This Is One Of The Worst Times To Be A Greedy Dividend Investor

seekingalpha05-05

This is not the right moment to be speculative in the dividend world.By putting exercising some due diligence, investors can access juicy yields with limited risk.In this article, I tackle three ...

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First, why it is a good time to be a dividend investor? Second, what do the Goldilocks yield investors should focus on?Third, why is it not worth chasing even higher yield?In the article I also outline my dividend investing philosophy.   nicolamargaretThe reason why I think that this is not the right time to go high up in the risk curve to chase extra yield is because the existing offering that stems from highly defensive names is attractive enough to capture tangible streams of income. Similarly, in my opinion, looking at the macro-level dynamics it seems that each hundred basis points in yield above the average yield that is offered by well-structured companies introduces unfavorable risk and reward element, where the increase in risk exposure outweighs the yield benefit. To put some meat on the bones here, I will structure my thinking in the following sections:  Why it is a good time to be a dividend investor? What is the average yield that can be found in the market without assuming excessive risk levels? Why it is not worth chasing even higher yield?   Let's start. Why is it a good time to be a dividend investor? The answer for this is rather simple, where the key driver behind the overall yield increase across different security types (e.g., fixed income, equities, preferred shares etc.) has been the notable uplift in the Fed Funds Rate, which reached its highest level in the past ~ 15-year period.  Board of Governors of the Federal Reserve System (US)Higher Fed Funds Rate sets automatically a floor as to how low the risk-free rate and high investment grade bond yields can go. This dynamic, in turn, percolates through the overall capital market space by repricing the assets based on a higher yield assumption, where usually the risk-free rate acts as a reference point for the discount factor. So, in essence, it is a mathematical process that has made the dividend investing environment more favorable. However, it is not only the mathematical process (i.e., multiple contraction) that has rendered the prevailing yield more enticing. It is also the robust economy and improving cash flows that contribute to a favorable dividend investing conditions. For example, according to the FactSet, the analysts expect (year-over-year) earnings growth rates for the S&P 500 of 9.7%, 8.6%, and 17.3% for Q2 2024, Q3 2024, and Q4 2024, respectively. There are similar trajectories (albeit not to such a huge extent) across the REIT, BDC and MLP markets, which are commonly associated with juicy current income streams. Finally, in relative terms or compared to growth biased alternatives, the value names (which typically are the same companies that are deemed attractive for yield chasing investors) seem to be better positioned to at some point deliver value from the convergence process. The chart below illustrates how since 2020 the growth companies have really went ballistic (part of which has been multiple driven), creating a significant and unusual spread from the Russell 2000 companies. There are obviously reasons for that, but purely from the mean-reversion perspective, this situation bodes well for value names. The concept behind the mean reversion is based on the assumption that asset prices will always revert to the long-running average of a given data set, where there is a notable amount of evidence of such relationship holding true over a long period of time. In fact, it is so fundamental that effectively the technical analysis in finance is dependent on such an assumption (e.g., moving averages, average directional index, relative strength). So, once again, looking at the chart below it does seem that a considerable movement in either the Russell 2000 or the S&P 500 (or Nasdaq 100, which is even more growth factor heavy and diverged from the historical relationship) should take place as currently the return relationship has really deviated from the long-term average.   YChartsSo, in a nutshell, dividend strategy has become quite attractive largely due to more aggressive discounting process, which in many cases has nothing to do with the underlying financial performance. This warrants a situation in which dividend investors can find companies that have suffered multiple contraction, while their earnings continue to expand. Moreover, the more conceptual context of value lagging heavily behind the growth factor adds an interesting probability, where dividend investors could potentially benefit from mean-reversion process. What is the Goldilocks yield level? Before I elaborate further here in the section, it is vital to underscore that there is no right or wrong answer about the optimal yield that the investors should aim for when it comes to constructing their portfolio. Each investor has a different risk tolerance, preference for yield over capital appreciation and potentially a different tax situation, where in some instances capital gains could be treated more favorably in receiving current income. So, I will address this question from my perspective, which is the following:  To keep me motivated in allocating decent chunks of my salary into capital markets, I have to have periodic streams of current income. This means that each investment I make has to have a yield component. To be honest, I doubt that this is the optimal way of investing and most probably by incorporating some S&P 500 tilted equity exposure in my