I'm sure you've all seen or heard that the bond market is highly efficient, why is that?

Essentially, the bond market is highly efficient because the cash flows are basically in stone. The market knows the coupon rate, the face value, and how many payments remain until maturity. These future cash flows are discounted back to the present to arrive at today's price for the bond. Not much room for error here.

Now take a dividend stock.

The process is similar. Investors know the current dividend and earnings growth can be estimated (let's not argue about the precision of earnings estimates). Let's assume the dividend grows at the same rate as earnings, not a bad assumption. The only missing parameter in the determination of the stock's share price is the investor's required return. This can be determined using CAPM with estimates for the risk-free rate and the market's return, or it can be supplied by the investor based on knowledge of his personal situation. While there's more room for error in this case than there is in the bond case a fair estimate of the stock's intrinsic value can be determined. Again, the intrinsic value (ie price) is the sum of the future cash flows discounted back to today.

I think there might be a tendency to forget these things. People may be assuming if they hold a dividend stock forever and it continues to pump out growing dividends at some point in time the process of collecting or reinvesting the dividend becomes a gravy train. Well, it doesn't.

I'm not going to go as far as to claim a dividend is a return of capital, but remember you did pay for every cent in dividends received. 

Good Luck, Ken. 

Well....Aren't you the turd in the punch bowl :o}

I agree by the way.  The big advantage to dividends is that you get them in cash, as opposed to share price appreciation that can disappear in a New York minute.

There can be earnings surprises (in both directions).  With bond funds, the coupons vary with the economic winds.  Stock dividends usually increase, but not always.  Also, isn't taxation also an issue re: dividends vs. bond coupons for those who hold assets in a taxable account?

 In reality, there is no "gravy train," only the yields available in the market, whether they be bonds, stock dividends, appreciation or CG's (and a few more exotic sources of market income).  What counts is their safety, consistency, and their placement in various accounts for minimizing taxation.

Greg

In reality, there is no "gravy train," only the yields available in the market, whether they be bonds, stock dividends, appreciation or CG's (and a few more exotic sources of market income).  What counts is their safety, consistency, and their placement in various accounts for minimizing taxation.

Greg,

Well said. 

helmut 

Ken,

"I think there might be a tendency to forget these things. People may be assuming if they hold a dividend stock forever and it continues to pump out growing dividends at some point in time the process of collecting or reinvesting the dividend becomes a gravy train. Well, it doesn't."

I'm not sure what your point is.  The total return you get from any investment is the sum of all dividends you receive, while holding the asset, plus/minus any capital gains/losses on your investment based on your purchase and sale price.  Nothing more, nothing less.

"I'm not going to go as far as to claim a dividend is a return of capital, but remember you did pay for every cent in dividends received."

Well, yes.  You did make an investment.  And, from the point in time whenever the sum total of all dividends your receive from the company equals your initial investment, you are on a gravy train, in that your total return will be greater then zero!

You have two companys.  One pays a 6% dividend and has a 4% dividend growth rate.  The second has a 10% dividend with no dividend growth.  Both have an expected total return of 10%.  Which would you rather own?

Next, if you are Josh Peters, and expect your investments in individual stocks to return only 8%, then both of the above might be potential candidates for your portfolio.  Each has a 2% 'slop factor' built in.  Are you more comfortable with that slop factor being 2% in current dividend or in expected dividend growth?

Remember, of course, that to get dividend growth, you have to have earnings growth, while to maintain a current dividend with no growth, only stable earnings are necessary.

El Lobo... the situation is much  more complicated than you suggest.

Company A- 6% dividend yield, 4% growth
Company B- 10% dividend yield, 0% growth

If nothing changes, in 13 years the dividend income for Company A will be larger than the dividend for Company B... even though the yield for Company A will still be less than the yield for company B.

Looking at the percent of dividend cut as a function of dividend yield, we see the risk of the dividend being cut is almost 50% more for a company yielding 10% than a company yielding 6%. By this measure Company B is riskier, despite the fact that it requires no growth.  I think the point is that Company B must maintain its earnings without growth.

There is a definite advantage to larger current yield--larger initial income.  But growth is also important because inflation is eating away at the income. 

The formula that Josh Peters uses is an oversimplification.  That does not make it useless...

Nevertheless, I prefer to compare Company C to Companies A and B

Company C: dividend yield 4%, dividend growth 15%. 

Still 6 years until the dividend income from Company C equals that of Company A.  I think C also comes with less risk of dividend cut; one of my larger worries.  Hard times for company C means slower growth, hard times for Company B means dividend cut.

Thats the way this pre-retiree looks at it.  After retirement I may come around to your way of thinking, but for now...

Best
Stats

Stats,

Some good thoughts.  Does your 13 year number assume anything with regard to the 4% 'excess' dividend yield of company B over that of A?  That is, do you assume compounding?

