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Money published an article in 2016 titled “The Science of Why We Fall for Scams That Are So Obviously Scams”.

The article cites Peter, a retired lawyer, who lost $2,000 on a literal get-out-of-jail scam. It was supposedly to keep his step-grandson out of jail: something he admits he’s “much too smart” to fall for.

Or at least he should have been…

Unfortunately, mere brains aren’t enough to avoid such traps. It also takes mastery over our emotions, which can fall fast and hard when something near and dear to us is on the line, whether that’s a loved one, our own pride, or our dreams.

All of us have a weak spot. Probably many of them. And they have a bad habit of getting us in trouble far too often.

This tendency applies to the world of investing just as easily as anything else. There are so many ways we can lose our cool… and our cash… if we don’t watch out.

Perhaps complicating the situation even more, it’s not that we always have to guard against literal thieves trying to sell us a load of hooey. Although that does happen, it’s far less likely than getting taken in by that well-meaning “hot tip” from our neighbor.

Or our own fascination with get-rich-quick schemes.

While not a scam in the literal sense, there are plenty of companies with dividend yields that sound too good to be true. That’s because, more often than not, they are.

I call these “sucker yields”. And today, I’ll tell you how to avoid them.

Born Every Minute

To be fair, most sucker-yield companies aren’t going out of their way to damage your finances.

They’re offering what they’re offering because of poor management, really bad luck, or a combination of both.

But as bad as we might feel for them being in that position, we don’t want to be in it with them. That’s why, as a true measure of safety, investors should always analyze at least three aspects beyond just yield:

1. The dividend’s underlying safety

2. The dividend’s ability to grow from current figures

3. The stock’s overall merit

Real dividend power can’t be calculated by yield, but by overall quality – the kind you can see by studying a company’s history of dividend payments.

Here are some of the questions you want to ask about it:

• Has it increased over time?
• How has it funded those payouts?
• Are those methods sustainable enough to continue funding them in the near future?

Past performance, of course, doesn’t guarantee future performance. But that doesn’t mean you shouldn’t consider it at all.

You should actually consider it a lot.

Looking in the rearview mirror almost always gives snapshots of corporate performance and tendencies. If a company has been a reliable dividend payer for years or decades, chances are good management will do everything it can to maintain that reputation.

On the other hand, if you see any dividend cuts, it could suggest management isn’t effectively controlling risk and might repeat those actions in the future.

Again, it’s not always the company’s fault. Sometimes, stuff happens… Like the COVID-19 pandemic, which forced many real estate investment trusts (“REITs”) into places management couldn’t have foreseen.

But even in those cases, we can empathize with management, it’s true. But we don’t want to stay on the ship with them as it goes down.

A Clear Example of a Sucker Yield

In the spring of 2023, I singled out Global Net Lease (GNL), a REIT that owned 309 properties covering 51 industries. At the time, its portfolio occupancy was 98%.

Even better, its dividend yield was enormous at 15%.

That was tempting. There’s no way of denying it. As I explained at the time, however:

… upon closer inspection, we find the company has around 41% invested in the office sector.

Why is that a problem?

Well, just remember the average office REIT is now trading at an adjusted funds from operation (AFFO) multiple around 9.5x.

[AFFO is an important metric used to evaluate REITs. It measures a REIT’s funds from operations, adjusted for recurring expenses to maintain the properties’ quality.]

This may help explain why GNL is trading below that multiple at 6.6x. Most net-lease REITs, however, are trading in the 15-17x area. So clearly GNL does not have the cost advantage compared with its actual peer set.

Speaking of cost of capital, GNL’s equity yield is an eye-popping 15% which makes it virtually impossible for the company to acquire properties with any investment spread whatsoever.

What about the dividend?

GNL is a high-yielder – with a dividend yield of 14.5% – and of course the 6.6x multiple explains much of the risk. However, you must also remember the elevated payout ratio of 95.8% (based upon GNL’s full-year 2022 AFFO) suggests the yield may not be sustainable.

During 2022, GNL’s AFFO fell by 5.65%, from $1.77/share to $1.66/share. Falling fundamentals combined with an extremely high dividend payout ratio do not signal a safe dividend.

That analysis turned out to be spot on.

In December of 2023, GNL slashed its dividend from $0.40 per share to $0.35. And then this June, it had to cut deeper still, slashing the dividend again to $0.275.

All told, GNL’s dividend has fallen by 31% since I wrote on it.

Longtime readers know I’m a big proponent of dividend investing. But those dividends must be safe.

They must be reliable. Otherwise, what’s the point?

Warren Buffett once said, “Look around the poker table. If you can’t see the sucker, you’re it.”

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