Diary of a Dividend Diva: On Avoiding Temptation

 | Sep 23, 2013 | 8:00 AM EDT  | Comments
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Stock quotes in this article:

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As you accumulate income using the dividend-capture strategy, the temptation will arise to take shortcuts either in order to reduce your turnover, or to generate really, really fat levels of income. I practice (and advocate) a target range for each individual dividend in a range of 0.7% to 1%, which to me balances the level of turnover you must use and the risk inherent in each individual stock.

Much larger dividends will often come along, and they'll sit there like sirens on the rocks, whispering to you in an enchanting voice to "buy me, buy me." As beautiful as these yields look, you're better off not yielding to the temptation, so to speak.

The dividend setup this week offers a perfect case study. There are several dividends ranging between 1% and 4% that would offer a quick pop to your income generation. I list them in the table below, highlighted, as a reminder that they represent risk you do not want to take on. The non-highlighted names are stocks I am playing this week, because they fit far better into how I operate the strategy.

Dividends to Avoid
Source: FactSet

There are a variety of reasons I am not using the highlighted names. The mortgage real estate investment trusts have yields that indicate substantial risk in this group's business model, and those stocks could drop and keep dropping when they go ex-dividend. Annaly (NLY) cut its dividend, telegraphing that its business model is under pressure, for instance -- and American Capital Agency (AGNC) holds similar risks.

Names like PennWest (PWE), PG&E (PCG) and TransCanada (TRP) are less risky from a business perspective, but they are "income stocks" owned for the yield. I have found that those names trade too efficiently, and if you buy them you might be stuck in them a couple months waiting for the post-dividend price rebound.

Windstream (WIN) has a similar profile, although it is a telecomm name rather than energy. I do play the telecoms gingerly, and have had mixed luck with Verizon (VZ), AT&T (T) and the like. The yield in Windstream is too high for me to be comfortable with using it.

Finally, the "property trust" REITs have the same issue as the energy names, as they have an efficient trading pattern. I rarely play REITs or income trusts, and these two fall into that "avoid" category. This reflects no opinion on their business prospects -- only on how the stocks trade.

As Ben Graham warned, "The essence of investment management is the management of risks, not the management of returns." This applies to income generation in our dividend rotation just as equally, if not more so, than it does to standard capital-gains investment strategies.

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