Next, consider this.  Company B with a 10% yield, catches fire with the market, so share price doubles.  Paying same amount of dividend, yield now falls to 5%.

Does this make the probability of a dividend cut LESS then Company A, with it's 6% yield?

Also, company A, with it's 4% dividend growth rate, needed to maintain that growth rate to match the yield of  company B in 13 years.  If earnings don't grow, neither will the dividend.  If earnings for company B don't grow, that probably wouldn't be a reason for the company to cut it's dividend, but it should still yield 10%.  The point is that almost ALL companies stop growing at some point in time, so one in the hand might be worth two in the bush, so to speak!

In my view, earnings/dividends grow, are steady, or decline.  This is the over the lifetime of a company.  Relying on growth for a good portion of one's return seems a bit more risky to me then relying only on steady cash flows.

In fact, a SMALL high dividend yield company may be less risky, from this standpoint, then a large high dividend yield company!

Does your 13 year number assume anything with regard to the 4% 'excess' dividend yield of company B over that of A?  That is, do you assume compounding?

[/quote]

El Lobo... yes, I was using compounding.  If the dividend is growing each year by some amount then over time it will eventually be worth more than the dividend of Company B with no growth.  That is the nature of the thing.

The way I see it, say a utility with very little growth but high dividend yield provides cash now.  But over time because it has very little growth the income it throws off will lose to inflation.  This makes this type of investment good for income but not for an entire portfolio.

A company that is growing its dividend at a very fast pace, say JNJ (Johnson&Johnson) could very well pay out more income in 15 years than one of these high yielders today.  Of course, JNJ must keep growing like they did back in the seventies, eighties, and nineties.

I think you see risk in trusting the company to continue growing so fast.  One of those bird in the hand is better than two in the bush kind of thing.  I think a portfolio should be made up of both types of investments.

Stats

Stats, what about the compounding effect of taking the 4% difference (between the 10% high yielder and the 6% payer) and re-investing that amount in the 10% yielder stock?  If you do that - and nothing else changes (which, of course, never happens) - then the '6% payer & 4 % grower' never catches up to the 10% high yielder.  I think.

Regardless, I certainly agree with (and practice) the concept of a portfolio made up of both types of investments - very high payers who may not grow much and reasonably high payers who grow quite nicely. 

Regards.

Cliff

This post was editted to correct an error.

There are billions of scenarios... how about we take 5% income and reinvest the rest. 

I think I have confused Company A with Company B above.  In this post, 
     Company A-- 10% yield with no growth
     Company B--  6% with 4% growth

Then both companies are giving us 5% income each year.  Company A grows at 5% a year because we are reinvesting. 

Company B produces 5% income also, we reinvest 1% and the stock grows by 4%.  At the end of year 1, we have the same amount of income and the same value of stock.

Here is a table of the first ten years of values.

So the two stocks are equivalent in return.  The only question is which is riskier.  There is lots of risk on both sides.

Stats

Stats,

You are, of course, assuming constant P/E and D/P.  That is, the growth portion of the Josh Peters model is dividend growth, not share price growth.  His is a complete buy and hold model, IOW.

In your calcs, company B had share price appreciation (along with dividend growth).  That was how the value of each holding remained equal.  Company A bought more shares with the excess yield, company B had constant number of shares with share price growth.

Stats,

Put another way, the dollar amount of dividend yield distributed by the company is N*Y, where N is the number of shares owned and Y is the per share amount of the dividend.  Company A has Y increasing by 5% per year, company B has N increasing by 5%.

Also, if you talk dollars, not percentages, the math is a bit different.  Increasing Y (and underlying earnings) by so many cents per shares, not 5%, gives you, I believe, linear functions, not parabolic, and the two will never converge.  I also believe that this is the way companys typically grow.

That is, small caps can maintain a fairly steady percentage increase in earnings and dividends, while large caps can maintain a fairly steady per share dollar amount increases.

Stats,

You are, of course, assuming constant P/E and D/P.  That is, the growth portion of the Josh Peters model is dividend growth, not share price growth.  His is a complete buy and hold model, IOW.

In your calcs, company B had share price appreciation (along with dividend growth).  That was how the value of each holding remained equal.  Company A bought more shares with the excess yield, company B had constant number of shares with share price growth.

[/quote]

Yes, Company B had share price growth.  Josh Peters model assumes that the dividend is increasing each year AND that the yield is constant... the implication is that shares are increasing in value.  I did not clearly show that in my little table above... but the share price was increasing by 4% a year in Company B.

In this very simple world, constant yield and constant dividend growth it does not matter if you choose Company A or Company B.  I think there are reasons to hold both, but I believe the higher yielding company is the riskier choice.

Roger

My point never stated very clearly (heck never stated!)

Among all stocks that have "equal dividend yield plus dividend growth" I think an investor should choose the stock with the highest dividend yield (but no higher) that matches their income needs (and by the this is the stock that has the highest dividend growth in the group).

