A Trip to the Big-Yield Store

If you’re like me, you like to buy stocks when they trade at a discount. For dividend-paying equities, a big yield is perhaps the clearest indication of a bargain-priced stock, assuming that the company can sustain its payout.

Therein lies the rub: Stocks have big yields not because of management’s generosity, but because doubts about the dividend’s sustainability depress share prices.

Worst of all, the skeptics are often right. And dividend cuts usually add insult to injury by triggering a sharp selloff in the stock, even in situations where the shares have “priced in” a lower payout.

That’s the most important takeaway from the aftermath of NuStar Energy LP (NYSE: NS) and Frontier Communications Corp’s (NSDQ: FTR) dividend cuts last month.

Prior to these reductions, the stocks sported double-digit yields, territory usually reserved for names with at-risk dividends. Even though these payout cuts were widely expected, that didn’t stop investors from exiting NuStar Energy and Frontier Communications en masse. Albeit painful, slashing the payout was the right thing to do for these companies to save cash and pay down debt.

The best way to avoid a reduction to your income stream and permanent capital loss is to steer clear of potential dividend cutters. That means scrutinizing your holdings continuously for signs of weakness and being willing to take a loss to avoid an even more pain.