A 75%+ dividend yield

Dividend yield has an inverse relation to the underlying stock price. If the dividend payout is constant, then the higher the stock price, the lower the dividend yield, and vice versa. So as a general rule, don’t be lured into some high dividend paying stocks, especially those with very high yields. It often means the stock price is declining fast that usually suggests something wrong with the company. So I’m hardly interested in such kind of very high yield stocks. But this one has some interesting wrinkles with it. Let me explain.

 

The company I’m talking about is EP Energy (EPE), an independent exploration and production company for oil, natural gas and natural gas liquids in the United States. It is going to pay a quarterly dividend of $0.575 with an Ex-date of Oct27 (i.e. you must own the stock at least on Oct 26 to qualify for this dividend). With share price around $3, the annual dividend yield will be about 75-80%. Here are few things you need to understand:

• The dividend EP pays out cannot be covered by its cash flow, meaning it is paying out the dividend on debt. Indeed it is true that EPE is heavily in debt that is a big risk for long term holders.
• EPE share prices have been extremely volatile and in a big downtrend in the past 3 years since it became listed. Understandably this is not unique to EPE but for the whole sector as the past 3-4 years have been the most brutal period for the oil sector. In the past year, it has declined 25%. But lately the oil sector appears to have been stabilized and may have reached the bottom. Oil stocks are accordingly showing the early sign of recovery. EPE may be also in the same bottoming process and its weekly technical is promising. In other words, unless the company has something terribly wrong that is unknown to investors yet, its downside risk is probably limited and may even start to move up moving forward.
• The most intriguing part is its unbelievable track record of hiking dividend consistently in the past 5 years during the worst period of its business era. It has increased its dividend each quarter for the past 21 quarters (at an average rate of 9.1% per quarter and 35.7% per year) and the current quarterly amount ($0.575) will make the annual payout to $2.30, an extraordinary 75%+ forward dividend yield based on the current stock price. 

So what’s the take from the above information and what will be risk if one wants to earn this 70% dividend? As I said, normally I won’t even look at such a trade given the inherent high risk involved for stocks with extremely high dividend yields but this one may be worth a try.  You see, EPE has a good track record of boosting dividends  consistently for 5 years during the worst period and now it has good sign that the energy sector is stabilizing and may even start to move up in the next few years. So it may be reasonable to bet that EPE is less likely to cut its dividends in the next year regardless if it will continue to increase it. If the latter that seems also quite possible, then it’s a bonus for traders. If this expectation holds true, then traders will have at least 70% downside risk protected if you hold it for at least a year to get the full annual dividend. Again, if the sector is stabilizing, such drastic stock plunge seems also less likely unless EPE surprises everyone with some really bad news not publicly known up to now. But let me be very clear, this is risk-reward probability game. Even though the odds is quite favorable to me, the worst case scenario may still come that could wipe out most of the invested capital if not all. Only trade with what you can lose if you want to bet for it!