So among stocks A, B, C, D, E, F, ... (A has 10% yield, no growth, B has 9% yield, 1% growth, C has 8% yield, 2% growth, etc.)  The best choice for the investor is to pick the stock that has a yield that is equal to their income needs.  If you are going to need to make 5% withdrawals in retirement for income, then choose the stock with 5% yield.

In all this is my implicit assumption (El Lobo disagrees and has good arguments for why) that higher yield stocks are riskier.

Of course, all things are not equal.  Sometimes stocks are cheap and sometimes expensive, there is diversification to worry about, and the financial condition of the company.

Stats

Stats,

Is it only your assumption that a 10% yield stock is riskier then a 5% yield stock?  That is, knowing absolutely nothing more about each company then the yield.

Next, for any given company, do you believe, or just assume, that it's a riskier investment if the yield is 10% then if the yield is only 5%?

If your assumption is that dividend yield is a measure of risk of an individual company (lower yields mean lower risks), how risky is a company that pays no dividend?

(I agree that high yield DEBT is riskier then low yield debt.)

The best choice for the investor is to pick the stock that has a yield that is equal to their income needs

In all this is my implicit assumption (El Lobo disagrees and has good arguments for why) that higher yield stocks are riskier.

Of course, all things are not equal.  Sometimes stocks are cheap and sometimes expensive, there is diversification to worry about, and the financial condition of the company.

Except for your last paragraph, which seems to focus most on specific stock selection, this whole argument/discussion takes on the "feel" of active/passive arguments.  There's one choice or  selection and it comprises the entire portfolio and is the sole income source.  Although there are some individuals (that was not the i word I was thinking of) whose entire portfolio consists solely of one stock or off the mainstream fund  most of us have SS, possibly pensions, bonds and a reasonably well diversified portfolio or collection of assets.

 I don't have steak for dinner every night, night after night.  There's hamburger, fish, chicken and shrimp and sides and how filling those are determines the amount of the main dish I might serve so that there's a lot more of sides than entree.  Our portfolios are like that.  GE provides me with $20/quarter income.  ACAS provides me with $100/quarter income on approximately the same original amount of money bought at the same time.

Roberta 

It was not my intention to say there is only one choice... or heaven forgid to sound like indexing :-).  Just the opposite...

I think we all agree that when faced with investment choices that have the same expected growth, we will choose the least risky one.  This last statement seems obvious.  In my post above, I was saying...

If you believe that risk increases with yield, then when choosing between *identical* investments (idential defined here to mean those with equal "dividend yield plus dividend growth") then the investment with the least yield is best (in my opinion).  This statement hinges on believing there is a correlation between risk and yield. 

Unfortunately, some do not believe... ***That is an indexing-like statement***

Stats

equation is a simplification of the equation generally used, he points this out early in the book. I don't know why he made the simplification, the general equation is not much more complex...

E = [ D ( 1 + g) ] / P + g

E, expected return

D, the current div

P, the current price

g, earnings growth.

Generally it's assumed div growth will be approximately the same as earnings growth, but this need not be the case.

Good Luck, Ken. 

gets older it's probably ok to tilt more toward yield, the long term is becoming less of an issue so give me my money now. Sort of like the AA shift from stocks to bonds as one ages, supposedly.

OTOH, while div growth is a great thing I think having div growth on an already sizable dividend is the cat's meow. Div growth doesn't help when a stock is yielding 0.01% for a time, then cuts the div...time wasted.

IMO HY beyond a certain point is riskier, less money channeled back into corporate growth and long term security of the dividend. That certain point is the rub, and why at least for now I'm quite comfortable having my fund managers do this analysis.

Good Luck, Ken.

Stats,

Now I'm confused.

"If you believe that risk increases with yield, then when choosing between *identical* investments (idential defined here to mean those with equal "dividend yield plus dividend growth") then the investment with the least yield is best (in my opinion).  This statement hinges on believing there is a correlation between risk and yield."

OK, you have two companys, A has a 10% yield and zero yield growth rate, company B has a 1% yield, 9% dividend growth rate.  Both companys are identical in all other respects (think two oil companys, like XOM and ERF, for example).  Again, do you believe company A is riskier then company B?  If so, why?

Next, what kind of a correlation are you thinking about (between risk and yield)?  Specifically, what is your measure of risk?  (I assume you are thinking the volatility of either the yield or the underlying share price of the stock.)

Ken,

"less money channeled back into corporate growth and long term security of the dividend."

That's the rationale for a high dividend payout ratio stocks being riskier, not high percentage yield.  Also, the risk is tied to the ratio and the dollar amount of the dividend, not it's percentage yield, which depends on share price.

yes, but if the price is low, ie HY, you're in even worse shape. Then you have a company in distress paying out a high div.

Ken,

"Then you have a company in distress paying out a high div."

