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By Charles Sizemore
| March 6, 2017
I love dividend stocks. If dividends could be personified, I would marry them and sire children by them.
OK, that might have gotten a little weird. But in all seriousness, dividend stocks are an important part of any long-term portfolio, and they make up a major part of my investing strategy.
If you’re already retired, dividends provide a constant stream of realized income. That’s particularly important in a sideways or bear market, as it reduces your need to sell stocks at depressed prices to meet your withdrawal needs. But even if you’re years or decades away from retirement, dividend stocks should still be a major part of your financial plan. Companies that pay dividends tend to be healthier and more stable, and dividends paid can be reinvested in new shares.
But with bond yields still in the toilet, income-starved investors have resorted to chasing yield in dangerous dividend stocks. If you see a yield that seems too good to be true, chances are good that it is. An abnormally high yield can be the sign of a company in distress … and that dividend is often likely to be cut or eliminated altogether.
You also have to ask that fundamental question: What is a dividend?
A dividend is a distribution of profits to the shareholders. So when you see dividends that are consistently higher than profits, that’s a problem. It may be a sign that the company is recklessly borrowing to maintain its dividend. That’s a major no-no. In evaluating dividend stocks, you want to see consistent and growing profits that can safely support the dividends being promised. You don’t want to bet your retirement on an income stream that could evaporate tomorrow.
Today, we’re going to take a look at 10 dangerous dividend stocks. Some of these are OK to wait out if you already hold, but you should avoid if you don’t. Others should be dumped with haste.
Prices and data are from the original InvestorPlace story published on March 2, 2017. Click on ticker-symbol links in each slide for current prices and more.
Dividend yield: 3.1%
I’ll start with a household name, International Business Machines Corp.
It feels almost sacrilegious to include Big Blue in a list of dangerous dividend stocks given that IBM is one of Warren Buffett’s biggest holdings. But the Oracle of Omaha, as talented an investor as he is, failed to take into account how cloud computing would take a wrecking ball to IBM’s business.
Today, IBM’s fiercest competitor is Amazon.com, Inc.’s (AMZN) Amazon Web Services (AWS). And frankly, IBM is getting its butt kicked. Its revenues have fallen for 19 consecutive quarters.
Stop and read that last sentence again. IBM’s revenues have been shrinking for nearly five years straight, with much of its lost revenue going to Amazon and other cloud competitors. Yet IBM continues to raise its dividend every year (21 years running), and today the stock yields 3.1%.
Don’t be seduced by the yield. While the payout ratio looks reasonable at a current 44%, earnings per share is being sustained by debt-fueled buybacks and not revenue growth. That’s not likely to end well.
Dividend yield: 6%
Up next is Mattel, Inc. Like IBM, Mattel is getting trounced by its competitors these days. Its iconic brands like Barbie simply aren’t growing. Meanwhile rival Hasbro, Inc. (HAS) is knocking ‘em dead with its Star Wars, Marvel superhero and Disney princess toys and accessories.
Children’s toy preferences can be fickle, and so it’s entirely possible that Mattel’s toy lineup will come back in style. But I don’t see it happening any time soon. At the end of the day, Hasbro has Disney’s massive marketing machine behind it, and Mattel doesn’t.
Furthermore, as kids embrace video games and apps at younger and younger ages, the window in which they play with more traditional toys is getting increasingly smaller.
Meanwhile, Mattel’s 6% dividend looks unsustainable at a payout ratio of 165% of profits.
My advice would be to dump Barbie and move on.
Dividend yield: 3.3%
Heavy-duty equipment maker Caterpillar Inc. is up big in the past year, sure, largely led by optimism about President Donald Trump’s grand infrastructure plan.
But Caterpillar has, operationally speaking, had a rough run in recent years. Its revenues peaked in 2012 and have been in decline ever since. The center of construction and mining activity was in China and the developing world, and a multi-year slump has been bad for Caterpillar’s business.
CAT has always operated in a cyclical industry, and this certainly isn’t the company’s first rodeo. But if you’re looking for dividend growth any time soon, you’re not likely to get it here. The payout ratio has been climbing for years due to both regular dividend hikes and stalling profits. And as of last year, the payout ratio isn’t even calculable, as earnings were negative.
On top of all that, Caterpillar appears to be in the crosshairs of the IRS and other federal agencies, which raided three of the company’s corporate locations in Illinois on Thursday. The investigation reportedly is connected to a lawsuit alleging that CAT was trying to evade taxes via offshore shell companies.
As far as dangerous dividend stocks go, Caterpillar isn’t the worst. But it’s still one I’d steer clear of, especially amid this latest uncertainty.
Dividend yield: 3.2%
I’d also recommend steering clear of that most venerable of dividend stocks, Marlboro maker Altria Group Inc.
I should be clear on one point here. I actually don’t consider Altria’s dividend at risk of getting cut any time soon. My concern with Altria is valuation.
Remember: Cigarette use is in terminal decline across the world. American teenagers are more likely to have used an illicit substance in the past year than to have smoked a cigarette. Companies in declining industries can be fantastic investments … if they are priced right. But Altria is priced at 22 times expected earnings, and its Dividend yield, at 3.2%, is the lowest it has been in nearly 20 years. That’s not a reasonable price for a company whose product is dying.
