening news, this couple learns that the Fed has forecast 3 interest rate hikes in 2018. This couple puts two and two together and realizes that this will impact returns on investment vehicles of lower risk. If the gap in yield between lower risk investments and these somewhat more risky investments narrows, what is the likelihood investors, are going to find the 5%+ dividend yielders attractive.

This couple begins to wonder if the luster of these juicy dividend yielding stocks will wane as we enter a rising interest rate environment. In essence, if the shine comes off, will investors ‘head for the exits’ thus putting pressure on the stock prices?

This couple also begins to wonder why on earth people would invest in companies of dubious quality when there are countless great quality companies to choose from. Perhaps investing in sub 3.5% dividend yield companies will not generate sufficient income to service living expenses, and therefore, an encroachment on capital will be required.

While not an ideal situation, at least high-quality companies increase their dividends consistently. In addition, the probability of a permanent impairment to capital is much lower.

This couple ultimately decides investing in great companies really is the strategy to adopt.

Final Thoughts

It is apparent this couple realized that chasing yield can be a recipe for disaster. You can’t target higher yields without reducing your exposure to other favorable metrics.  High yield stocks tend to have lower quality and growth scores, as an example.  Extra caution must be taken when analyzing and investing in high yield stocks.

If, after having read this, you still insist on chasing yield I suggest it may be wise to remember the old adage ‘if it seems too good to be true it probably is’.

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Disclosure: Sure Dividend is published as an information service. It includes opinions as to buying, selling and holding various stocks and other securities.

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