High yield dividend paying stocks, those paying over 6%, are generally considered riskier than other equities. There is good reason for this. Simply stated, if there weren't risk, perceived or real, then the price of the equities would rise thereby reducing the yield toward the norm, which for the majority of dividend paying stocks is between 1% and 3%. Equities paying over 15% are usually shunned entirely by stock brokers and investment advisors based on the theory that there simply must be something wrong for an equity to be paying such a dividend. They don't want their clients to buy a stock based on the current yield only to find the dividend is cut substantially, or the price per share drops significantly. It is easier to simply avoid these stocks.
There are certain circumstances where equities are paying a high yield, and for the time being, that yield is generally safe. The key terms here are "for the time being." For example, there are a number of MREITS, (mortgage real estate investment trusts) that are currently paying in excess of 15%. In many cases this is due to the current economic circumstances where historically low interest rates allow them to borrow at extraordinarily low rates and lend at higher rates. Then through leverage they are able to achieve significant profits. As REITs, they pay no corporate taxes, and by law must pass along 90% of their profit to their stock holders. The problem is, everyone knows, or at least believes, that when the FED starts raising interest rates again, the profitability of these equities will drop rapidly, dividends will likely be cut, and the stock prices will decline precipitously. Since no-one knows when the FED will start to raise interest rates, and since the market usually predicts movements ahead of time, these REITs are considered very high risk and thus generate yields in the high teens. While professionals tend not to recommend these REITs to the public, it is interesting to note that in most cases over 50% of their shares are held by institutions. Why would institutions buy these shares? Very simply, these professionals believe that they are smart enough to predict when interest rates will start going up. By listening to Ben Bernanke (the FED Chairman), who speaks publicly and is quite transparent in his speeches, and by paying attention to what the FED says in the minutes of their meetings, which is public information, anyone can have the same data as the institutions and make their own predictions as to when the FED will begin raising rates. From recent data, it certainly doesn't appear to be anytime soon. Nevertheless, these are not "buy and hold forever" stocks, but for the near term any individual can enjoy yields in the high teens the same as any institution. The key is to know and understand what you are buying and to be ever vigilant as to changes in the market place that may impact these equities.
MLPs (master limited partnerships) are another tax advantaged equity that by law must pass through 90% of their profits to avoid paying corporate taxes. Additionally, MLPs generally have the unique feature of having very high depreciation and their distributions are for the most part considered a return of capital and therefore generally a high percentage of their quarterly distributions are not subject to tax. There are other complexities to their tax structure that make these equities appear difficult to understand and are frequently avoided for that reason. There are a great many MLPs, generally in the oil and gas exploration and/or storage and pipeline businesses, that are paying in excess of 6% and have been doing so for a long time. Interest rates, the price of oil, and the overall economic outlook can impact the price per share of these unique entities, but if an investor is willing to do his/her homework, understand the tax implications, and make careful selections, these equities may provide an opportunity to lock in high yields with potential capital gains for years to come.
Business Development Companies (BDCs) are another investment vehicle that by law must pass through 90% of their profits to stockholders to avoid paying any corporate income tax. By the very nature of a recession, it is a slow time for business growth and BDCs tend to struggle during these times. Conversely, they do well during boom times. Right now, if you believe that the recession is behind us and that the environment is improving for business, BDCs might be the very place to lock in high yields. Due to the recession, and dividend cuts in a number of BDCs, they currently remain out of favor and therefore offer yields that are frequently 8% or higher. If the economy continues to improve, these yields will probably not last. Like MREITs and MLPs, BDCs are subject to impact from interest rate changes and revisions in economic outlook, and cannot be purchased and put in a drawer and forgotten. Finally, these investments are not as transparent as many corporations because they invest in a portfolio of smaller companies whose financial information is not generally available to the public. Such being the case, an evaluation of management skills and historical results are key in determining which BDCs to buy.
Like MREITs, BDCs and MLPs are often held by institutions because of the high yield. These institutional investors pay close attention to what is happening in the market place and make quick adjustments to their portfolios when the investing environment changes. Astute individual investors can do the same thing. The information that professionals act on is all available on the internet, and there is nothing preventing an individual investor from accessing it.
There is a plethora of information on MREITs, MLPs, and BDCs available through any search engine on the internet. It is important for any investor considering purchasing these equities to do his or her due diligence to insure that they understand what they are buying and that their chosen securities meet their specific criteria, as well as fall within their own tolerance for risk. Like institutional investors, it is incumbent on individuals to not become "married" to any individual equity, but to keep an equity in the portfolio only as long as it still makes sense.
Copyright 2010 Boyd Investment Holdings LLC. All rights reserved worldwide.
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