When it comes to dividend stocks, what is commonly called a “payout” would sometimes be more accurately called a “payoff.” Many picks have little to offer investors in the way of growth, so their high yields are really just ways of making up what is lacking.
Exhibit A: Sleepy telecom stocks like AT&T (T), which offers a juicy 5.3% yield to make up for what’s expected to be single-digit annual earnings growth for the next five years.
Of course, while some stocks’ dividends help spackle over a few flaws, others are making up for some potentially serious disasters waiting to happen.
One way to find such companies is to look for high-yielding stocks that investors are still pretty bearish on. Heavy short selling in many cases isn’t necessarily a kiss of death, but a red flag that merits further consideration — and in some cases, might indicate that investors feel these big yields are in danger.
Let’s take a closer look at four heavily shorted dividend stocks that investors are probably better off avoiding:
Sturm, Ruger & Co.
Dividend Yield: 3.7%
Float Short (as of July 31 data): 30%
Our first company, Sturm, Ruger & Co. (RGR) yields well north of 3% yet is pretty heavily shorted … though the company isn’t in terribly dire straits. But you could find much more appealing sources of income right now.
Using the past four payouts, RGR’s yield sits at 3.7%, but if you annualize the most recent 65-cent payout, that’s bumped up to a hefty 5%. Meanwhile, RGR’s dividend has increased at a robust rate in recent years, and it also paid out a $4.50-per-share special dividend near the end of 2012.
Plus, the fundamentals aren’t bad either. Cash and short-term equivalents have increased during the past three quarters, and operating cash flow has more than doubled in the past three years.
The bad news — besides the hefty 30% of the float that’s sold short — is that RGR earnings are set for a big drop. Sturm, Ruger’s EPS is expected to decline 32% in 2004, which would be $3.50 … and thus simply maintaining that 65-cent quarterly payout would take nearly 75% of the company’s earnings.
Also, short sellers aren’t the only RGR bears — the median analyst target for the stock is $40, which represents 30% downside from current prices. And a drop like that would eat up your dividends and then some pretty quickly.
Dividend Yield: 8.8%
Float Short (as of July 31 data): 23.5%
InvestorPlace Editor Jeff Reeves mentioned Frontier Communications Corp. (FTR) recently, noting its popularity with shorts. As he put it earlier this month:
“Shares have underperformed handily in 2013, and barring a buyout from a bigger telecommunications company, it’s clear FTR has little to offer beyond its dividend yield.”
Unfortunately, that dividend yield looks shaky as well. While FTR has robust operating cash flow, the company’s cash and equivalents have dwindled from more than $2 billion in September 2012 to roughly 25% of that as of the most recent quarter.
Plus, while Frontier has paid a dividend since 2004, what began as a 25-cent quarterly payout was decreased in 2010 and again in 2012 to just a dime every three months. And that might not even last, considering at its current rate, FTR will pay out 40 cents per share in a year in dividends, but it’s only projected to earn 24 cents per share in 2014.
Even past the dividend, it’s easy to see why the bears are circling. Frontier’s revenue has fallen for the past eight quarters, and earnings are on track for an ugly 15% haircut for this year. Unless you really believe a buyout is coming, I’d stay away.
Dividend Yield: 7.5%
Float Short (as of July 31 data): 24.3%
Our next stock is a biopharma play, so it’s hardly a surprise that “reliable” doesn’t come to mind. Still, considering the company’s current 7.5% yield, investors might be tempted to ignore the industry’s stigma and pick PDL BioPharma (PDLI) for income.
That’d be a huge mistake.
For one, what started as a 50-cent biannual payout in 2008 has been slashed down to a 15-cent quarterly payout — an overall decrease of 40% annually. But this isn’t a normal income-paying stock, either.
As James Brumley explained earlier this year — in an article titled “4 Tempting Dividends You MUST Resist,” mind you — PDL BioPharma “buys rights to sell revenue-bearing drugs, and passes along a piece of its royalty income to shareholders.”
While that income stream is nice right now — amounting to that hefty 7.5% yield — an important patent is slated to expire in December 2014. It’s called the Queen patent, and covers the company’s top-selling drugs. Unless the company is able to replace those royalties, you can say bye-bye to your sweet divvy.
That patent expiration is likely one reason shorts are circling the stock. Another could be the stock’s market-doubling run since late January that has boosted PDLI shares to around 14% higher than analysts’ median target.
Alon USA Partners
Dividend Yield: 18.7%
Float Short (as of July 31 data): 20.3%
So far, the shorts have been right for our last pick.
Alon USA Partners (ALDW) was spun off from Alon USA Energy (ALJ) late last year. The spinoff hit the markets for $16 per share, and is currently trading 8% lower than the offer price despite a strong start. So far in 2013, the company has lost around 38% of its value.
It’s likely a number of people chased what even initially was a double-digit dividend before realizing what they were piling into. See, the structure of limited partnerships like this one is a double-edged sword. Sure, ALDW is required to pay back most of its earnings to shareholders — which is why the company’s second payout amounted to $1.48 per share — but Alon’s earnings have been taking a huge hit of late, and that results not only in lower payouts but share-price declines thanks to fleeing investors.
The most recent payout was more than cut in half while, in the most recent quarter, the company missing earnings expectations by around 22%. Overall this year, earnings are slated to fall by more than 52%, while 2014’s EPS should take another 45% haircut.
Heck, contracting crude oil differentials contracted have hurt the company so much, a Credit Suisse analyst actually posed this question at the last conference call:
“I’m just wondering if you see yourself in a situation where the cash available for distribution in the third quarter kind of below zero. Would you … try and raise debt to pay out some kind of distribution or what would be your thought process there?”
The fact that such a possibility is being openly discussed is a huge red flag — and should make you realize that an 18% dividend yield might be a lot of things, but it sure isn’t sustainable.
As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.