portfolio and some diversification from different asset classes (e.g., gold, other commodities, private equity, bitcoin) my total return results would have been better. However, dividend investing allows me to be consistent and aggressive in wealth accumulation, which in the long-run should deliver greater monetary benefit than if I for any emotional reasons did not allocate so much into capital markets. All of my investments have to possess de-risked financial characteristics so that I know that it is very likely that going forward my dividend will remain stable and / or gradually increase. The greater the frequency of dividend income the better (again, to manage the emotional biases). The yield has to be tangible enough and more biased towards receiving higher income now than sacrificing some basis points in yields just to expect compensation down the road in the form of steady dividend hikes.  As outlined above, I think that this is a very attractive moment to invest in dividend paying stocks as the yield have gone up, but the financial health of the companies is on average strong. So, what could be deemed an optimal yield, where on the one hand investors can access decent current income already now, and on the other hand not assume unnecessary risk (i.e., so that yield sustainability is maintained)? There are two parts to this answer. First is the easy one. The yield should be at minimum what the U.S. 10-year Treasury note or even the U.S. 2-year T-bill offer, which is 4.5% and 4.8%, respectively. Second is where things get tricky. Now the question is how much of a credit risk investors can take in order to enhance the yield above the risk free rate benchmarks and still comply with prudent investor principles, where dividend stability is a must. The answer is quite boring - it depends. It really depends on the situation as there could be specific names that are depressed multiple-wise and thus are able to offer juicy income, while the reason for the extra discount is nothing related to the stability of dividend, but, for example, growth potential or some failed transaction. With that being said, from my experience covering BDCs, equity REITs, MLPs and other high yieldings segments (e.g., coal, pharma, utilities) I would say that it is not that uncommon to find a dividend yield of 8% that is underpinned by robust fundamentals and a great margin of safety. This implies roughly 300 basis points above the risk-free rate, where I think it is possible to capture these yields, while investing in companies that have below average leverage, ample dividend coverage, really strong business profile in terms of the market share, size and growth projections. Here are two examples per each of the most common dividend investing segments. I have also added references to my bull thesis on these names. REITs or REIT focused CEFs  EPR Properties (NYSE:EPR) - dividend yield of 8.1% (bull thesis is here). Cohen & Steers Total Return Realty (NYSE:RFI) - dividend yield of 8.5% (bull thesis is here).  BDCs  Ares Capital (NASDAQ:ARCC) - dividend yield of 9.3% (bull thesis is here). Fidus Investment (NASDAQ:FDUS) - dividend yield of 8.4% (bull thesis is here).  MLPs  Energy Transfer (NYSE:ET) - dividend yield of 8.0% (bull thesis is here). Plains All American (NASDAQ:PAA) - dividend yield of 7.4% (bull thesis is here).  Why is it not worth chasing extra yield? The answer to this question is simple as well, and already captured by the above reflected arguments. In my humble opinion, it does not make sense to assume greater risk to chase yields that are in the double-digit territory, thereby sacrificing yield stability component. By accessing a yield of ~ 8%, we get very close to the 30-year average return that has been delivered by the S&P 500 (i.e., circa 10%). So, by investing in the securities that yield 8% and assuming that there is no price appreciation angle of these stocks (which is very unlikely), investors can lock in yields, at low risk, that come very close to the S&P 500 long-term return profile. By chasing even higher yields, say, in the double-digit territory, in most cases it means that investors are just going up the risk curve and additional risk. These risks are mostly leverage related, where the underlying company has taken just too much of a debt that renders the long-term cash generation quite uncertain. This is especially the case now when we experience strengthening of a higher for longer scenario. For example, in the REIT universe double-digit yields are usually associated with office related stocks, where the debt maturity wall in conjunction with structurally lower demand have introduced a lot of speculation around the going concern principle in some names. There are some specific names in health care like Global Medical (NYSE:GMRE) and Medical Properties Trust (NYSE:MPW), in retail like Slate Grocery REIT (OTC:SRRTF) and etc., where the yields are above 10%, but with a ton of balance sheet / debt financing risk. The bottom line In my opinion, this is not the time when it is necessary to invest in very high-risk instruments just to maximize the yield potential. The overall investment environment is favorable enough that investors by putting in some due diligence can find companies that offer truly attractive yields - around 8% - and at the same time provide the necessary income stability.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.","kind":null,"is_publish_news":null,"is_publish_highlight":null,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"symbols":[],"gpt_button":0},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.22.4","shortVersion":"4.22.4","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2433109134"}