Consider Dividends While Worrying About a Correction
Nihar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I normally like to organize my stock ideas by theme, usually by industry. However, sometimes you do not care about what a company does, but rather what it does for your portfolio. The whole market has risen so high lately that there is a general worry that it could tumble, even if the decline is only temporary. That is the reason I tend to like dividend stocks as a part of a portfolio.
If I had a large enough portfolio, the safer money would be in dividend stocks, because anything safe that barely moves without offering a dividend would not even be worth considering for me. I prefer getting cash over exposing myself to a flat stock, still running a risk that a 2008 downturn could happen right when you need money.
A lot of times you will see dividend stocks lumped altogether, and many dividends can be categorized together as safe, long-term investments. However, there is a class of dividend stocks that you need to be more careful with, and these are the ones that have very high yields.
Annaly Capital Management (NYSE: NLY) fell out of favor as the spread between the long-term and short-term rates tightened. REITs like Annaly make money by borrowing at the lower-rate and loaning at the higher rate. When spreads shrunk as the Fed aimed to keep driving down interest rates, Annaly became less popular than some of its competition, like American Capital Agency (NASDAQ: AGNC). Just comparing yields, Annaly has a 13% yield and American Capital has a 20% yield. Both stocks are down recently, and that stems from some worry that the Fed is going to raise rates.
The Fed is not going to up its rate by 5%, and companies will have time to adapt to the change. Increasing rates actually present a strange situation for these companies. It lowers the book value, but the spreads may start increasing, allowing the companies to make more money. That is a good sign, but you need to choose the company that will offer the most stability. Annaly is my preferred mREIT, because it tends to use more conservative business practices with less leverage than American Capital Agency.
Annaly is also lowering management costs by going for external management. There are lots of small things that make Annaly a good choice once it gets cheap enough. Personally, I would wait till the bottom sets in as book values shrink if rates start rising. Every Fed meeting is met with fear that the gravy train is ending, however for REITs the spread will no longer be as severely compressed. Lots of people expect rising rates to do a lot of damage to the mREITs, but if rates stay low it will continue to place pressure on income for the companies. If rates rise, wait for the market to digest the news and take a position. Be ready to exit if earnings show long-term weakness for the companies.
Big and the small
I always fall back on Seaspan (NYSE: SSW) because it always strikes me as a well run company come earnings time. I have been harping on it since it was at $17, but I know one day I might pay the price for relying on its reliability. For now, I like the company's history of returning money to shareholders. Buybacks and dividend hikes are the norm for the company. The yield is a bit above 5%, but the stock is at $22 and right against the 52-week high. The company is always expanding its fleet slowly. The goal is not to get ships and have them sit idle, and the company does a good job of securing contracts for its ships. The company has 69 ships in its fleet, and has secured deals that could let them expand up to 89 ships.
The last earnings report contained some small problems, but they were not red flags. Some of the ships were not used as much and with increasing interest expense due to expansion, which hurt EPS a bit. The company had EPS of $0.21 for the quarter ending March 2013, versus $0.30 in 2012. It is still a solid result for a company that is yielding 5%.
For a classic taste you can go with Coca-Cola (NYSE: KO), because it has been a solid return for decades now. The company aims to maintain its dividend and make buybacks. The yield of 2.78% seems low, but Coca-Cola does move. In the last three years the stock has gone up over 50%, which is not too bad for the lower risk that it offers.
The stock is near its all-time high. On the Yahoo! Finance max chart you can see that in 1998 the stock hit $42. That might not sound like a great 15 year return, but there were dividends to be made and the stock shrugged off the financial crisis. The 20-year return looks great, as does the 10-year return. If you had the capital I would hold it for the dividend and write calls against the position to boost returns, but keep the strikes above and rolling forward with the stock. Coca-Cola is stable and consistent, and a good price would be the current price as long as you are looking out into the future.
Is the market teetering on the brink? Maybe, but the economy is actually doing better. A down market does not mean a down economy. Coca-Cola is the safest stock in this article, and I would like that with Seaspan for collecting capital appreciation, dividends, and writing calls. Annaly is the most problematic, because rising interest rates will reduce book, value while keeping the rates low will compress the spread. Both those events can be viewed as negatives even though they are direct opposites of one another. A shake-out seems likely, even if the stock will do well eventually, so the risk due to uncertainty is high.
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Nihar Patel has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and Seaspan. The Motley Fool owns shares of Seaspan. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!