Are you becoming a momentum income investor? Judging from the price charts of many dividend-paying stocks, more than a few investors are–many very likely inadvertently.
Essentially, momentum investors use a range of technical indicators to time purchases of stocks that are deemed to be in accelerating rising trends. Conversely, they sell or go short when their indicators show upside momentum has stalled.
The strategy was highly popular in the late 1990s, particularly with day-traders betting aggressively on the mostly upward action in technology stocks. It was discredited in the eyes of many following the tech wreck of 2000-02. And it remains so today for many investors, a lot of whom have shifted their attention to buying dividend-paying stocks.
Ironically, there’s every indication the basic premise behind momentum investing–that rising stocks are always the best bets–appears to be very much alive and well. The difference is dividend-paying stocks, not technology stocks, are the preferred vehicle this time around.
In a market where many investors are almost paralyzed by fear of another 2008, stocks deemed “safe” are awarded with hefty premiums. Meanwhile, stocks where investors smell risk have been dumped, some driven down to exceptionally low levels.
In terms of percentage yields, the gap has rarely been wider. Of the 208 essential-service companies I track in Utility Forecaster, yields range from under 3 percent to more than 15 percent. Yields for the 160-plus companies represented in the Canadian Edge coverage universe range from as low as 2.5 percent companies to as much as 16.2 percent. Australian Edge How They Rate companies go from less than 2 to well over 15 percent. Even MLP Profits–which exists to track every master limited partnership in the US–ranges from just 4.2 percent to 12.2 percent.
So long as people are investing like its 2008–or 1932–there’s going to be a safety gap, as investors search for what’s truly bullet-proof and eschew everything else. When the consensus becomes slightly more positive, the yield gap will narrow somewhat, as the battered attract buyers. But we can count on the gap to widen again when bad news strikes.
To some extent a yield gap is justified. Companies growing dividends, for example, should always trade at a premium to companies that aren’t. Similarly, companies whose dividends are backed by very secure and steady businesses and conservative financial policies should trade with a lower yield than companies where the dividend is at risk of being cut.
Today’s yield gap, however, is by far the highest ever for companies tracked in Utility Forecaster, which has been around since 1989. It’s far higher, for example, than during the actual meltdown of 2008, when all companies were battered. And that goes for distribution-paying MLPs as well as dividend-paying Canadian and Australian stocks.
The reason: Income investors are essentially piling into dividend-paying stocks when their prices are rising and dumping those whose prices are falling.
Markets aren’t wholly irrational, even in the near term, when perception matters more than reality. There’s almost always at least some reason related to the underlying business that begins a selloff or a rally. A beaten-down stock, for example, reflects extremely low expectations that aren’t tough to beat. And unless the overall market is really reeling, someone will notice. Conversely, a stock that gets bid into the stratosphere is progressively more prone to disappointing high and rising expectations, and taking a hit.
What appears to be different this time is the degree to which buy or sell action is sustained at some companies and not at others. ONEOK Partners LP (NYSE: OKS), for example, is rightly considered a high-potential master limits partnership, thanks to a strong and growing portfolio of infrastructure assets tapped into the natural gas liquids (NGLs) boom. It’s increased its distribution 10 consecutive quarters, a solid 7 percent over the past 12 months.
All this good news, however, is probably more than priced in for an MLP that’s returned 47 percent the past 12 months, making new all-time highs almost daily. ONEOK Partners today yields just 4.3 percent to new buyers.
Standing in stark contrast is dry-bulk tanker Navios Maritime Partners LP (NYSE: NMM), which actually lost 4.8 percent over the past 12 months. Today the stock yields nearly 11 percent and has been extremely volatile as well. Quite unlike much-loved ONEOK, Navios is clearly a target of investor skepticism that it can maintain its dividend.
This is despite the fact that Navios has actually increased its payout 2.3 percent over the past 12 months.
The ONEOK-Navios 12 month performance gap is 51.8 percentage points. The yield gap is equally impressive at nearly 7 percent. Some may attempt to justify the difference on the premise that the tanker business is extremely risky in the current global economy. Navios, however, has basically locked in its revenue with long-term contracts for 2012, and most of it for 2013 as well.
Moreover, it’s not as though ONEOK is a fee-driven infrastructure company, like Enterprise Products Partners LP (NYSE: EPD), which, by the way yields nearly a percentage point more than ONEOK despite equally strong distribution growth and a string of 30 consecutive quarterly increases.
Rather, ONEOK Partners’ revenue is exposed to changes in prices of NGLs. That’s been a very good thing in recent months, and given global demand and high oil prices it’s likely to be for some time to come.
That, however, doesn’t alter the fact that ONEOK’s business, like Navios’, is exposed to commodity-price risk and therefore will be volatile in the long run. That makes a yield gap of 7 percent wholly unjustifiable, at least based on dividend safety and underlying business value.
Where the performance and therefore yield gap do make sense is in terms of momentum. The higher ONEOK Partners has flown over the past year, the greater investor interest has been. And the more Navios has floundered the more investors have inferred risk and unloaded.
This is the essence of momentum-based dividend investing. Although I can certainly understand its popularity, I know of few greater threats to income investors’ wealth here in early 2012 than getting caught in such a web.
First, those who buy a dividend-paying stock that’s shooting up on momentum will by definition pay a high price and lock in a low yield. Then, when the momentum inevitably runs out and the stock heads back to a more reasonable valuation, the temptation will always be to assume something has gone wrong and to sell, locking in a loss–possibly a big one–and no income.
Second, those who sell a dividend paying stock that appears caught up in downside momentum–and without a discernable business reason for the decline–will lock in a loss that will be reversed, so long as the underlying business stays solid. We saw that happen repeatedly in 2011, particularly at times when the overall market was selling off.
How can you avoid momentum investing your dividend paying stocks? The most important thing is to keep tabs on the health of the underlying businesses of the stocks you own. So long as those are capable of maintaining and preferably increasing dividends, they’re going to recover from any momentum-related selloffs, no matter how crazy things may get in the near term.
Second, don’t chase stocks on the upside. All of my advisories publish target prices below which the stocks I cover rate a buy. Those are based on dividend yields, projected dividend growth and safety. Subscribers should never pay more.
Third, don’t use stop-losses to protect positions in dividend-paying stocks of healthy and growing companies. Volatility is part and parcel of momentum investing. It’s too easy to get taken out of a good company on a meaningless move that has nothing to do with the health of the underlying company.
Remember, stops are not guarantees you’ll be sold out at a certain price, just that you’ll be dumped out if that price is hit. If too many people have stops at the same price, sell orders will overwhelm the bids and prices will plunge. You may get taken out at a price far below where you set the stop. Just ask those who had stops on Enterprise Products Partners LP (NYSE: EPD) on Mar. 15, 2011, the day it opened and closed at $40 but traded as low as $28 in between.
Fifth, you can take advantage of momentum investors by setting buy limit orders at “dream” prices for companies you want to own, i.e. well below current price levels. You won’t be executed unless a stock falls to that level. But if it is, you’ll be collecting a huge yield on a great stock that would have seemed unachievable at today’s prices.
Finally, don’t be afraid to take a partial profit on any dividend-paying stock that appears to have really surged on momentum. You can still keep part of your position. But the profits you’ll book can be reinvested to claim fatter returns, with negative momentum stocks of still-strong companies as great potential candidates.
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