Investors seeking to invest in high yielding stocks often face a real dilemma: They like the high yields they see, but at the same time, they are concerned that the yields are too high. In essence, is it safe to buy these juicy dividends or is there something wrong with the business that represents a fundamentally flawed value trap?
A recent article by Daniel Schonberger, which appeared in SeekingAlpha, discusses two stocks that fall into this category and come from two completely different sectors: GameStop (GME) and Alliance Resource Partners (ARLP). Both stocks currently have dividend yields over 10 percent. In addition to dividend yield, Mr. Schonberger says that investors should look a payout ratio, free cash flow and dividend history to help in making investment decisions. Let’s look at what he had to say:
GameStop is a specialty retailer that sells new video game hardware, new and pre-owned video games, and video-game accessories. The company is a dividend challenger, having raised its dividend for six years in a row. Mr. Schonberger indicates that the balance sheet looks fine and the company, trading at only 4 times earnings, looks like a real value. He cites the main concern with the company is its future growth. It’s payout ratio, however, is low, coming in under 50 percent. He concludes that the firm “Can withstand a declining revenue and a declining free cash flow for quite some time before the dividend has to be cut”.
Alliance Resource Partners
Alliance Resource Partners is a master limited partnership that is involved mainly in coal mining. Coal has been a bad word for much of the last decade. Indeed, the share price of ARLP has been depressed, giving it a P/E ratio of 6.3 to go along with its very high dividend yield. Nonetheless, Alliance Resource is profitable, has excellent free-cash flow and appears capable of maintaining its generous dividend from continued operations.
For high-yield stock investors, it’s aways a balance. Is the high yield supportable and likely to be maintained? Or should one avoid investing because the fundamentals do not look bright. Due diligence and research is the key to making the decision.