Continued from Part 4
The dividend trap
If there’s one takeaway I want you to pay attention to, it’s this: don’t focus on the trailing 12-month dividend yield. It’s irrelevant. It’s tempting to look at Yahoo and see a bunch of REITs with 20%-plus dividend yields and think you may have found a gem. Don’t fall into that trap.
An extremely high trailing dividend yield is a warning sign. It means the market is discounting the past and that it views the future as more uncertain. REIT dividends are volatile. To put this into perspective, Annaly (NLY) has paid the following dividends over the years:
Past performance definitely doesn’t indicate future performance. One thing to note with Annaly’s dividend stream: as the economy started recovering from the post–stock market bust and 9/11, rates started to increase. Look at Annaly’s dividend in 2003–2006. It fell. By a lot. Notice how the dividend increased rapidly as the financial crisis took hold and interest rates collapsed. Remember the scenarios I outlined in Part 3? As a holder of 30-year fixed-rate mortgage-backed security, Annaly benefits from economic weakness and declining interest rates. This also explains why the stock is off over 25% since May 1, when interest rates started to rise. The macroeconomic backdrop that benefits Annaly is over.
The absolute worst thing an investor can do is say, “I can pick up Annaly at $12.00 a share and get a 17% dividend yield.” You may get 17%, but you may not. And before you say, “Well, how much can they really cut the dividend?” the answer is, “A lot.” From 2004 to 2006, Annaly cut its dividend by 70%. If that happens again, you’re looking at a 5% dividend yield. Not bad, but it’s not 17% either.
Most of the REITs have yet to declare when they’re announcing earnings. The only REIT that has officially announced a date is CYS, which reports next week. As a general rule, the REITs tend to cluster around August 1 or so. When you look at their earnings announcements, pay attention to their leverage, book value, and asset mix, and compare the data to the macroeconomic outlook. Don’t fall in love with a high trailing dividend yield.
© 2013 Market Realist, Inc.