Or you have a company NOT in distress, paying it's normal dividend, whose share price has been beaten down by the market.  Or whose share price is moving within it's normal range.

Correct me if I am wrong, but do you assume that, since high yield debt is riskier then low yield debt, the same holds for equity?

The point is that you can have quality dividends and risky dividends, based on many factors, but you can't simply assume that high percentage yields are riskier then low percentage yields.  After all, percentage yields are a function of TWO numbers, one of which (share prices) are considerably more volatile, hence risky, then dividend distributions!

El Lobo... I am thinking the risk of a dividend cut.  

I have seen a table (can not find it now), maybe it was in Dreman's book on high yield stocks that shows the relationship between yield and dvidend cuts.  The table showed that as yield increased the risk of a dividend cut increased as well.

I know there are quality dividends and their are risky dividends.  But in a discussion like this where we are not focussing on quality or risky but on a current yield of 10% versus 1%, I assume that the 10% dividend company is riskier.

It seems like we are talking around each other.  I am not doing it intentionally nor do I think you are... but clearly there is a disconnect.

I just do not see how you can think that a company that pays 10% dividend is safer than one that pays 1%. To put it another way.... YES, I think that risk of a dividend cut at ERF is much higher than one at XOM.

Stats

The only justification I can come up with for EL's stance is that he is not concerned with the long term, if he can skim a sizable income for even a short period of time the investment pays off for him. IMO, this is no different than investing in zero dividend small growth stocks, hoping one will knock it out of the park.

The disconnect is EL's refusal to acknowledge that reinvestment of earnings and earnings growth actually helps to secure the long term dividend and its growth. 

I continue to be frustrated. People refuse to listen to what ElLobo is saying.

Focus on the payout ratio. Focus on the quality of the dividend. Make sure that smoothed earnings cover the payout. Be aware of cyclical effects. Etc. Conduct due diligence (ouch!).

Don't start by saying that a high yield is bad. A company with a high yield may be a bad investment, but not because the yield is high. It is because the dividend AMOUNT is not sustainable.

Have fun.

John Walter Russell 

Stats, Ken,

A company pays a $1/share dividend, while it has $2/share in earnings.  It has decent ROE, ROA, and any other financial fundamental you can think of.

Please explain why, if the market prices the shares of that company at $10/share, there is a greater risk of a dividend cut, or a share price cut, then if the market prices those same shares at $20/share?

Now, if you simply 'assume' it is riskier, or you simply 'feel' it is riskier, we have no disagreement.  That's Bill's position.  I both assume and feel the opposite, until something indicates otherwise!

If two companys each pay a $1/share dividend, have $2/share in earnings, take oil from the ground and refine it, have decent ROEs, ROAs, and any other financial fundamental you can think of, why would it be riskier if I pay $10 for one share of the first, while I pay $100 for one share of the second?

Ken,

"Yield is a numbers game, unless he's buying shares having the price drop doesn't do a retiree any good."

But it doesn't do him any harm either!  After all, the harm occurs whenever the dividend is cut, not the share price.

Unless, of course, his yield income doesn't cover his withdrawals, in which case, he has to sell depreciated shares!

The point is that a retiree who withdrawals, and spend, LESS then, or an amount equal to, the income generated by his portfolio is share price behavior neutral!

Please explain why, if the market prices the shares of that company at $10/share, there is a greater risk of a dividend cut, or a share price cut, then if the market prices those same shares at $20/share?

If the price drop from $20 to $10 is due to an overall market decline there may be a lengthy time delay before the dividend cut. IOW, the price drop is due to market risk...not business/sector risk or specific issue risk. Investors are likely undervaluing all stocks until the market works it way through the problem. (This is frequently referred to as good volatility, because it presents a good buying opportunity.)

If the price move from $20 to $10 is due to problems with the company or the sector (recently financials) pressure will be applied to reduce the payout ratio so more earnings can be retained for use in turning the company around. (This is bad volatility for the individual issue. Also, some good companies in the troubled sector may see their price decline due to sector concerns...for those good companies this would still be good volatility.)

Most investors want growth and income from their dividend stocks, and they want both to be as secure as possible. The only way the dividend can be secured for the long term is by making sure a portion of earnings is retained for future earnings growth. Future earnings growth provides price appreciation, dividends, and dividend growth. 

Yield is generally only meaningful when you're buying. Obviously, if the yield drops and there's been little price movement then the dividend has been cut...possibly a problem requiring further investigation.

A retiree taking all dividends as income locked in his yield years ago. 

Ken,

"If the price drop from $20 to $10 is due to an overall market decline there may be a lengthy time delay before the dividend cut."

Or the dividend may not be cut!

Asked a different way, WHY would a company cut it's $1/share dividend whenever the market prices it's shares at $10, but not whenever they are priced at $20?

"IOW, the price drop is due to market risk...not business/sector risk or specific issue risk."

