“Boy, that double-digit yield looks pretty juicy….” We would advise caution. Often, double digit yields can be an indication that the market doesn’t believe the current distribution is sustainable. Usually, yields move higher as investors perceive more risk. In this way, a higher current return is delivered as a way of responding to those concerns and encouraging ultimate investment. A higher current return, at least in part, protects the investor from a total return perspective if the price of the stock should decline.
Details matter – details such as:
- What business is the company in and do the characteristics of that business impact the returns investors demand? For instance, MLPs in recent years have regained high yields than large cap consumer staples stocks.
- What is the asset class? For instance, investors in corporate junk debt demand a higher current return than investors in investment-grade corporate debt.
- Where has the security or asset class traded historically? If the yield has never been in this range before, something could be seriously wrong. Or maybe the entire business-type or asset class has been re-priced in the market.
We believe there are multiple potential resolutions to atypical yields:
- Price moves higher to reflect a market mispricing of risk and/or opportunity. The stock moves higher and the current distribution generates a lower current yield.
- Dividend/distribution is cut to reflect more realistic underlying fundamentals and the current yield moves lower.
- A combination of price movement and reduction in dividend/distribution noted in each of the above scenarios.
- Current yield moves higher as the price declines further placing even more pressure on management to cut the distribution. The classic “value trap” – just because something is “cheap”, doesn’t mean it can’t get cheaper.
Remember, “quality” demands a premium and very rarely trades at a double-digit yield.
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The views presented herein are those of Validus Growth Investors, LLC and are provided for informational purposes only. The information is current as of June 2019 and is based on the economic and market conditions as of this date. The information is not intended as a discussion of the merits of a particular offering and should not assume that any discussion or information provided herein serves as the receipt of, or as a substitute for personalized investment advice from Validus Growth Investors, LLC or any other investment professional.
This material is provided for informational purposes only and does not constitute a solicitation. The material is not intended to be relied upon as a forecast, research or investment advice and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. There is no guarantee that any forecasts made will come to pass.