It was too good to be true.
At first glance, Broadmark Realty Capital (BRMK) looked like a dividend investor’s dream: a double-digit yield that paid out monthly.
But below the surface, the company was in serious trouble.
Broadmark Realty is a commercial mortgage real estate investment trust (REIT). So it’s obligated to pay out a dividend. But it was increasing that dividend yield at a rapid pace, and it wasn’t for the right reasons…
It started the year with a reasonably high 9% yield and quickly jumped to a juicy 10%. But over the past six months, Broadmark’s yield steadily climbed as the share price dropped.
As interest rates started rising and put a strain on the real estate market, share prices kept falling. Meanwhile, the yield soared to an eye-opening 12%… then a starting-to-be questionable 14%… and finally to a scary 16% before the company finally slashed its payout by 50% earlier this month.
Predictably, that triggered yet another round of selling. In total, the company is down around 58% this year.
Here at Wide Moat Research, our goal is to invest in companies with safe, sustainable, and growing dividends. And an important lesson for dividend investors is identifying stocks you should stay away from – or what we call “sucker yields.”
Sucker yields like Broadmark Realty look attractive… but inevitably end up disappointing investors because their dividends are not sustainable.
In today’s issue, I’ll tell you how to spot the underlying problems that define these sucker yields. If a company has these problems – no matter how compelling its dividend looks – its share price and the value of its dividend is sure to come down, too.
I’ll also share the names of two stocks I believe are sucker yields that dividend investors should stay away from right now.
How to Spot a Sucker Yield
Back in September – two months before the company announced it – I warned readers that a dividend cut for Broadmark Realty was imminent. That’s because I’d been paying attention. And the signs of trouble were increasing and getting worse for many months.
Here are three reasons I knew Broadmark’s dividend was doomed:
High-risk business model: Though Broadmark is classified as a commercial mortgage REIT, its primary business is in making risky construction loans that traditional banks won’t touch. That means even in the best of times, the company expects many of its loans will go bad.
In a real estate downturn, the company would not only have trouble making loans, but those it did would be more likely to default.
Dividend payout exceeded earnings: While it may seem self-explanatory that paying more dividends than earnings is a bad sign… this isn’t uncommon for equity That’s because in their case, depreciation reduces reported earnings, but not cash flow.
However, Broadmark was a mortgage REIT, which functions more like a bank. And by paying out more than it was earning, it was reducing the capital it had available to make new loans, reducing its earnings potential.
Pay attention to management: Broadmark had planned to transition to a new CEO at the beginning of the year. While it’s hard to judge the performance of new leadership in such a short time, there were changes I didn’t like.
The company increased expenses by hiring more people in a bid to increase performance despite increasing defaults. It also began making higher-risk loans. During Broadmark’s August earnings call, the CEO was unwilling to defend the dividend, passing it off as a decision the board of directors would make. Then in October, the CFO resigned. In November, the new CEO was fired after a dismal earnings report.
These signs all indicated a leadership team that wasn’t committed to rewarding shareholders.
So while some people were lured in by Broadmark’s double-digit dividend yield, I was able to spot the cracks early and steered my readers clear.
The Best Way to Earn Dividends
As a dividend investor, it’s important to check the safety of your income investments every so often. To catch the warning signs that a dividend is in trouble, you should understand how the business makes money and make sure it covers dividends by earnings or cash flow.
It’s also important to pay attention to what management is saying and doing to make sure it’s what’s best for the company and shareholders.
And right now, based on what we’re seeing in the mortgage REIT sector, more dividend cuts may be in store for some of Broadmark’s peers.
Don’t be tempted by extremely high sucker yields like the 16% dividends from Annaly Capital Management (NLY) or Granite Point Mortgage Trust (GPMT). Annaly has extremely high leverage and is a chronic dividend cutter. And Granite Point has been paying out more than it has earned for many months.
Those payouts are unsustainable and are likely to be cut.
The safer, surer way to build wealth is by investing in blue-chip companies that steadily grow their dividends. I’ve put together a list of these reliable dividend growth companies. And you can learn how to access it here.
Happy SWAN (sleep well at night) investing,
Editor, Intelligent Income Daily