By now, if you have been in the market for a while, you know that a very high yield stock should be looked upon with suspicion. That’s not to say that the yield isn’t for real and sustainable, but a very high-yield stock — something significantly in excess of 9% — may indicate that something is very wrong with the company.
A very high yield stock is likely correlated to a very low absolute stock price. That stock price may be very low for a reason. You have to start digging into the company to see whether there are fundamental issues with the company that may mean that the dividend will either be caught, or that the company is in serious trouble.
High-Yield Stocks to Avoid: Government Properties Income Trust (GOV)
Government Properties Income Trust (NASDAQ:GOV) seems like it would be a slam-dunk investment, and a high-yield stock paying 12.6% just seems like it would make sense. After all, we’re talking about a REIT that has 90% of its annual rental income generated by the U.S. government. You’re not going to find a more reliable tenant than the federal government. Its pockets are literally impossibly deep.
However, there is a problem with GOV and its business model. It deals with gross leases and not triple net leases. The former means that it is the landlord that pays all of the operating costs, including taxes, insurance, parking and even utilities. That means there are substantial additional costs to GOP stock that do not exist in other REIT investments.
In addition, GOV occupancy looks to decline by 5% or more in the next couple of years. Filtering this down to the AFO payout ratio, GOV is going to be at 125% this year. That plus the very low stock price speaks to a strong possibility of a significant dividend cut this year.
High-Yield Stocks to Avoid: Uniti Group Inc (UNIT)
Uniti Group Inc (NASDAQ:UNIT) is yielding 14.4% — it’s a true high-yield stock with a number so high that it should be raising your eyebrows.
This is another REIT, but it happens to be involved in a hot industry. Normally, this would be a REIT that would be very interesting to look at as far as an investment. It handles mission-critical communications infrastructure and wireless infrastructure real estate.
There’s only one problem. 70% of its revenue comes from a company called Windstream Holdings Inc. (NASDAQ:WIN), because the REIT itself was actually spun off by Windstream. The whole idea of the spinoff was to help Windstream escape from a liquidity crisis, because it shucked off a huge amount of its debt onto UNIT.
Well, Windstream is failing. The stock is down to $1.77-per-share, large debt maturities are coming due, and the cash flow is generating is not enough to meet these maturities. I don’t see this dividend as being sustainable.
High-Yield Stocks to Avoid: Oxford Lane Capital Corp (OXLC)
Oxford Lane Capital Corp (NASDAQ:OXLC), which has a yield of 15.9%, is a bit of an oddball. It is a very highly leveraged closed-end fund that deals with collateralized loan obligations in various tranches, most of which are subordinated. As a reminder, a collateralized loan obligation are a portfolio of high risk, high-yield bank loans. The more subordinated they are, the more susceptible to defaults they are.
In the case of Oxford Lane, the company invests in B or BB rated investments, which are highly speculative. It is the multiple layers of leverage that create enormous risk with this closed-end fund. As it is, these high-yield bank loans are based on highly leveraged corporations that are junk rated. This doesn’t even mention the preferred stock issued by the closed-end fund, that must be redeemed at some point, used in order to buy these loans.
The bottom line here is risk, risk, risk. The faults are going to mean less income for the fund, which reduces the dividend yield. And the level of risk here is so high, that I think you have to be crazy to own this fund.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.