High Yield Stocks To Stay Away From

Author's Avatar
Feb 23, 2015

As an investor, your first preference would be to invest in stocks that pay you reasonably well. While it is perfectly alright to follow this technique, there are certain things that you need to watch while thinking of investing in these high-yield stocks. Not all stocks that pay investors well are great stocks. The yield of a particular stock may be high because the share prices have fallen down, as both these factors are inversely proportional to each other. You should never just look at the yield per se; you should also spend time in analysing details about share price history, earnings growth, future potential etc. The following stocks have a very high dividend yield, but it would do you a world of good if you stay away from them for various reasons. Read on to know more:

Increased borrowing rates may erode profits

According to the rules, all REITs (Real Estate Investment Trusts) should pay a minimum of 90% of their taxable income as dividends to investors. Annaly Capital Management (NLY, Financial) is an REIT with one of the highest dividend yields today. It sports a whopping 11.3% yield right now and it is close to 6 times more than the REIT S&P 500 Index values. However, you should refrain from investing in this stock, because Annaly would not be able to sustain this high yield in the future.

Being a REIT, Annaly borrows short term mortgages and invests the same in long-term, government supported securities that give out a better yield. The difference between short term and long term rates is the profit that Annaly gains. As long as this difference is quite big, Annaly and its investors have nothing to worry. However, the situation is not looking bright for Annaly right now as the federal government is likely to increase the short term borrowing rates this year. According to analysts from Compass Point Research & Trading, as the short term rates increase, profits would come down for Annaly, as a result of which, the trust would announce a dividend cut this year. Cash flow would take a hit then and analysts recommend that it is safe to stay away from this stock right now. The stock movement of the trust for the last few years is seen below:

03May20171146001493829960.jpg

Energy sector takes a hit due to oil price slump

Breitburn Energy Partners (BBEP, Financial) reported a 63% reduction in share prices last year, which shot up its dividend yield to 27.5%. There is nothing positive for the investors in these values, as Breitburn suffered a lot due to the slump in oil prices last year. The recovery of oil prices is still looking like a distant dream; therefore, one should avoid investing in Breitburn right now. On the first week of January, Breitburn reduced its dividend pay-outs by almost 50%, which is definitely not good news for the company. The energy sector company usually pays out its investors monthly dividends. The dividends that are paid out right now, after the huge reduction, too are not likely to continue in the future.

This is because Breitburn has calculated its dividends on the basis of two expectations – oil prices would cost an average of $60 per barrel and natural gas would cost at $3.50 per million BTUs. The shocking reality, however, is that both oil and natural gas are trading at much lower values in the market. This could result in huge losses for Breitburn and there is a chance of further dividend cuts by the company. To add insult to injury, the company’s financials are not looking great at all. Out of the $2.5 billion line of credit applicable, Breitburn has already taken debts worth $2.2 billion. If it wants funds in the future for acquisitions, diversifications or expansions, it has very little window left to borrow the same. Analysts from the Westwood MLP and Strategic Energy Fund strongly believe that investors should stay away from this company if they want to safeguard their investments. Stock movement of the company for the last five years is seen below:

03May20171146011493829961.jpg

Conclusion

High dividend yield stocks, as much as they look attractive, have their own weaknesses as well. If you are a prudent investor, you will know that great dividend yields do not necessarily mean that a stock is doing great in the market. On the contrary, these should alarm bells for you as they are clues that a particular stock is not progressing in the right direction.