The Dangers of Fake Dividend Stocks

Welcome, everybody. I'm excited to be with you today to talk about bad dividend stocks, the good, bad, and the ugly on dividends. There's a lot of misinformation out there about, as you all know who follow us, earnings, cash flow, valuation. A lot of the people think that one of the safe corners in investing is dividends. It's straightforward. That's an easy play. It's smart. It's safe. Maybe not sexy. But it's easy and safe. Well, that's not true either. And over the next 3 weeks, we're going to be showing you how not just, not just to diagnose the problems, the traps, the dangers of dividend investing. We're going to give you solutions as well. We always do that in New Constructs. We don't just give you problems. We don't just tell you what's wrong. We show you how to fix it. So let's jump in here. I will share my screen. And we will get going. So, successful dividend investing, how to avoid fake dividend stocks. A reminder that we are not an advisory firm or advice firm. We are a publisher of financial information. We do not provide advice. That's for somebody else to do. We provide information, the best information in the world on US stocks. And I want to hear from you in the chat. Look, let's make this interactive. Is this your first time with us? What kind of investor are you? And if we have time at the end, I will diagnose some of your dividend stocks. If you got a dividend stock that you're wondering about, you want an answer, I will, I will take at least 2. So let me start with a quote. We'll mix it up a little bit. This quote is from Ben Hogan and one of the, the best guys I ever worked with in the, in the business. a guy named Mike Grimness, he used to use this quote a lot because we would market together. He changed it around a little bit, but he would always quote Ben Hogan in our meetings about how golf is not necessarily a game of good shots, it's a game of bad shots. What does that mean for investing? It means something very, very important. That is that investment success is not so much about how well you pick your good stocks, but how well you avoid bad stocks. Buffett has said this, all the greats have said this. Because look, it's easy to play it safe with an index fund or something like that, and that's great, but you got to keep it safe. You're okay if you pick a stock that's going to go up, but if you pick a stock that goes to zero or gets crushed, that's really where all the money managers, all the studies will tell you that underperformance most of the time is about the bad stocks, not so much the good stocks. This idea, this strategy that it's important to avoid the wrong kinds of stocks, the wrong kinds of dividend stocks, the bad dividend stocks, I think is very valid in today's market, because we're all a little bit shaky. It's good news one day, bad news the next. Tariffs are legal, tariffs are illegal. Who knows what's going to happen? I think this administration is going to be marked by a lot of surprises. It's attention grabbing. I think that is a big part of modern political strategy, modern influencer strategy is all about how do I get attention, not necessarily how do I inform, how do I do anything? Attention is the premium. In that environment with the leadership that thinks about that, I think we're going to see a lot of volatility, because it brings attention. We'll see the opposite of boring. What does that mean? This market's going to be tough. It's not gonna be as easy as it has been in the past. So let me talk to you about some key points on bad dividend stocks. First of all, not all dividend stocks are good. Not all stocks are good, but not all dividend stocks are good. Just because it's got a dividend doesn't mean it's a good company, doesn't mean it's a good stock. Fake dividend stocks, what we're gonna be focusing on today, might have enticing dividends, but the downside risk in the stock Cancels out the potential dividend yield. So it doesn't matter if you've got a 10% dividend yield and the stock drops 20%, you're still down 10%. The stock goes down more than the dividend yield, you lose. Now, in general, there are 3 kinds of bad dividend stocks: fake dividend stocks, false dividend stocks, and dividend trap stocks. We're gonna talk about all 3 over the next 3 weeks. Today, the focus is on fake dividend stocks. And let me do some live demonstration like we like to do at NewCosta to show you exactly what we mean. So I put together a portfolio of fake dividend stocks. This is our professional membership. And so I'm going to be showing you, like, this is like the Lamborghini of research, my friends, right? And we've got other options, and I'm going to show you how to get access to good dividend stocks in a very inexpensive way here at the end. But while I'm doing this work, I want to show you, I like to drop this one. If you're going to ask me which website membership to use, I'm going to use my institutional membership. So, it asked me, am I going to drive my Lamborghini or am I going to drive my much lesser car? I don't want to necessarily insult any smaller other cars, but you know what I mean, right? I'm going to drive my Lamborghini. This is our Lamborghini. It's my institutional subscription. It does all kinds of cool stuff. Let me show you how I found fake dividend stocks in our system. I went in here and I said, I'm going to get anything with a dividend yield greater than 2.5%. And I'm going to say, then I want very unattractive rated stocks. I filtered on that, click this button, gave me an answer of these, I don't know, it's around 40 or 50 stocks. Now we can sort by dividend yield, we can sort by market cap. whatever we want. Top of the