Here’s What Happens When You Chase 10% Dividend Yields

December 21, 2011 · 2 comments

I’ve seen this play out time and time again (often because I was a current or recent holder in the particular shares).  You see a juicy 8-12% yield on a stock you’ve never heard of, do some brief research on it, perhaps even taking a look at the recent chart to make sure it’s not an “artificial high yield” stemming from a recent drop and then buy it.  So, many investors jumped into Annaly Capital Management, Inc. (NLY) earlier this year chasing the 10% yield.  The company deals in mortgage pass-through certificates, collateralized mortgage obligations (CMOs), Agency callable debentures, and other securities representing interests in the obligations backed by pools of mortgage loans.

While the stock was yielding about 10% at the beginning of the year, a YTD chart shows a 9% loss, so for 2011, it’s essentially a wash.  Contrast that with the S&P500 (SPY) and you’re down 4% with a 2% yield for an effective loss of about 2%.  Given the much lower volatility and diversification of 500 stocks and the difference in the two being almost a rounding error, it calls into question the prudence of chasing NLY to begin with.

BOOM!

What is especially disconcerting about NLY is the recent dividend cut.  Presently showing a 15% yield, that just seems too risky for usual valuations, so it should not have come as a surprise to investors to see the recent announcement that the next dividend will be decreased to 57 cents per share from a high of 65 cents per share earlier this summer.  On one hand, even 57 cents per share would give 13.9% yield at today’s close, the question is whether that 57 cents is going to become 52 cents next quarter and so on.  The end result there would of course be not just declining dividend payouts, but also, declining share prices.

So, the question is, at what dividend yield can an investor feel safe?  Unfortunately, there’s no easy answer.  There are plenty of examples of stocks that were yielding 8% that performed great into the future on both a dividend increase standpoint and capital appreciation and conversely, plenty of examples where 6% yielders went south (witness virtually all financials during the collapse of 2008-2009).

What Are Your Favorite High Yield Stocks?

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