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Finding
a dependable high-yielding investment these days is a little
like learning to choose a fine wine. From the outside,
one bottle of wine looks much like another. But grapes
from some regions always produce better wine than others.
Some dividend yields may also look alike at first
glance. But, like grapes, better quality dividends
come from a certain financial region -- they come straight from the
company's earnings.
A Tale of Two Yields
To illustrate the strength of earnings-backed dividends,
let's look at two different high-yielding funds.
Although these are actual examples of real funds, we'll call them "Fund A"
and "Fund B" for the purposes of this
demonstration.
Fund A enjoys a staggering 15.3% yield. But
Fund B's 17.4% yield looks downright tempting. Both
funds invest in dividend-paying stocks and dish out monthly
distributions, which they have kept at a steady rate since
their inceptions.
So which fund can you count on to deliver the steady
income you need to pay your monthly bills? If you're looking
for a secure high-yielding investment, the answer should
depend on the underlying source of each fund's distributions.
Fund B paid distributions of $1.35 a share to
shareholders in 2007. But according to the company's latest annual
report, it only earned $1.31 per share. Worse yet, after
payouts to preferred shareholders, the fund had just $1.20 per share
remaining to distribute to shareholders. They
literally had to pay out more money than they made to foot
their dividend bill!
Robbing Peter...to Pay Peter?
So where did the money come from?
It turns out that if you were a Fund B shareholder, over
half of your dividend distribution came right out of
your own pocket.
To meet its dividend payment, Fund
B
had to siphon off money from the fund's original investment capital. In effect, much of
the dividend you received came out of the very same money
you invested -- and you now own a fund that has less
investment dollars at work.
The less money Fund B keeps in the fund, the more
likely they are to have an earnings shortfall when they have
to make their next dividend payment. Eventually they
may have to dig even deeper to pay their distributions.
That starts a dangerous cycle for income investors looking
for dependable income. Sooner or later, something's
got to give -- and chances are it will be your high yield.
Compare that with Fund A's distribution. In 2007,
its first full year of operations, the fund raked in
earnings of $2.60 per share. It gave shareholders
$1.98 of that amount in dividends, saving the rest for a
rainy day. The distribution consisted entirely of
investment income earned from dividends and interest from
the fund's portfolio holdings.
Fund A paid out only what it earned,
retaining a little cushion to ensure they could continue
paying the high yield investors were counting on.
And depending on how the earnings are generated,
earnings-driven yields also can be tax-advantaged. In
Fund A's case, almost all the dividend income qualifies for
the reduced federal tax rate of up to 15% on dividends.
Special Distributions Aren't
So Special
Another thing income investors
should be wary of is advertised high yields that include
irregular capital gains distributions or a return of
capital.
Although these capital gains payouts can sometimes be huge, you can't count
on them as part of your regular income stream. They're
generally paid out only once or twice a year, if the firm or
fund has profited from selling assets like stocks, real
estate, options or other derivatives.
And like capital gains, a return of capital isn't
generated from a firm's regular recurring earnings either.
Sometimes, it is simply cash flow in disguise. For
example, income trusts or master limited partnerships (MLPs)
may include a return of capital in their distribution so as
a means of passing along cash flow that's not part of their reported
earnings.
Make Sure Your Dividend Growth Is the Real Deal
Usually, it's a good sign when a company or fund raises
its dividend. Investors naturally assume that the
firm or fund must be doing well. But sometimes this is
a false signal.
For instance, Fund B's payouts nearly doubled from
$0.72 per share in 2006 to $1.35 in 2007. But the
fund's total investment income dropped by almost a third
from $1.91 per share in 2006 to $1.31 the following year.
Returns of capital, not earnings, accounted for the lion's
share of the distribution growth.
It's good to find an investment that continues to
grow its dividend, but only if earnings are growing right
along with it. If you're counting on a steady income
stream, you have to be sure the company can continue to
support it -- and they can only do that with earnings.
Earnings are the Secret to
Dependable High Yields
The bottom line is earnings are one of the more
reliable sources of sustainable dividend income over the
long-term.
I currently own Fund A in my "10%-Plus Portfolio"
-- a model portfolio that I reserve exclusively for
subscriber to my premium newsletter,
High-Yield Investing.
And in a recent issue, I profiled a number of
other high-yielding investments that passed my rigorous earnings
test. For example, I highlighted a foreign bank that
offers an outstanding yield of 14.2% - and has the earnings
to easily cover its generous dividend distribution.
In fact, this rock-solid bank has a large enough earnings cushion to let you
sleep at night, knowing your income stream is safe -- and
likely to increase.
If you'd like to learn the name of Fund A, which is
currently paying a staggering 15.3% yield, plus the name of
my favorite bank stock, plus
receive a steady stream of stocks, funds, and other
investing ideas with abnormally high dividend yields each
and every month -- then I'd like to extend you a personal
invitation to try my premium newsletter . . .
High-Yield Investing.
Visit this link to learn more.
Thanks for joining me on my search for today's
highest-yielding securities!
-- Carla Pasternak
Co-Editor
Global Dividend Opportunities
GlobalDividends.com
839-K Quince Orchard Blvd.
Gaithersburg, MD 20878-1614
P.S.
-- Don't miss a single issue! Add our address, Editors@GlobalDividends.com,
to your Address Book or Safe List. For instructions, go
here.
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