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On July 1st, Standard and Poor's issued the following in a
press release:
"Dividend decreases were posted by 250 issues during the
second quarter of 2009, the highest number since the second
quarter of 1957, over 50 years ago."
According to Howard Silverblatt, a senior analyst at S&P,
annual dividend increases have outnumbered decreases for as
far back as S&P records go -- 1955. But that streak looks
like it will end this year.
"It's not a good time for dividend investors," according to
Silverblatt.
Judging from this report, you might think income investing
is a lost cause. You couldn't be further from the truth.
For example, the portfolios in my premium
High-Yield
Investing newsletter have rarely seen better days. I
informed readers a
few weeks ago that every single one of my current
holdings was showing a gain. As of my latest update I did
have one pick in the red -- it was down -0.3%. Moreover, my
holdings yield as high as 12.9%. And only two of the 23
positions yield less than 6%.
So you can see it's possible to make this environment a
great time for income investing, but now -- more than ever
-- you have to focus on dividend safety. The question is,
with so many stocks cutting payments, how can you get any
sense for the safety of the dividend?
Two Tricks to Find Safety
The first trick I use is an old standby of income investors
-- the payout ratio -- but with a twist. The payout ratio is
simple. Take how much the company earns and divide it by how
much it pays in dividends. If a stock earns $1 per share and
pays $0.50, it has a payout ratio of 50%. Ratios below 80%
are generally considered "safe."
But sometimes you have to be a little more sophisticated
with payout ratios. Some securities carry unreasonably high
ratios if earnings alone are compared to dividends paid. But
in the case of shippers or telecoms -- or any company that
encounters high depreciation expenses -- a more accurate
payout ratio comes from comparing operating cash flow to
dividends paid.
This figure can be found on the company's cash flow
statement and backs out non-cash charges like depreciation.
Depreciation expenses lower earnings for a company, but
don't actually affect the cash available for dividends. By
accounting for this nuance, investors can have a better
sense of the dividend's safety.
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Trust
Preferred Shares |
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Can be bought or sold throughout the day on the
NYSE.
Usually issued at a par value of $25 per share.
Investors receive that amount at maturity or if
called.
Fixed payment that can't change at management's
discretion.
Interest payments are debt obligations that must
be paid before common share dividends. |
Income Required by Law
The second technique I'm using to prosper is focusing on
securities required to make payments to investors.
Believe it or not, the dividends from common stocks are the
least secure of any income investment. These payments are
made solely at the discretion of company management. When
business goes south, cutting the common dividend is usually
the first move made to save cash.
But there are dozens of securities that offer guarantees of
payment. For example, real estate investment trusts (REITs)
and master limited partnerships (MLPs) are required by law
to pass on a bulk of their income to investors.
But one of my favorite legally obligated income streams
comes from trust preferred shares. These beauties have many
of the same characteristics of bonds, but they trade on the
NYSE just like a common stock, making them easy to buy and
sell.
As for safety, they can be second-to-none. I picked up
shares of Wells Fargo 8.625% Trust Preferreds (NYSE: WCO)
in January. These notes are backed by Wells Fargo, which
carries a credit rating of "A3" from Moody's and "A" from
Standard & Poor's -- indicating little risk of default.
At the height of the financial crisis Wells Fargo had to cut
its common dividend by more than -85% to save cash. But the
trust preferred shares have kept making their steady
payments of $0.54 per share every quarter (for a current
yield of 8.1%) ... and have even
risen in price to above their par value. In fact, since
adding WCO to my
High-Yield Investing portfolio, I've
gained nearly +20% and don't have to worry about my income
stream being crimped.
It just goes to show that by keeping a close eye on safety,
right now can still be a great time to be an income
investor.
Good Investing!
Carla Pasternak's Dividend Opportunities
P.S.
-- Don't miss a single issue! Add our address,
Research@DividendOpportunities.com,
to your Address Book or Safe List. For instructions,
go
here.
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