High Dividend Yields Can Be Payout Traps: Know These Four Rules
Retirees seeking income are often lured by high dividend yields, but these attractive payouts can be traps. The key to avoiding a cut in monthly checks and share price is knowing which payout metrics to use for different company types.
Cisco Systems (NASDAQ:CSCO) is an example of a durable payer with strong cash coverage, using free cash flow as its denominator. In contrast, REITs like AGNC Investment Corp. (NASDAQ:AGNC) require adjusted funds from operations (AFFO).
AGNC's 14.4% yield looks attractive, but its monthly payout has been cut from $0.22 in 2014 to $0.12 today at a leverage of 7.4x. This is a classic mortgage REIT yield-trap profile.
The four tests for avoiding dividend cuts are: matching the payout ratio to the right denominator, reading the dividend growth record, checking the balance sheet before the yield, and comparing the yield to its own history.