One of the best characteristics about dividends is they usually offer a consistent, preferably growing stream of income. However, investors can easily fall into the trap of becoming complacent that future payments will continue to flow in, even when the business isn’t generating enough cash to fund the dividend.
The higher the yield being offered generally means the riskier the dividend is and sometimes losses can outweigh the expected income. For example, Dynagas LNG Partners (DLNG) cut its 16% yield back in April and shares are down 24% since.
With government bonds paying around 2% to 3%, dividends above 10% need to be scrutinized closely and I’ve identified two that are in danger of disappearing.
Dangerous Dividend No. 1: Legacy Investments Could Smother the Dividend
Blackrock Capital Investment (BKCC) is a business development company (BDC) that is trading below its net asset value, which generally signals a potential buying opportunity. That said, the company’s portfolio includes legacy investments that are a wet blanket and could smother the 11.5% dividend yield.
In fact, management has failed to generate enough NOI to pay the dividend four of the past five quarters.
The company’s net asset value actually fell during the period, as management had to write down legacy investments in the industrials, insurance and metals businesses.
Another red flag for Blackrock Capital is the current leadership vacuum in the C-suite.
The company has been without a full time CEO since April and its interim CFO has been “filling in” for 11 months now.
Blackrock Capital’s bonds are currently rated BBB- by the major agencies, which is last level before reaching junk status. Debt investors will demand their interest before any dividends are paid and the next management team may have to sacrifice its payout if push comes to shove.
Dangerous Dividend No. 2: Feeling the Margin Squeeze
MFA Financial (MFA) is a real estate investment trust (REIT) that invests in mortgage securities. Like most others in the financial world, the company is feeling the squeeze of the flattening yield curve.
Simply put, mortgage REITs borrow at short-term interest rates and reinvest the funds into higher-yielding mortgage instruments. It’s no surprise that the Fed has been steadily increasing short-term rates, while yields on long bonds have remained stubbornly low, as far as MFA Financial is concerned.
The company earned $0.17 a share in the second quarter, aided by $0.02 of investment gains. Either way you slice it, management didn’t cover the quarterly dividend of $0.20. That’s the second time in the past four quarters MFA Financial has failed to earn enough to support the payout.
Not only is the yield curve working against the company’s favor, as evidenced by the 18% year-over-year revenue decline last quarter, but management also reported higher operating expenses in the period. In my experience, a stock that regularly under-earns its dividend will struggle to sustain the payout for more than a year.
— David Peltier
Chasing double-digit yields is risky business. The investing graveyard is littered with dividend promises left unfulfilled when the cash was no longer flowing in to sustain these lofty payouts.
A stock like Dynagas or these two potential time bombs can spell disaster for your portfolio, especially when in or nearing retirement. Not only might you have to forego some much-needed dividend income, but you could also potentially lose your hard-earned nest egg.
The good news is: there’s a better way. My colleague Brett Owens has created an “8% No-Withdrawal Portfolio” that generates steady income and impressive capital gains.
Whether you’re already retired, or looking to augment your paycheck with the passive income that dividends afford, you no longer have to choose between measly 2% to 3% yields from dividend “aristocrats”, government-secured interest payments that barely keep up with inflation and dicey double-digit dividends.
Wall Street has tried to address this issue with structured products, such as single premium immediate annuities (SPIAs). But just like the casinos don’t pay for all the glitz and glamour because gamblers usually win, the big financial service firms charge hefty fees to provide you with that steady income.
Instead, Brett’s system could hand you $40,000 a year on every $500,000 invested with under-appreciated income plays like:
- Closed-End Funds (CEFs)- We’ll share our top three CEF picks with you, each of which pay a monthly dividend. Many of these trade at a discount to net asset value; but unlike Blackrock Capital, actually can afford to pay their dividends.
- Preferred Stock- Brett lets you know two of the best active managers in this space to invest alongside with.
- Recession-Proof REITs- discover two REITs that actually benefit from higher interest rates; rather than being crippled by the Fed, like MFA Financial.
That’s 7 contrarian investment picks just to get started. Click here for instant access to the full 8%, No-Withdrawal portfolio.
Source: Contrarian Outlook