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Beware These Dividend Red Flags

04/16/2012 11:30 am EST


Kelley Wright

Managing Editor, Investment Quality Trends

Companies paying out more than half their earnings or offering very rich yields might be riskier then investors reckon, says Kelley Wright of Investment Quality Trends.

Kelley, in this world that we’re in today, everybody is increasing their dividends. More and more companies are paying dividends. We’re seeing dividend payout ratios start to inch up a little bit.

What should be an early warning sign for an investor, because everyone wants dividends? They like dividends, but they don’t think about when is too much or not enough.

Sure. It’s interesting. We go through these cycles where I like to say that it’s like Billy Graham went out and had a giant tent revival meeting, and everyone got religion, and now they all want to own dividends.

Good analogy.

But they don’t understand how to use them in terms of value. One thing that investors can look at always is the payout ratio. You know, what percentage of the earnings is paid out in the form of the dividend.

Now, really good, healthy, blue chip, mature…as long as they are kind of at, you know, around 50% or less, that’s good. I mean, if they get up to 55% or so, don’t worry about it. Utilities have a little bit of a different capital structure, and just usually as long as they stay around 75% or less, I don’t worry too much about it.

But if you see something where a company is starting to inch up and inch up and inch up and inch up, you know either the board is not necessarily confident enough to increase the dividend. Or they know that there is something coming down the pipe and they don’t want to do it. Or it’s just something else that the market hasn’t flushed out yet.

So it’s important to really look at the pattern?

Yeah, yeah. I mean, these days of when you buy something and then just tuck it away…

They’re over.

Hello! Yeah, I mean, come on. It’s a business. You know, you don’t start a business and then ignore it, you know? You have got to pay attention.

So when you’re talking about dividends, I mean people always tend to think dividends are just great, but there are things that investors do need to be concerned about.

What else do people need to know about dividends when they are looking at a company? Like there are mortgage REITs out there that are paying almost 20% in dividends. Do you think an average investor should just go and jump on that bandwagon?

Well, you know, not all dividends are created equal. And what one company calls a dividend, I think some of that is a return of capital or a return of principal depending on how they do it, and for some of them it is capital gains. OK?

That’s a big difference than when you have got an operating company. You know if you take what Coke (KO) and Johnson & Johnson (JNJ) and folks like that…do, and then what XYZ mortgage company does…I mean those are horses of a different color that you’re not comparing.

So just because it’s a great big dividend doesn’t mean you should automatically invest in the company?

Absolutely not. I mean, where is it coming from? And if somebody is paying you 19%—please.


In this environment. I mean, what are Fed Funds?

Very low. Extremely.

And what are junk bonds?

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