Stats said the risk was a dividend cut, not a share price drop.  Actually, the share price drop risk is GREATER whenever the shares are priced at $20 then whenever priced at $10 (reversion to mean arguments).  So this company is riskier, at 5% yield then at 10% yield!

"If the price move from $20 to $10 is due to problems with the company or the sector (recently financials) pressure will be applied to reduce the payout ratio so more earnings can be retained for use in turning the company around. (This is bad volatility for the individual issue. Also, some good companies in the troubled sector may see their price decline due to sector concerns...for those good companies this would still be good volatility.)"

If my aunt had gonads, she'd be my uncle!  8-))

Seriously, a company will cut it's dividend for any number of reasons, but I see no reason to do so simply because it's percentage yield is 10%!  Remember, I'm talking cause and effect.  Cause is 10% yield, effect is dividend cut, all else equal.

"The only way the dividend can be secured for the long term is by making sure a portion of earnings is retained for future earnings growth."

No, not true.  A dividend is secure if earnings are stable, that is, neither growing or shrinking.  The point is that you don't need earnings growth.  You DO need earnings growth for dividend growth and share price growth, just not for the dividend itself. 

"Future earnings growth provides price appreciation, dividends, and dividend growth."

Almost.

Ken,

Perhaps it's only me, but I reacted very negatively to your post:

 As an investor gets older it's probably ok to tilt more toward yield, the long term is becoming less of an issue so give me my money now. Sort of like the AA shift from stocks to bonds as one ages, supposedly.

 I felt it was exceedingly patronizing.  You're telling me the long term is less of an issue but retirement planners are telling me to plan for 30 years of retirement.  In terms of give me money now, guess what I'm living on.  We keep telling you that withdrawal is different from accumulation.  It's like dieting.  Trying to gain weight, when you need to, is as difficult as trying to lose weight, when you need to, but they both involve food.

Stats,

In many ways, you're falling into the same trap that Ken is and generalizing and demonizing high yield.  El talks about the quality of the dividend and the company..  Copie and I talk about cash flow and money management and Bill talks about total return.

I did some numbers this morning, trying to look at this from different viewpoints.  I just used some stocks and funds that are frequently discussed here and am well aware that  there are inequality issues.  They are presented in the order they popped into my brain.

stock/fund                        yield                   10 yr growth of 10k

O                                     6.74%                 $37,051 

SO                                   4.56%                 $34,048  

GE                                   3.83%                 $14,542

JNJ                                   2.76%                 $21,451 

VWELX                             3.27%                 $20,349

ACAS                              12.71%                 $31,408 

DODGX                             1.52%                  $25,479

JAVLX                                0.19%                 $22,501

CSRSX                               2.53%                 $32,826

I recognize that this has been a period where small cap, value and real estate dominated.  A different time frame would have given different results on the total return but that goes into diversification and sector rotation.  Besides, it was easier to just grab the last 10 years.

Roberta 

Fixed earnings don't last very long.

You have to deal with higher prices for equipment, salaries, etc. Without earnings growth the fixed dividend is going to be in jeopardy.

Roberta... I am not trying to demonize high-yield... but I am suggesting caution.  I think portfolios should hold some high yield.

My point is simply that higher yield stocks have greater chance the dividend will be cut.  That is all.

The investments you list are all excellent... and the risk of a dividend cut is different each. 

ALD, which we own, and ACAS have double digit yields.  Their dividends seem safe for now but there is worry of cuts next year.   O, which we own, is dealing with bankruptcy of two of its tenants and its dividend was suspect for a time earlier this year, but they seem to have handled that situation.  I think it is very unlikely that JNJ or GE are going to cut their dividend

Stats

I'm not demonizing HY, and I ain't falling into a trap either.

The bottom line is the long term security of the dividend. Companies have different ways of approaching this, if you feel you've studied your HY stocks and you're content that the div is secure that's great...that's the way it should be.

However, HY can be its own undoing. This can be so because not enough earnings are being pumped back into the company for earnings growth. 

So, from JP...

Room to grow. A company that has little or no prospect for earnings growth over the long run might have maxed out its ability to pay dividends already. The next change in the firm's fundamentals might well be for the worse.

From his current M* article. 

I don't disagree with you all either.  It's individual selection; it's part of the fundamentals of looking at a purchase, whether it's an individual stock of a fund.  There's a big difference between a fund like white oak growth and dodge and cox.  High yield is just one of many things that need to be looked at.  Why are you buying it, what role does it have in your portflio, etc., yabba dabba do?

Roberta 

Ken,

"However, HY can be its own undoing. This can be so because not enough earnings are being pumped back into the company for earnings growth."

For the umpteenth time, this means a high dividend payout ratio, NOT high yield!!!!!!!

A company paying a 2% dividend, with a payout ratio of 90%, is riskier then another company paying a 10% dividend at a payout ratio of 50%.  Your reasoning is exactly opposite.