list is Digital Realty with a 2.8% dividend yield. If we want to look at the company with the highest dividend yield, we could take out IRE Commercial Real Estate, KKR Real Estate Finance Trust. These are all some pretty small market cap companies, or AES. But you see, these are all really high dividends. And I hit this button right here and I put it into the fake dividend stocks portfolio for May 30th. So let's talk about what we're really getting down to here, my friends. And we'll do a couple case studies. Let's start with Digital Realty Trust. So 2.8% dividend yield, but an unattractive rating. What does that mean? That means that the dividend yield might be a drop in the bucket of what your capital losses will be. Speaking specifically capital loss, we can focus on the right-hand side here, the valuation side. And you got a lot of red flags here. First of all, most importantly, the market implied growth appreciation period. I mean, that's a big red flag when it is more than 100 years. That means when we put consensus estimates into a forward-looking discounted cash flow model, it takes more than 100 years of profit growth to justify the stock price, or we can't get the model to generate a value as high as the stock price, even with 100 years. Forecast horizon. That's expensive, my friends, very expensive. Same here with price to economic book value. That's the price to the no-growth value of the stock. Let's go into the breakdown here a little bit more. You'll see that the economic earnings are negative and declining. That's bad, even though accounting earnings are positive, mostly flat here, actually going up, and economic earnings went up a little bit too, but they're pretty darn negative and the trend is Looks pretty opposite here to me, but you got declining— I'm sorry, yeah, rising accounting earnings, slightly less negative economic earnings. But the takeaway here is this is a bad business. Return on capital. The one thing that's surprising here, though, is that you look at the margin, the margin's been pretty high. It's coming down, maybe a little bit better, but it's not a terrible margin. Not a terrible margin. But yet the economic book value of this business, We get down to the valuation section, or my favorite valuation section here, the economic book value of this business is negative. It generates some profits. This is why it's a fake. It generates some profits, but guess where all those profits are going? To somebody else, to non-equity holders. I'll get specific here in a second. The economic book value per share is a negative $38. So that means that the no-growth value of the stock for equity investors is negative $38.30. You can see it's been pretty consistently negative for a while here. What's going on? How does this company have a good positive profit margin when the economic book value is negative? Well, let me show you. We'll come over here, we'll go to the GAAP reconciliation section. This is where we take a look Okay, what's going on on the income statement, the balance sheet, the valuation, which are all important elements, necessary elements for understanding a business. You got to look at the whole thing. You can't just be one of those blind men who's got one hand on the elephant and telling you what he thinks. We at New Constructs, we cover the elephant with an AI scanner, so we know everything that's going on. That's really what our analysis is about. Income statement's got no— we got no problems with income statement. In fact, NOPAT's higher than net income, mostly because of— I'll tell you in a second. And then the balance sheet, the invested capital is about the same as the total assets. That's not bad. So we're not seeing any red flags there. What's the issue? When we're going through liabilities, oh, it's this $17.4 billion in debt. The reason NOPAT is higher than net income is because NOPAT is what we call unlevered. We take out the interest expense so we can look at companies assuming that they have no debt. And we take the cost of debt out in another area when we're looking at economic earnings. So NOPAT is what we call unlevered. It's debt-free so that all companies can be apples to apples. So we make them all look debt-free so we're all comparing them based on their economics, not necessarily their financing choices. So that's why the NOPAT is higher than net income because we've added back the interest expense. But that interest expense is a big number, $17.4 billion. What does this mean now, back to going to economic book value? The point is that, yeah, the company's making profits, but all those profits got to go to the debt holders. There's nothing left. In fact, there's not even enough necessarily to cover the debt holders. Another way we can see this is in our credit rating. Look, this is all bad here, EBITDA to debt, free cash flow to debt, cash to debt, interest coverage, These are all unattractive or very unattractive, except cash-to-debt's okay. They've been able to raise a lot of capital. This is a great capital market story, by the way, Digital Realty. This was a focusless short stock at one point. Debt-to-total capital, what's happening here? Oh, David, that's not so bad. Yeah, well, because the market cap is inflated. This has been a hyped-up stock because it's been an AI stock because they do data centers and renting facilities and stuff. for that. When we wonder, as we wrote in here, data centers are dinosaurs, the AI boom has changed that. But the idea that a data center is some sort of really difficult business to replicate, and there's a competitive advantage there for profits, well, it's certainly not paying out historically. When we went to Look at profits for Digital