Actual Dividend Yields (paid / average price) have skyrocketed for Investment Corporations, BDCs, and REITS...why?

By Jeffrey Cohen, President, US Advanced Computing Infrastructure, Inc.

What we know:
What we see in our model analysis is that twenty-two stocks paid an actual dividend yield of 18% or more last year. This is calculated simply as the sum(dividends) / average (adjusted closing price) for each stock over the past 253 trading days. There are normally five to ten of these stocks, and now there are twenty-two.

These 18% or higher dividend yielding stocks are almost too good to be true. Our model corrects for the adjustment of closing prices based on dividends paid (most data providers adjust down for dividends paid, and that understates BETA).

The companies represented by these common stocks (not preferred, nor bonds) are typically capital managers, holding companies, business development corporations (BDC) real estate investment trusts (REIT), and the occasional operating company (e.g., they make and sell things, or provide services to customers).

As Hans Gruber said in Die Hard, "by the time the figure out what went wrong, we'll be sitting on a beach earning 20%." This is a lifetime goal of mine (not the Nakatomi Plaza part, but the beach part). This is the dream of most investors. Passive income of 20%, especially when inflation is 2% to 4%.

A dream come true? Time to buy 20 of those stocks with 5% each of our investable capital and head to Puerto Rico? Yes...BLOG post over. Wrap it up. Why am I telling you about this when you can buy those shares before me and drive up the stock prices?

Not so fast...

What we think happened (our hypothesis):
Our hypothesis is their share prices fell hard and fast. The market has lost focus on high-dividend stocks either due to macro-economics, interest rates, or a fundamental belief that those dividends will not repeat.

Clue 1: Past dividends are not a guarantee of equivalent future dividends. It is possible that some of these dividends were one-time events (like the shipping companies during the COVID-19 pandemic that earned above-market profits, or companies paying out excess capital or earnings back to investors). One stock is an investor in energy companies that fought off a short attack by paying an exorbitant one-time dividend that the short seller had to cover.

Investors will sell the stock, and lower the share price, if they don't believe dividends are repeatable or sustainable. Investors need to evaluate whether dividends can continue based on the fundamental performance and assets of the company underlying the stock.

Clue 2: Stock prices may have fallen on high-dividend stocks reflecting macro-economics, such as rising interest rates or slowing economic activity.

We once made money betting against bonds (savings and loans) when interest rates were rising (during the Federal Reserve Board (FRB) Federal Open Market Committee (FOMC) tightening cycle. We knew interest rates were rising and bond prices would fall. They did. 

This same logic holds for stocks with high dividends that look and act like bonds. For example, a REIT pays out 90% or more of its income in dividends, by SEC regulation. If they are a stable performer with stable assets, maybe increasing rents with inflation, then they look like a bond and their stock price will be reduced as interest rates rise.

So, it is possible that rising interest rates (e.g., US Treasury bills (short-term money) has been yielding ~5.4% for months now, and the long bond kissed 5% recently, and is around 4.4% currently. These rates were significantly lower.

The reduction in stock prices due to rising interest rates (an alternative, risk-free, place for money) could be temporary if interest rates fall, or we could see the continuation of this effect if interest rates continue to rise. This is truly an external event.

We made a related mistake a few years back. We bought a high-dividend, utility-type company that had massive debt to fund the purchase of their assets. They were no longer growing their business, but they were profitable, had a good reputation, and in the past paid down their debt when times were good. We lost money because the company's stock dropped as interest rates rose. Why? The company just stood still. Their revenue growth was anemic despite a significant capital investment (5G build-out), they did not buy back their debt at a huge discount (they could have), and they seemed to tread water. The rise in interest rates and their 'bond-like' behavior caused their stock price to fall about 40%.

Clue 3: Capital arbitrage opportunities may have dried up as the prices of capital assets have increased. We read that real estate prices have risen to reflect rising rents, which rose due to inflation (an external event). We have also heard that the prices are 'so high' that new home building has fallen, aging the asset base. I cannot remember the last time I saw a new skyscraper go up in Chicago (where we live), but I do see the occasional warehouse shell being built to accommodate the shift from brick-and-mortar retail to online shopping and multi-channel logistics.

We also notice more stocks being traded on the public exchanges (NASDAQ, NYSE and BATS), and some capital opportunities are being taken straight to the capital markets, which may limit the opportunities for business development corporations. We hear about fewer M&A deals and private equity investments, and we hear whispers of worry about war and economic slow-downs, which could create a short-term ice age for investors.

If you would like to learn more, or contact us to discuss becoming an investment advisory client, please call me at 312.515.7333 or email at [email protected]. Thank you.
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Hans Gruber, Die Hard, "We'll be sitting on a beach, earning 20%"