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Posted by on Apr 6, 2017 in ETF Strategist, Investment Perspective, Market Insight

Avoiding Groupthink Yield Chasing

Avoiding Groupthink Yield Chasing

By Roger Nusbaum, AdvisorShares ETF Strategist

There was news Tuesday that a one-time dividend investor favorite Seadrill (NYSE: SDRL) was warning shareholders that they should expect to “receive minimal recovery for their existing shares” as concerns have escalated to whether it can continue as a going concern.

A few years back, dividend and dividend growth investing dominated the content at Seeking Alpha. Seadrill was one of the favorites of this cohort. It has always been a debt heavy company with decent cash flow and it paid a very high dividend for many years. It ceased paying a dividend in 2014 just as the stock imploded, dropping by 2/3rds in a very short period of time.

Seeking Alpha shows that 80,000 of its members follow the stock. It is written about constantly even to this day despite the dividend being long gone. The debt load was always massive, currently Yahoo Finance shows $10 billion in debt, $1.5 billion in cash and cash flow of $1.18 billion.

In looking at the Seeking Alpha archive of articles for the stock you will see bullish posts all the way down (in price). Before the stock showed any sign of problems, bullish articles tended to explain away the debt concerns because it was part of its growth strategy of adding more rigs which would increase the cash flow and sustain or hopefully increase the dividend.

The groupthink on this probably stemmed from the yield and that it is an interesting story (Norwegian oil rigs).

The point isn’t to pick on people who were wrong on this as every investor will be very wrong a few times (at least) in their investing lifetimes. But this one falls into the behavior of yield chasing and it is important to recognize this and the risk that goes with it.

One ongoing theme here over the years has been that something with an 8% yield in a zero percent world (maybe a little more than zero now) carries a lot of risk and anyone thinking there isn’t a lot of risk probably doesn’t understand the risk they are taking.

The problem isn’t buying one of these and then that it ends badly, again over an investing lifetime there will be a few of these but there are a lot of these types of stocks like riskier MLPs and shipping stocks, even closed end funds (CEF) where over longer periods of time, or not that long, the charts move from the upper left to the lower right with a rather steep slope.

In the past when I have pointed this out, readers have commented that such and such CEF isn’t down 50% when you add back the dividend. I think there is a flaw in that thinking at least for people living off the income because the dividend (or distribution) comes in and they spend it. Half of their original investment is gone (sticking with the same example), spent on bills.

The need for yield of course is vital but there are many ways to get yield that will permanently impair capital and loading up on a bunch of 8-percenters is one of them.

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.