12.5% Dividend Yield: How Much Risk Is Tolerable?
The YCharts Stock Screener shows a dozen S&P 500 stocks offering dividend yields between 5% and 12.5%, including several popular conservative plays like AT&T (T) and Entergy (ETR). It’s a list any investor should appreciate, considering the returns promised here beat the roughly 4% gains strategists forecast for share prices in 2014 and well exceed Treasury yields. A sample in the chart below includes those companies and Windstream Holdings (WIN), healthcare REIT HCP (HCP), and utility FirstEnergy (FE).
But like most companies paying big dividends, each of these high yielders has ingrained problems that cause shareholders to reach for the Rolaids. Issues like dying business units, cyclical slowdowns and rising interest rates provide consistent threats to both the share prices and the actual dividends, giving their shareholders good reason to worry. So how does an investor decide if the stress is worth a shot at a great dividend?
One strategy is to consider the nearly-worst-case scenario. Assuming solvency, the two biggest risks for income investors are that the company will cut/omit the dividend, or that the share price will fall more than the yield on the payout. (Or fall enough to seriously minimize the total return.)
In occasional columns, YCharts evaluates on both fronts for top dividend payers using fundamentals analysis. For a right-brain element, we also assign a rating for each investment based on an estimated stress level taking on the shares would generate. A 3-Rolaids rating indicates a high risk investment; a 1-Rolaids rating the least risky. (High yield investments that don’t involve antacids are rather rare.) We start here with Windstream and its roughly 12.5% dividend yield, which is the highest in the S&P 500.
Rural telecom company Windstream has been a good example of how an investor can lose money in a company with a huge dividend yield. Over a two-year period, Windstream’s total return price performance (share price change plus dividend) was a negative 15% even though the shares maintained a dividend yield above 8% during that period.
This year’s total returns are running at about 6.5%. That’s considerably less than the 10%-plus dividend yield the company has had all year and the 29% total return for the S&P 500 so far, or even the 26% gain in the index without dividends.
Of course, Windstream investors still got their 10%-plus quarterly payouts and only lost money if they sold the shares. One strategy for collecting its high dividends today is to resign oneself to holding onto the shares even if the dividend is cut on the bet that improving company financials will eventually rebuild the share price. Twelve percent is a big return, even over a two or three year period.
But a dividend cut would likely devastate Windstream’s share price, and the charts point to a likely one soon. Windstream management insists that won’t be necessary, but you can by the charts below why they have to spend the bulk of any investor presentation explaining why not. The company is spending more than four times its net income, or 80% of its free cash flow, on dividend payments -- frightening levels for a payout ratio and a cash dividend payout ratio.
Windstream contends that a growing broadband services division will make up for its shrinking rural telephone line business before the dividend payments become unsustainable. But Windstream’s revenues and earnings are expected to fall this year. The following year is supposed to see revenues level off and a significant turnaround in earnings.
YCharts was skeptical of Windstream back in April 2012 when the dividend yield was 8.5%, both because the payout looked unsustainable and the core business growth weak. The share price is down 31% since then; total returns are down 18%; and there’s still little growth. The dividend, much to our surprise, remains intact. Chasing it, however, will require even more Rolaids now. If you're still curious, read the 10-K and subsequent Q's, and unleash some financial advisor tools on the stock.
Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at firstname.lastname@example.org. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.
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