Beware Momentum Income Investing

06/05/2012 11:00 am EST

Focus: STRATEGIES

Roger Conrad

Founder and Chief Editor, Capitalist Times

Income investors should not chase the most popular high-yielding stocks, warns Utility Forecaster’s Roger Conrad, but he does share two high yielders that he likes.

Momentum income investing. We’re here with Roger Conrad, and he’s going to tell us why to avoid it.

Well, you know Gregg, some people worry about interest rates and some people worry about the economy when it comes to investing.

I worry about it all.

And as well you probably should. You know, this market looks a lot like 2010 and 2011, when we had a very strong start with a lot of weakness in between, and a lot of people started worrying about stuff, and then it came out the other end looking pretty good.

But the people who really got burned throughout that whole process—and I think are set up to get burned again—are people that got very excited about certain companies that they thought were absolutely safe and could never lose money, and they bid these companies up, dividend-paying companies.

Other companies, something might have happened, something trivial, some worrying. Selling then begat more selling and we saw stocks going down for the reason that people are selling because the stocks were going down.

That’s really the essential focus of momentum investing. And it was very popular in the 1990s. I’d wager that most income investors would argue that’s not what we’re doing and that’s the farthest thing from what they’d want to do, but when you do chase the stock up because you think it’s safe or you sell a stock off hard for no good reason other than the fact that it’s selling off, that’s essentially what you’re doing.

Especially for income investors, I mean, the goal is to find good solid companies and stick with them over the long term, so that you don’t have to deal with all of the taxes of capital gains and everything else, plus to get some consistent yields, right?

Yeah, absolutely. You know, with dividend yields, you don’t capture them if you’re buying and selling. One of the biggest advantages that income investors have, though, is when dividends are raised, stock prices move up behind them. So you get capital gains as well if you’re in there buying and holding.

But to get that, you’ve really got to look at companies, buy the businesses, and make an assessment of each company and its value. What’s it worth? And shorthand could be taking the yield and taking a dividend growth rate or the earnings growth rate and adding those together. If you get the 10% for something very safe, I think you’ve got a pretty good bargain there.

Now, you want to keep in mind safety issues with these things. So you have to keep in mind the debt levels and payout ratios and so forth to make sure these dividends are sustainable, and make sure your value isn’t hanging on some sort of artificial peg.

But again, this is the way you should look at it, company by company staying on the ground. And don’t be afraid to buy something if the numbers look good on it and people have just sold it because of more selling or its caught up in a momentum. Negative momentum investing.

Do you have a couple of examples of what you like?

Well, I think a lot of the telephone companies have really been victimized by momentum income investing, and for good reason—or understandable reason, anyway. A lot of these telephone companies, there have been dividend cuts in the sector.

But a company, Windstream (WIN), that we follow, announced some earnings that were a little bit disappointing maybe, but it looked that it cut through a bunch of stops. It looks like people began selling it because other people were selling it, and so even though the company covered its dividend very effectively, now it’s yielding over 10% because the stock prices have come down very hard.

So that’s an interesting opportunity. I’m not a believer in averaging down or doubling down in these stocks, but for somebody with new money, it’s a pretty good place to take a look at some of these companies that have come down.

Another company would be Buckeye Partners (BPL). It’s a pipeline company, and there’s sort of a fear out there that it’s also going the way of some of these other companies. It’s gone down pretty much from the low $60s to the low $50s, which for an income stock is a pretty big deal.

Basically, it’s gone down because they did not raise their dividend in the most recent quarter as they had in previous quarters, and they did that to be a little more fiscally prudent and a little bit more fiscally conservative. As a result, you’ve had this massive reaction in stock. People selling it. Stops going through.

So those would be examples of negative momentum. An example of positive momentum would be a company I actually like a lot, which would be Enterprise Products Partners (EPD).

But it’s appreciated pretty dramatically: the yield’s now well under 5%. And they are increasing their dividend over time, but if you look at the yield and you look at where it’s gone, I think people have sort of fixated on it as a safety. That’s the danger of momentum investing.

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