Realty. We've not seen any. It's getting worse since the AI boom started, not better. So, we're switching back to the credit rating. This one, me as an analyst, I throw debt-to-total capital out. All this is telling me is that relative to the total capital of the company, which is equity capital, it's a big part of it because the stock's overpriced, there's not that much debt, but there is. I mean, $17 billion of debt on a $58 market cap, that's still a lot. And it's so much that there's no value or cash flow left over for your equity holders. So that dividend— the stock can go down a lot more than 2% in a year or over the next several years. We, when we wrote a report on this a while ago, Data Centers Are Dinosaurs, great report, and What it showed when we did the reverse DCF analysis on Digital Realty, and this is when the stock was already trading a little bit lower, that you make a really good case for the stock being $59, $29 a share when you look at the economics of the business. For example, even the 58% downside, the margin would have to improve up to 19%. And I think what we saw, 10.5%, we saw the trend going the other way. On the ratings page, and grow revenues at consensus rates for the next couple of years and 9% after that, which is the consensus, and that would be just $59 a share. That's what it gets you to. On the other hand, to justify $141, you got to grow by more than double consensus or close to double consensus for 10 years. That was for $141 a share. The takeaway, folks, is that there's a lot of downside risk. You wanna avoid very unattractive rated stocks. You wanna avoid the very unattractive rated stocks no matter what. Even if it has a dividend, you wanna avoid. Good question here about Carvana. Whew. Let's talk about, yeah, the convertible debt deals at Carvana. Roger, great question. Let me tell you a little story about these deals with Carvana. So one of my good buddies is a technology investment banker. He lives out on the West Coast. I've known him since 7th grade. We get together, our kids are around the same age, they play football, or at least some of— one of his— 2 of his kids play football. And so we talked about that. And anyway, great friends. He's a tech banker, and we've had a lot of good conversations over the years. I've been asking some questions like, how in the world can you justify IPOing this company? What advantage does it have? And we go round and round. And one time his answer was, well, that company can raise more money than other companies. I'm like, Okay, why do I want to invest in something like that? We have had some great conversations about those junk companies, and we have also had some great conversations about junk companies that are sticking around for a while. He told me that there is a trick that they play out there on the West Coast with these junk stocks. It is where venture investors or investors in general will see a stock like a Carvana that is dying on the vine. It's all but bankrupt. These are— and we— because we talked— this was back when my zombie stocks were all the rage. And I was telling him about some of these zombie stocks, like, what is going on? Like, how do these zombies survive? And he said, oh, here's the trick, David. Big investors come in, they see it priced as if it's about to go bankrupt. They give it an injection of life with convertible debt that converts at the near-bankruptcy stock price. So, like when Carvana was down, let's say Carvana, I think it's like $100 and What is Carvana now? We can look that up. CVNA. Carvana is at $319 a share. And where was it at its lows? It got down around $7 a share. So the strategy is we give this company a bunch of debt that converts if the company does well. If the stock goes up, it converts at $7 a share. And they can do this over and over. So let's say they give them, rough numbers, $10 million worth of debt that can convert into 1 million shares at $7. Well, if it goes from $7 to $70, a 10x, you're easily going to make your money back and then some. If it goes from $7 to $150, you're doubling. Your money, so you can lose all that debt. That's the point. That debt can be a dead loss because that's what I was asking my buddy. Like, how do these zombie companies keep getting more funding? It's because people can come with convertible net, make so much on the conversion that they don't care about losing their principal. What does that rely on? Suckers, suckers that are willing to buy in, and it seems to be plenty of them. And what I'm trying to help you do is not be a sucker. On a bad dividend stock. So Roger, yeah, I don't think that these secondary offerings can necessarily— yeah, you're talking probably about secondary stock offerings. And that means if they do a secondary stock offering, Roger, then your dividend's going to— let's say they double the shares outstanding where your dividend yield gets cut in half, because you're now getting paid out a much lower number because you got to pay it to a lot of great Way more shares. So however companies choose to dilute you, it's a bad thing if you are a dividend investor in a bad stock. But great question. I hope that hope that answers it adequately, and hope you guys enjoyed my story. So let's take another one of these. Let's go one of these really high dividend guys we found before. Let's go with yeah Doc at seven percent Health Peak Properties very attractive. Hybrid REIT is the reason this is suspended. That's because it's difficult for us to really understand what's going on with respect to the debt and the equity because they don't disclose it well. But you can see bad credit rating, bad stock rating, everything's bad here. Negative economic earnings, a