Where Can You Start Trusting A Yield?

Yield Cutoff: Identifying Dividends You Can Trust

If you look at a list of stocks with the highest nominal dividend yields, you’ll see that many of them are arithmetic freaks.

Some stocks paid a special dividend last year and won’t do so again. Others are about to cut their dividends or are paying dividends out of capital rather than income.

It’s only as you go down the dividend list that you begin to find stocks in which a sensible person would invest – and that leads us to a crucial question: Is there such a thing as a yield “cutoff”?

That is, can we define a specific yield below which dividends can usually be trusted and above which they can’t?

In today’s low-yield, inflated markets, that cutoff may be lower than you think…

In fact, it’s about 6%. That’s a pretty low threshold, especially considering that the front-runners on Nasdaq’s list of the highest dividend payers all have indicated yields above 40%.

Of course, while such yields look exciting, the dividends of these small firms merely represent a return of capital.

The top one, UBS ETRACS Monthly Pay 2x Leveraged Wells Fargo MLP Ex-Energy ETN (LMLP), is currently paying monthly dividends of $0.90, effectively cannibalizing itself. The second, New Germany Fund, Inc. (GF), is a closed-end fund paying out large capital gains, and the third, Swiss Helvetia Fund. Inc. (SWZ), is a Swiss closed-end fund that’s also paying out its large 2014 capital gains.

Now, there’s nothing wrong with an investment that makes you a 40% return in a year, even if you have to pay taxes on the distribution. But in these cases, the distribution is capital gains, not income, and the outcome is highly unlikely to be repeated in years to come.

Similarly, fallen angels often have very high nominal dividend yields that aren’t likely to last.

SandRidge Permian Trust (PER), for example, is an oil and gas MLP that has fallen on hard times and has seen its share price halved since last August. Since its latest dividend was based on the fourth quarter of 2014 – and reflects the high earnings from having sold oil forward at high prices – its dividend yield is currently a tidy 38%. Alas, that dividend is unlikely to continue once its hedges run out.

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