My advice is to be patient here. If Altria had a good selloff and was available at a 6% yield, I might be inclined to take a nibble. But at any yield less than that, you’re simply not being fairly compensated for the risk of holding the stock.
Dividend yield: 14.9%
The crown for the highest-yielding stock on this list of dangerous dividend stocks goes to Frontier Communications Corp. At current prices, the stock yields nearly 15% … at least for now.
Dividend yields can only fall two ways.
It has been years since Frontier Communications has earned enough in profits to properly cover its dividend. Now, some of this is due to exceptionally large non-cash expenses like depreciation. But at the end of the day, FTR is a debt-loaded legacy communications company with no real competitive advantage.
In the interests of Frontier’s long-term survival, the board would be wise to slash the dividend and use the cash to pay down debt.
Dividend yield: 9.1%
CenturyLink Inc. is in the same boat. As a mid-sized phone and internet provider, CenturyLink operates in slow-growth, low-margin businesses. It also comes nowhere close to covering its large 9%-plus dividend with current earnings, and its dividend payout ratio has been over 100% for most of the past decade.
Like Frontier, CenturyLink has more cash available for dividends than its profit numbers would suggest due to its high depreciation charges. But all the same, dividend payments eat up half to two-thirds of free cash flow every year, not leaving much left over to expand or reduce debt.
CenturyLink will probably be able to maintain its current dividend for at least another few years. But do you really want your retirement to hinge on a legacy tech company with growth prospects that are modest at best?
Yeah, me neither.
Dividend yield: 5.2%
When I was a kid, it seemed like there was an office supply store on every corner. These days, they are a lot less common. E-commerce, led by Amazon, has taken a wrecking ball to traditional brick-and-mortar retailers. And office-supply leader Staples, Inc. is no exception. Annual revenues peaked in 2012 and have been drifting lower ever since.
One look at the stock price would tell you that this company is in trouble. The stock price has declined by nearly two-thirds over the past 10 years.
I should be clear that I don’t expect Staples to go out of business any time soon. But I do wonder how much longer its 5%-plus dividend will be sustainable. The company is losing money and is closing unprofitable stores. How much longer until the board of directors decides to conserve cash by slashing the dividend?
Dividend yield: 5.2%
Kohl’s Corporation is another brick-and-mortar retailer with a very uncertain future.
Even before e-commerce started wreaking havoc on the retail industry, Kohl’s was at best a middling retailer. It was never quite a burning dumpster fire like J C Penney Company Inc. (JCP) or Sears Holdings Corp. (SHLD), but it hasn’t exactly been a growth dynamo either. Revenues have been essentially flat since 2011, and earnings per share have been declining since 2012.
It hasn’t helped that economic growth has been tepid. But you also get the feeling that, were we to return to 4% GDP growth tomorrow, Kohl’s wouldn’t be the first place that Americans decided to drop their money.
Kohl’s dividend payout ratio is still relatively modest at 61% of profits, so there is not an immediate risk that Kohl’s 5%-plus dividend will be cut. But I would certainly be worried about its long-term sustainability given a tough competitive position faced by traditional retailers.
Divided yield: 5.6%
I’ll give Pitney Bowes Inc. credit. The company is a survivor. Given the decline of “snail mail,” it’s hard to believe that a company whose primary business is selling postage meters and related supplies has managed to stay relevant.
I might literally go a month without checking my mail. All of my bills and professional correspondence are sent electronically. I’ve actually considered physically removing my mailbox from my house, as all it seems to do is accumulate coupons for the local doughnut shop or dry cleaner.
Granted, I might be a little eccentric, but the fact remains that the traditional postal service is dying a slow death. And not surprisingly, Pitney Bowes has seen its revenues drop every year since 2008. Annual revenues today are clocking in at 2002 levels.
PBI stock currently yields an attractive 5.5%. But this is a company that has already had to slash its dividend in recent years, and I expect to see more dividend cuts to come.
Dividend yield: 6.1%
And finally, I’d recommend you be very cautious with British telecom giant Vodafone Group Plc.
Vodafone has been a mainstay in dividend portfolios on both side of the Atlantic for as long as I can remember. But mobile communications are no longer a growth industry, and the competition gets more and more brutal with each passing year. Rivals like Telefonica S.A. (ADR) (TEF) have already had to accept reality and slash their dividends, and I expect to see a lot more of that across the industry.
Big telecom firms used to be utilities with low turnover and high barriers to entry. Today, they’re more like a commodity producer in that price seems to be the only factor that matters to consumers. That’s bad for long-term profits and bad for the safety of the outsize dividends that investors have gotten used to.
At current prices, Vodafone yields a little more than 6%, which is the sort of thing that makes a dividend investor’s mouth water. But I recommend you tread carefully here. In the current competitive environment, telecoms are dangerous dividend stocks.
This article is by Charles Sizemore of InvestorPlace. As of this writing, he was long TEF.
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