The Market's Measure
One More Thing To Worry About: Dividends

One More Thing To Worry About: Dividends

Earnings and cashflow volatility put payouts at risk.

The market’s now digested the news of the Fed rate hike. Perhaps not so well. There’s still a lot of hiccups and burps heard in trading rooms. One thing’s certain, though: a quarter-point boost in the Fed Fund target rate ain’t making anybody rich. Not if they’re savers or retirees.

Such folk remain hungry for yields and ready users of income strategies, most especially high dividend stocks and funds. There are some pretty enticing dividend yields being dangled in front of investors now, free of interest rate and duration risk.

Dividends, of course, carry a different kind of risk. They aren’t guaranteed. Dividends can be cut or suspended at will, though companies are generally loathe to do so. Slashing dividends spooks investors, no matter what reason is given for the decrease. And nowadays, there are plenty of reasons to cut dividends. Deterioration in earnings and cashflows, in particular, figure large.

More than a few dividends, identified by the Reality Shares Advisors DIVCON screen as “very risky,” are in imminent danger of cuts or suspensions. These are mostly payouts from mortgage REITs, energy companies and financial institutions.

Some exchange-traded funds are loaded with shaky dividend payers. One in particular is the PowerShares Russell Midcap Pure Value Portfolio (NYSE Arca: PXMV) which owns nine of the 15 riskiest stocks. Together, these issues take up more than six percent of PXMV’s capitalization:

 

Stock Dividend Yield (%) Portfolio Weight (%)
Annaly Capital (NLY) 12.16 1.16
First Energy (FE) 4.60 1.05
American Capital Agency (AGNC) 12.83 0.92
Frontier Communications (FTR) 8.84 0.85
Marathon Oil (MRO) 5.45 0.70
Newmont Mining (NEM)  0.62 0.69
Energen Corp. (EGN) 0.16 0.54
Consol Energy (CNX) 0.41 0.34
Freeport-McMoRan (FCX) 2.06 0.15

 

 

 

 

 

 

 

 

The bad juju from any one of these issues may not cripple the PXMV fund but in concert, the capital effect could be devastating. Three of the lowest dividend yields (NEM, ENG and CNX), in fact, result from cuts undertaken over the past year. In that time PXMV shares lost nearly 12 percent of their value versus a three percent dip in the S&P 500.

If the wobbly dividends in the PXMV make you nervous, you ought to be absolutely frantic about the exposures in the mortgage REIT ETFs. The iShares Mortgage Real Estate Capped ETF (NYSE Arca: REM) gives up more than a quarter of its portfolio to NLY and AGNC. Likewise for the Market Vectors Mortgage REIT Income ETF (NYSE Arca: MORT). NLY and AGNC dividends have been in steep decline as prices for both ETFs tumbled.

The lesson to be learned here? Just this: If you’re living off dividends, make sure your dividends are likely to live on.

 

Brad Zigler is REP./WealthManagement's Alternative Investments Editor. Previously, he was the head of marketing, research and education for the Pacific Exchange's (now NYSE Arca) option market and the iShares complex of exchange traded funds.

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