Likewise, you haven't answered the question as to why any company, paying a $1/share dividend with, say, $2/share in earnings (a 50% payout ratio) would be more likely to cut that dividend down to $0.50 whenever the market prices it's shares at $10, rather then at $20.

You have argued all of the reasons why earnings affect dividends, and I agree, conceptually, with most of what you say.  You have also argued that, whenever earnings fall, the market punishes share prices, which I also agree with.  In this situation, the company cuts it's dividend NOT because share prices have fallen (increasing percentage yield) but because earnings have fallen.

I am again asking why, if earnings are stable, or even growing a bit, and the dividend payout ratio is decent, say 50%, but the market cuts share prices in half, doubling the percentage yield, that company would cut it's dividend?  This would be the normal situation where the the share price of an individual company would be range bound.

Ellobo,

I am again asking why, if earnings are stable, or even growing a bit, and the dividend payout ratio is decent, say 50%, but the market cuts share prices in half, doubling the percentage yield, that company would cut it's dividend?  This would be the normal situation where the share price of an individual company would be range bound.

I know that your whole argument for your investment strategy hinges on the fact that share prices are to volatile to depend on for retirement income.
It might be helpful if you could show several stocks "with stable earnings or even growing a bit" that were paying a 50% dividend payout ratio that has had their share price cut in half in a range bound market.    
I do not doubt you, but this type of scenario is more likely on stocks paying little or no dividend.  I believe the circumstances you just laid out will be less frequent than your HY companies that experience dividend cuts.
The bottom line is your hypotheticals are way too simplified to draw any meaningful conclusions.

helmut 

I responded to all the scenarios you brought up.

Specifically, I mentioned good volatility...this is the scenario you keep raising.

Again, share price can be down because of an overall market correction, problem, etc.; however, if the share price is down due to business or issue risk then we have a different scenario.

However, when you encounter a high yield (JP sets a threshold around 8% I believe) you need to be cautious. If the stock meets all your tests, fine.
 

Ken, 

The point I have tried to make is that you can't simply look at the percentage yield of a stock and determine whether or not it is risky.  Just because it's HY.  You have to look at those other factors.  I call that the quality of a dividend.  Things like it's payout ratio, earnings, earnings growth rate, P/E, P/B, ROE, ROA, sector, moat, market cap, . . . . .

And you have to look at all of those quality conditions, regardless of whether the percentage yield of the stock is 10%, or 2%.  That is, a 2% stock could be riskier then a 10% yield stock, if all, or most, of those other factors were present.

My ONLY point in writing any of this is whenever I see anybody catagorically say that HY is riskier then LY, or no yield.  Say that high payout ratio is riskier, or no/negative earnings growth rates are riskier, or high P/E and P/B stocks are riskier, or small cap is riskier then large cap.  Say that HY bonds are riskier then LY.

"(JP sets a threshold around 8% I believe)"

The 8% was a 'target' that he used, and was the sum of the current yield plus the dividend growth rate.  He had a minimum yield of 2% or so, and the higher the current yield, the less dividend growth rate he needed.  Likewise, the 8% included, as I recall, a percent or two of what I call slop.

For example, in my case, I designed my retirement portfolio to support a real, inflation adjusted 6% (of the initial portfolio value) rate of withdrawal.  I felt that 4% was a slam dunk, using almost any yield based withdrawal strategy.

Applying JP's methodology, needing 6%, I would include 2% of slop, so would choose assets (individual stocks) where the sum of the current dividend plus the dividend growth rate was 8%.

That 8% could come from a stock that had a 4% yield plus 4% growth, 6% yield plus 2% growth, 8% yield plus 0 growth, 10% yield with a MINUS 2% growth rate!  That is, 10% yield where you expected earnings, and dividends, to decline.  All of these add up to the magic 8%, which is 33% more expected return then the 6% that I need.

I don't invest in individual stocks, but if I did and I came across an approximately fairly priced stock and its yield was too high I wouldn't buy it. If I came across another stock that did not pay any dividend and it was undervalued I would buy it.

IMO you may have to take a long term approach with dividend payers, not necessarily so with stocks bought for price appreciation. To me, if the yield is too high (and still assuming fair price) the long term dividend may not be as secure as I want it to be.

That is not to say the high yielding stock is riskier than the undervalued stock; however, I would view the long term dividend from the high yielding stock as more of a gamble versus investing in the undervalued stock for price appreciation.

Worth repeating: 

For the umpteenth time, this means a high dividend payout ratio, NOT high yield!!!!!!!

Have fun.

John Walter Russell
 

So, some 10% yield stocks are great, low risk buys, while other 10% stocks are poor, high risk investments!  Some stocks have a greater probability of cutting their dividend whenever their shares are priced at a 10% yield then whenever priced at a 5% yield.

How can you tell the difference, based ONLY on that 10% yield?

I see very high leverage and high payout ratio.

I'd like to know why anyone thinks the FRO dividend is safe. 

