Big Dividends are So Tempting! Is This Dividend Stock Good?

Big dividend stocks are tempting. Who doesn’t want to buy shares of a company and sit back to enjoy juicy passive income? Stock investing is not so simple, though. Big dividend yields can be cut.

As a dividend investor who targets extraordinary total returns, I sometimes battle between getting a nice dividend income and a high expected total return. Sometimes, investors can get the best of both worlds, though. When it’s clear a nice dividend stock could deliver high returns, it’s easy to make an investment decision. Other times, the market has given a clear signal that a high yield dividend stock’s dividend could be in danger. Usually, slow growth piggyback on high yield stocks.

Here’s a high-yield dividend stock you might have looked at over the last year.

A dividend stock with a +9% yield

Honestly, I have been tempted by Omega Healthcare (NYSE:OHI) juicy yield in the last month or so. Currently, it almost yields 9.2%! However, my investment decision doesn’t entirely depend on the +9% yield, because there’s the danger that the healthcare REIT could cut its yield to lower levels. Therefore, if I buy the dividend stock, it wouldn’t only be for the dividend, it’ll also need to be a good total-return investment.

What’s the market signaling?

The OHI stock selloff since August is signaling there’s something wrong with the underlying business. Even though it hit a relative strength index of about 30, the stock trades below the 200-day simple moving average. So, it’s still time for caution.

Lots of discussions state why OHI could cut its dividend. The bottom line is that it could experience a drop in its FFO per unit in the near term, which will weigh on its valuation and is a risk to its dividend.

Is Omega Healthcare going to cut its dividend?

Over the last month, the mean analyst target for OHI stock has declined but not too substantially. The new 12-month target is $35.57, which represents 21.8% near-term upside potential.

Source: Yahoo Finance

Let’s be conservative and assume it could cut its dividend by half (leading to a yield of about 4.6%). Then, its 12-month total return potential is roughly 26.4%.

Actually, a 4.6% yield is not a bad income and its near-term total return potential is decent, but don’t count on the dividend stock bouncing back any time soon.

Think of OHI as a value stock that could turn around and deliver 15-19% per year over the next 3-5 years if it doesn’t cut its dividend. I modeled this based on a 3% FFOPS growth rate and a normal P/FFO of 11.4, as shown in the graph below. (Its 5-year FFOPS growth rate is 5%.)

Source: F.A.S.T. Graphs

Here are some potential scenarios for the big dividend stock in the next 1-2 years. (Note that these are simple scenarios that, for example, don’t take into account that if a dividend cut occurs, that the dividend can start rising again within 5 years.)

ScenarioDividend cut %3-5 year total return estimate
10%about 15-19%
230% about 12-16%
350%about 10-14%

The investor takeaway

If you have a long investment horizon, Omega Healthcare stock might work as a small position in your diversified dividend portfolio. OHI is expected to have stagnant growth over the next couple of years. In fact, its FFO dip in the near term might put its dividend at risk. If it does end up cutting its dividend, it’s not the end of the world.

Many dividend stocks have delivered excellent total returns when investors buy on the correction of the selloff (before or after the dividend cut) and the underlying business successfully turns around. In fact, at times, when stocks cut their dividends partially, sometimes they rally immediately in reaction.

Stay tuned for NorthWest Healthcare Properties REIT (TSX:NWH.UN) and Manulife (TSX:MFC)(NYSE:MFC) over the next 2 weeks. Let me know if you’re interested in other high-yield stocks.

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Disclosure: As of writing, we own MFC stock.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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