price-to-economic book value of 11. So we're getting a 7% yield. I bet we're going to see a bunch of debt on this one too, really high debt level if we go down here. Oh, not too bad. Not too bad on debt. Let's take a look at the economic book value. It's probably part of why it still has a positive economic book value. Margin's kind of been all over the place. Return on capital below the cost of capital consistently. Had a bit of divergence here, just as we're seeing a bit of a divergence in economic versus accounting earnings, negative economic earnings. Again, that means there's not enough cash flow left over to pay your equity holders. when you see negative economic earnings. When we come in here and look at economic book value, so the price of the stock is $17.50, the economic book value is $1.59, that's a ratio of 11 times. So that's a significant amount of decrease in your principal that you can see before this stock gets to a more rational value. So if you're into this stock because, oh, it's got a great dividend, You're gonna potentially lose more, way more than that 7% yield. And the same is true for all of these fake dividend stocks. Alrighty, we got some voting going on here today. Let's take a few of your requests before I show you how to get an answer. Let's see here. Hello, friends. All right, we got 2. 2 big takeaways here. Let's go with MO. This is a popular dividend stock to take a look at. So, you know, truth be told, we took a pretty close look at MO here recently as a long idea. And what we found is, yes, very attractive rating. But we had a hard time getting behind it as a great long idea because growth is really— they're really struggling and they don't really have many great competing products these days. So yes, as a long idea, this one is a tough one because we're not really focused on dividend yields. But if you're focused on dividend yield, this is a great one. This is a 7% dividend yield and you've got a stock price already implying a permanent 30% decline in profits. You know, this looks pretty good to me in terms of dividend yields and how dividend yields go. So I, yeah, I can't tell you this would be one to avoid. Let's talk about the number 2 most requested stock today, Master Limited Partnership. Yeah, we have to warn people about Master Limited Partnerships, but some of you might know that we got some MLPs on our focus list long because they can do pretty well. So not as looking as good as Philip Morris, but you see a decent amount of decent quality of earnings, not terrible. Positive economic earnings. That's great. Free cash flow is flat, but you got a decent valuation. So you got a valuation that assumes a permanent 10% decline in profits. That's what the price-to-economic book value ratio means at 0.9, that the market cap is 10% below the no-growth value, which approximately means the market's implying a permanent 10% decline in profits. So cheap, it's a good risk-reward. All right, so let's finish up here and let me show you how to find the good stocks. We've got 2 options for you. Safest dividend yield stocks. This is a special portfolio that focuses on safety among all things. And the key thing this does is measure the cash flows of the company to ensure that they are greater than the dividend payouts in the past. Typically, we're looking at dividend-free cash flows that are well in excess of dividend payouts. So, there's opportunity to grow, not just safety. Also important is that they got a dividend yield greater than 3%, and all the stocks in this portfolio get an attractive or very attractive rating. So, this is one of those situations, folks, where not only is Wall Street misleading you into trying to trick you into getting into certain stocks, But new constructs can, can let you have your cake and eat it too. You can have safe and good stocks, and that's what you deserve. Here's another model portfolio, dividend growth stocks. This identifies the 30 best of the best among dividend growth stocks based on their dividend growth track record, potential for future dividend growth. All these stocks also have an attractive or very attractive rating, positive economic earnings and free cash flow. and increased dividends for at least 5 consecutive years and a dividend yield of at least 1%. So 2 great options. Both of these are just $49 a month. Think about that. You pay way more than that for insurance on anything. Here, you're not just getting insurance against bad stocks, because again, golf is not so much about how well you hit the good shots, but how badly you hit the bad shots. Right? We're giving you that safety, we're giving you that insurance, and then we're delivering you good stocks for $49 a month. That's 2 different portfolios. There's 40 safest dividend yield stocks, and there's 30 stocks in the dividend growth stocks model portfolio. 70 great model portfolio stocks for you. And I will put these into I'll put this link into the chat so you guys know how to access this. That's our dividend growth stocks model portfolio, and our— and then the safest dividend yields stocks model portfolio you can get right here. Alrighty, any questions about fake dividends, how to avoid bad dividend stocks? Why avoiding bad dividend stocks is important, why avoiding bad stocks is important, and how to get good stocks, how to get good dividend stocks. Well, thanks very much, everybody. I appreciate you being with me. Please fill out the survey at the end and let me know what you think. And remember, next Friday, same time, we're going to be going over false dividend stocks. The week after that, we're going to show you how to find or avoid the dividend trap stocks. Thank you and have a great Friday.