Regards,
Russ

Russ,

Good question.

The FRO dividend, as with almost ALL tanker stocks, depends almost exclusively on the daily spot market cost of transporting crude oil.  Here is a sample of a weekly report that discusses this.

Each tanker has a 'break even' daily cost to operate, and those costs are quoted on the various tanker websites.  Basically, if the company receives $X for each day it transports oil, and it's operating costs are $Y, then if X is less then Y, it looses money for that day.  If X is greater then Y, it distributes the excess as a dividend.  Rather, it sums up it's daily gains and losses for the quarter, and mades quarterly distributions.

Some owners lease out their ships on long term charters, at a daily rate above the daily operating cost rate.  These companys tend to pay a fairly steady dividend.  Other tanker companys have most of their ships out on spot rates, so the dividends are more volatile.

All tankers have a high payout ratio.  It does a tanker company absolutely no good to retain earnings to fund newbuilds, which increase the supply of ships.  That would lead to lower spot rates.  Whenever a company wants to add capacity, it will typically use short term debt to fund construction, then issue new equity to retire that debt.  The new ship will have some break even daily operational cost, and the cycle continues.

ElLobo,

 All tankers have a high payout ratio.  It does a tanker company absolutely no good to retain earnings to fund newbuilds, which increase the supply of ships.  That would lead to lower spot rates.  Whenever a company wants to add capacity, it will typically use short term debt to fund construction, then issue new equity to retire that debt.  The new ship will have some break even daily operational cost, and the cycle continues.

 I've read this before, and I might be naive, but it makes no sense to me.  Every company wants to increase revenue, and take market share away from its competitors.  The only way shippers can accomplish this is to build or buy more ships.   

It would be like Walmart saying they do not want to open anymore stores because it would drive the retail prices down on their inventory, or MCD saying they did not want to flood the market with more hamburgers.  That would only work if Target, Costco, Burger King, Wendy's and all the other competitors had the same policy.  It is hard for me to believe the entire Tanker industry is in collusion on this issue.

Furthermore retained earnings are for more than expansion, how about paying overhead and dividends when the company is operating in a weak economy?  How are they going to sustain themselves in a correction without retained earnings?

Personally, it looks like to me, the risk is so high that ownership wants to take as much cash (earnings) off the table as possible as to make their assets as judgment proof as possible.  Nothing wrong with that as long as you understand when the music stops, you may be the one standing with without a chair.

helmut

Russ, I just hate it when you ask a question like that about a company I'm invested in 'cause you know what you're talking about.

OK, let's say the Frontline FRO dividend is not safe.  At least in the sense that most dividend investors look at most companies.

The FRO dividend will be reduced from time to time.  It's happened various times over the last 3-4 years when they've paid out huge sums to investors.  Their dividend is based upon the prior quarter's actual results and if the rates for are down that quarter, then their profits are down and the dividend reflects that.

The FRO dividend could be eliminated for a quarter or two.  There's no law that says revenue in this business must exceed costs.  Could happen.  Probably will again at some point just like it has in the past.  It's a cyclical business as ElLobo points out.

BUT (big BUT here) I don't think the question is about the 'safety' of the dividend in the traditional sense - like for a company that Helmut expects to have ever-increasing revenues and profits.  We KNOW that the revenues and profits of this company and others like it is going to bounce around - demand considerations, capacity considerations, etc.  The recent history of FRO and others dependent largely upon the spot market shows these ups and downs in revenues and profits.

I think the question is - over time - given the business and financial model of a company like FRO, is the dividend investor going to be rewarded.

I think the answer to that question is yes.  Moving stuff over the seas ain't exactly a new play.  This business has been around a while I think we'd all agree.  As long as you want to keep driving that pickup of yours, Helmut, to the drive-in, you're going to need some of that oil that gets here on tankers operated by companies like FRO.  Over time the return on equity of FRO (in the 70-90% range) - both as a result of its leveraged structure and its very high operating margins - means that it has been very profitable.  And the owners receive most of the profits on a quarterly basis.

It is a mistake to think that because it is possible that there could be periods of lower profits that these guys won't be able to sustain themselves.  Some of the very smartest people own and operate these boat companies.  I think the largest shareholder of FRO is from Norway and makes another fortune in the oil rig business.  Significant shareholders in most of these companies are sophisticated and have the ability to either raise additional equity or acquire debt or, if they have to, write a check themselves.

One thing they seem to have in common is a desire to obtain a real cash return, on a regular basis, on their invested dollars.  I like to own a small piece of what they own a big piece of because that's what I want also.

FRO ain't a JNJ or a KMP.  Different animal.  Which, I think, means the metrics and analysis of business risks and rewards needs to be different.

Regards.

Cliff

helmut,

"Every company wants to increase revenue, and take market share away from its competitors."

