Dividend investors are always on the lookout for the best available yields on the stocks they pick. But if you only look at yields without digging a bit deeper, you can end up stuck in a trap that will cost you a lot of money in the long run.
When you look at Frontier Communications, BP Prudhoe Bay Royalty Trust, and DryShips, you'll see that each of them has a posted dividend yield that's above the market average -- and in some cases, far above it. Each of them has a longer story you need to understand before you make an investing decision you might regret.
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Losing the call
Frontier Communications has a long history of having top dividend yields, but unfortunately, those payouts haven't been large enough to offset the massive losses of shareholder capital that the telecom company has cost investors over the years. Frontier's share price has plunged by 85% in just the past year alone, and given its performance in past years, the stock has cost its longtime shareholders even more.
Frontier declared a quarterly dividend of $0.60 per share that got paid to investors at the end of December. That works out to a mouth-watering 29% dividend yield based on the current share price. But that payout is actually a greater-than-60% reduction from what Frontier paid as recently as early 2017, masked in part by the fact that the company did a 1-for-15 reverse stock split. With ongoing subscriber losses and few signs of any imminent recovery, dividend investors can't afford to rely on Frontier's payouts continuing indefinitely into the future.
The danger of variable payouts
BP Prudhoe Bay's dividend yield looks almost as attractive as Frontier's, coming in at 23%. Yet here, too, there's a story to explain the size of the payout.
For one thing, BP Prudhoe Bay is a royalty trust that makes variable distributions over time. The fourth-quarter payment of $1.23 per unit did indeed work out to an annualized yield of 22% based on the current unit price. However, that payment is the largest that BP Prudhoe Bay has made in a year, with its two previous payouts weighing in at $0.67 and $0.83 per unit, respectively. That still works out to a sizable trailing dividend yield, but it pulls the figure below the 18% mark.
The greater danger stems from the nature of the royalty trust. Despite rising oil prices, the acreage that BP Prudhoe Bay holds has seen declining production rates recently. When the trust dissolves, shareholders will no longer receive dividend payments, and the value of their shares will fall to zero. That in essence makes every dividend payment BP Prudhoe Bay pays a return of capital reflecting the depletion of the trust's future assets. That feature doesn't necessarily make BP Prudhoe Bay a bad investment if you think oil prices can stay high enough to keep the trust viable longer than investors currently fear, but you need to be aware of it before investing.
Ship this dividend out
Finally, DryShips makes the list not because of its particularly high dividend yield but because of the magnitude of its losses over the past year. The shipping company did not one but five reverse stock splits during the year, leaving shareholders with just a single share of stock for every 7,840 shares they started 2017 owning. That gave investors a loss of 99.9%.
In that context, paying any dividend seems ridiculous, yet that's what DryShips said it would do in early 2017. The company set aside a fixed dollar amount for dividends, with the number of shares determining what the actual per-share payout would end up being. With DryShips not having stated its dividend payout relating to the fourth quarter of 2017, investors shouldn't be surprised if even the 2.7% yield based on current prices falls.
Don't get trapped
Just because a stock has a high yield doesn't make it a good investment. By understanding what causes a stock to trade with a high dividend yield, you'll be able to make an informed decision about whether that stock deserves a place in your portfolio.
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