VALUE: After Hours (S08 E05): Yield Trap Warning: How to Identify Safe Dividends vs Risky High Yield Stocks

During their recent episode, Taylor, Carlisle, and Jay D. Hatfield discussed Yield Trap Warning: How to Identify Safe Dividends vs Risky High Yield Stocks. Here’s an excerpt from the episode:

[Jay] Well, first of all, it’s important for all ETFs to disclose something called SEC yield. And so that’s the cashflow coming into the fund. And so with our fixed income funds, the cashflow yield is essentially the distribution yield.

So we’re not returning capital. We might, from a tax perspective, return some capital, but that’s good because you don’t want to pay tax. But the cash coming in is very close to the cash going out.

And that’s published every month. And it’s very strict set of guidelines published by the SEC, hence 30-day SEC yield being the name. But you can also look that up for our equity income funds.

And then the reason that’s valuable, as you can see, like the distribution yield, the SEC yields usually like six or seven or eight. So that means we’re only getting 2% or 3% from ball routing. So having a substantial amount of real income is critical.

The other issue, some people, we have a European ETF, and I’m told that Europeans get really, really suspicious about any dividend yields much above three or four. And that’s a reasonable concern for common stock, but not preferreds. Preferreds, you get paid first.

That’s why it’s called preferred. And the yields are usually seven, eight, nine, sometimes six. So that’s not a sign of distress.

That’s just an indication that it’s more like that and less like common dividends. But so if a common stock has a dividend that starts approaching 10, a lot of time the management team will say, well, we’re not getting credit for the dividend and just cut it. So I would be concerned about trying to get super high yields from just common equities.

But it’s perfectly reasonable to get close to double digit yields from bonds and preferreds because that’s kind of their inherent return or yield rather. And it’s not a sign of necessarily distress. And also management teams, of course, with bonds, they have to pay them or else go bankrupt.

And then with preferreds that are loath to not pay them, and particularly all the ones that we invest in are public companies. So public companies want to have good credit. This is why they don’t need covenants as much.

Because their shareholders want them to have good credit. Their board wants them to have good credit, but most importantly, their counterparties. So the companies they do business with, pipelines being a good example.

If you’re transporting oil or natural gas, there’s credit risk on both sides. So it’s important for these companies to have good credit. So with better credits, you don’t have to worry as much about defaults.

And the sustainability of a dividend is quite high because the companies don’t want to suspend the dividends because then their rating agencies will downgrade them. Their counterparties will get concerned about their credit. So why are your dividends suspended on your…

Most of the time it’s cumulative, so you owe the dividends back if you start paying common dividends again. So I would say that’s a distinction to draw. Common stocks that pay super high dividends should be concerned about that.

Preferreds and high yield bonds, generally not.

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VALUE: After Hours (S08 E05): Yield Trap Warning: How to Identify Safe Dividends vs Risky High Yield Stocks

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