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Unlock Amazing 23.6%
Yields Powered by Earnings |
Published:
May 27, 2008
Choosing a dividend-paying security is a bit like deciding on a
bottle of wine with your dinner. The bottles might look the
same, but they will taste totally different depending on what
ingredients went into making them.
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The taste test applies to income investments as well. Take the
Boulder Growth & Income Fund (NYSE: BIF). It enjoys a staggering 16.9% yield. But the Alpine Total Dynamic Dividend Fund's (NYSE: AOD) 16.1% yield looks just as tempting. Both funds invest in
dividend-paying stocks and dish out monthly distributions,
which they have kept at a steady rate.
So which one should you spring for? The answer depends on what
went into making those
distributions. Boulder paid out
$1.35 a share last year to BIF
shareholders. But according to the company's latest annual
report, it only earned $1.31 per share. Worse yet, after payouts
to preferred shareholders, only $1.20 per share of earnings was
left for distributions to fund holders.
So where did the money come from to pay BIF's distributions?
Well, $0.57 came from investment income earned on the fund's
portfolio, $0.03 came from capital gains on stocks sold, and most -- $0.75
-- was simply a return of original investment
capital in the fund. In other words, the fund paid out more than
it could afford.
Compare that with Alpine's payouts. In 2007, its first full year
of operations, the fund raked in earnings of $2.60 per share. It
gave shareholders $1.98 of that amount in dividends, saving the
rest for a rainy day. The distribution consisted entirely of
investment income earned from dividends and interest from the
fund's portfolio holdings, and the fund paid out only what it
earned -- with no capital gains or return of capital.
"So what?" You may ask.
Capital gains payouts can be huge but you can't count on them as
part of your regular income stream. They're generally paid out
only once or twice a year, if the firm or fund has profited from selling
assets like stocks, real estate, options or other derivatives.
These special year-end payouts also can create great volatility
in the share price. That's because the share price drops to
reflect the amount of the payout when the shares go ex-dividend.
(The day before the shares go "ex-dividend" is the last day you
can buy the stock and still collect the payout.) As a result,
securities that generate large capital gains payouts can see
wild price swings around the ex-dividend date -- making them
unsuitable for conservative investors.
Like capital gains, a return of capital isn't generated from a
firm's regular earnings either. Sometimes, it is simply cash flow in
disguise. For example, income trusts or master limited
partnerships (MLPs) may include a return of capital in their
distribution so as to pass along cash flow that's not part of
their reported earnings.
Closed-end funds typically use return of capital to support the
distribution rate whether earnings rise or fall. To do this, the
fund may dip into its investment capital and essentially hand
back your original investment. You don't pay taxes on this
portion of the distribution, but the amount may reduce your cost
basis when you sell the shares. As such, you could end up paying
more in capital gains taxes.
There's something else about dividends that every income
investor should know -- don't assume dividend increases
signal that earnings are growing as well, particularly for a
fund. BIF's payouts nearly doubled from $0.72 per share in 2006
to $1.35 in 2007, but total investment income dropped by almost
a third from $1.91 in 2006 to $1.31 the following year. Returns
of capital, not earnings, accounted for the lion's share of the
distribution growth.
The bottom line is earnings are one of the more reliable sources
of sustainable dividend income over the long-term. And depending
on how the earnings are generated, earnings-driven yields also
can be tax-advantaged.
For
today's screen we went in search of high-yield stocks that offer
a high degree of dividend safety thanks to their earnings-driven
yields.
Important Note:
In the remainder of this article,
High-Yield Investing editor
Carla Pasternak provides an in depth list of dependable
securities that offer yields as high as 23.6%, and are driven
almost entirely by earnings. However,
in order to view the remainder of this article, you'll need to
subscribe to our premium investing newsletter --
High-Yield Investing. After you subscribe, you'll
receive immediate access to this full article, as well as our
monthly
High-Yield Investing newsletter and a host of
additional premium content. Please visit one of the following
links to continue.
Carla Pasternak
Editor
High-Yield Investing
http://www.StreetAuthority.com
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