High dividends are enticing. The prospect of earning 5 percent, 7 percent, or even 10 percent or more on your investment in the form of a dividend seems like it is too good to be true. But often, that is precisely the case. Dividends get to be high for a reason. Some companies, like limited partnerships or real estate investment trusts, have to pay out a certain percentage of their profits in the form of a dividend in order to retain their favored tax status, and you should expect higher dividends (but slower growth) from these sorts of companies.
But in general, a high dividend means that even investors who are focused on income-generating investments don’t want to get involved, and that is a red flag. So unless you have a very good reason to believe that a high dividend-paying stock is a worthwhile investment that the market is overlooking, you are better off looking for safer companies with lower dividend yields. In what follows, I list three companies that pay large dividends that I don’t think are very safe investments.
1. Annaly Capital (NYSE:NLY)
This has been a favorite high-dividend stock among investors. Annaly Capital is a mortgage REIT, which means that it manages a portfolio of mortgages. The company uses a lot of leverage — 6 times its equity — in order to generate outsize returns through the repayment of mortgages. While the company trades at just 9 times this year’s earnings expectations, it pays a 10.3 percent dividend, which means all of its earnings are going toward paying the dividend.
Furthermore, while the company’s earnings look good, a look at its shareholder equity tells another story. It is steadily going down as dividends are paid out. This is a bad sign, and more importantly, it suggests to me that the current strategy is unsustainable. This suspicion has come to fruition in the last couple of years, during which time we have seen the dividend cut in half, and the stock has fallen by 40 percent or so. While the stock has risen nicely this year as interest rates have gone down, this is unsustainable considering the fact that the company is losing value.
Given these observations, I think investors need to look elsewhere or use the recent market strength to exit their long positions.