There is a certain amount of oil to be transported from point A to point B.  There isn't much unique about the Very Large Crude Carrier (VLCC) that NAT owns compared to the one that VLCC owns compared to the one that FRO owns.  Excess capacity decreases the spot rate, hurting everyone, including the company bringing the new ship online.

Nevertheless, the argument you are making really doesn't apply to FRO.  They make their money by being the middleman, between the ship owners, like NAT and VLCC, and the oil owners, like BP, XOM, and so forth.  As I explained in another thread, FRO is making it's revenues from managing the fleet, not by owning the ships.

"It is hard for me to believe the entire Tanker industry is in collusion on this issue."

Go to the yearly report for any tanker company, and they are all well aware of the ships coming online in the next few years.

Remember, my answer was in response to Russ' question on the quality of FROs dividend.  I have tried to give a simple explanation.

"Furthermore retained earnings are for more than expansion, how about paying overhead and dividends when the company is operating in a weak economy?"

Overhead is in the daily cost of operations of a single ship.  Weak/strong economy has absolutely nothing to do with tanker profitability.  It is COMPLETELY supply and demand for crude oil.  So much is produced in places where a tanker is required to take it to market, so many tankers are available in that place, as well as other places.  If too many are available, the spot rate goes down.  If too much oil is available, spot rates go up.

"you may be the one standing with without a chair."

Last year, there was a glut of ships available for the amount of oil being pumped.  FRO actually converted a few ships away from transporting oil, helping to put a floor under the supply side of the equation.

Again, I suggest you go to the link in my first post and click on any of the weekly reports.  They each show weekly spot market rates.  Look at that in response to my simple explanation.

By the way, tell me about the moat of a tanker company.  What other means is there for getting crude oil from a North Sea platform to a Gulf Coast refinary!  Tell me what would cause the music to stop?  8-)

I never said that Tankers were not a viable business.  I just believe they are not as risk free as you suggest, and just because they sport an extraordinary yield, it does not put NAT, FRO, or VLCCF at the same risk level as JNJ, PG, MMM, or XOM.  

Overhead is in the daily cost of operations of a single ship.

Does that mean you see no risk?

When you say,

Weak/strong economy has absolutely nothing to do with tanker profitability.

That statement has an almost eerie echo, "It is different this time." 

Tell me what would cause the music to stop?  8-)

Oh, ElLobo, I won't even mention the Exxon Valdez.  Have you ever heard of The Grandcamp?  If you read the story in this link you will also see the collateral damage done to the High flyer as well.

Although I was not born until about six months later, I have listened to stories about the Texas City disaster all of my life

Obviously you and Cliff have followed and studied the shipping/Tanker industry very closely and I'm sure you will do well, but for me, I don't think I can consider capital preservation or dividends from tankers with the same confidence as stocks such as XOM, PG, JNJ & yes Cliff even MCD. So I will take my chances with what I know.

Cliff, if you ever take a cruise from Galveston you will be able to see oil tankers almost far as the eye can see just waiting their turn to enter the Houston ship channel.  Where the oil industry goes, the Houston economy follows, so you see I'm rooting for your team of Tankers.  Even though I'm more of the Exxon, Halliburton, Shell, Transocean, Fluor, Chevron, Marathon, Weatherford International type of oil investor, we are all in the same boat (pun intended).

helmut

I have enjoyed everyone points and views on this discussion, but it has seem to me over the years that unless you need the high yield now and need to take the risk to get it then it is better to grow a yield over time using the so called safe long paying dividend companies. Sure there are going to be a Washington Mutual(WM) come alone and throw you a curve ball when you are looking for the daily fast ball, but that goes with the game. On the other hand the SO's, PG's and XOM's have paided steady and in most cases raising dividends for years and I sure see Helmut ideals on tankers as being high risk as a tanker at sea with a full load of oil is a lot risker then a pipeline in the ground that KMP is running across the USA full of oil!

I still go back to this personal yield thing(yes Greg) as I am geting a high safe yield on XOM by holding it all these years and this has to be correct because the IRS is geting taxes on today dividend and if I sell the stock I have to pay taxes on the different between my cost and today sell price. :-)

 I have to feel confortable with a stock and one that I have now that I do not like is ACAS and as soon as it has paided it self out in dividends and share price then I will dump it. I asked myself why take a chance on this stock if I do not need to do it?  XOM is a business I unterstand as I was raised and worked in the oil fields all my life, but I still do not know 100% how ACAS makes their living so how can I judge it if I do not know the risks! This to me means why take a high risk chance if you do not have to as XOM meets my needs several times over. I can go in any food store and see somethng that PG makes and meets a need. In ever town I see a XOM sign. I see people every day using SO ele., but I never see a ACAS sign. One day they are buying back stock and next time issueing new shares. When I read their business models on what they do it reminds me of the three cups and one shell under one of the cups and they keep moving the cups around two at a time! Sure they pay a heck of a dividend, but at what risk!

Is this discussion thing not great!

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