There’s a contradiction in high-yield stocks that many investors choose to seek out.
On one hand, dividend stocks with a high yield seem like an inherently good thing. Generating 4%, 5% … heck, even 10% in annual income appears attractive, particularly in an environment where 10-year Treasuries are yielding
under barely over 2.2%. The higher the yield in a portfolio, the greater the income on the same base of assets.
The market rarely offers a free lunch, however.
The flip side of the near-term attractiveness of high-yield stocks is that in many cases, those same yields often signal danger ahead. In some cases, it might mean that dividend growth is slowing or stopping, or worse, that there’s fear of a dividend cut or suspension. It may be that the yield simply has an expiration date, as in the case oil trusts and other unique situations.
A 4%-plus yield can be an opportunity to boost investment income, but just as often, it can be a yield trap that snares unsuspecting investors.
It’s not always easy to tell the difference. Back in March, we here at InvestorPlace highlighted 7 high-yielders that looked safe. But even we missed a yield trap in Mattel, Inc. (NASDAQ:MAT), which cut its dividend
just last week in June.
Here are 10 more high-yield stocks that look dangerous, and where investors may be risking far too much principal for the dividends offered.
[Ed’s note: This post originally ran on June 21, 2017. We’re republishing it because these high-yields have changed but can still wreck your retirement.]
For years, shorts argued that cemetery operator StoneMor Partners L.P. (NYSE:STON) would have to cut its dividend, which generally yielded in the 8%-9% range. With the payment of its dividends exceeding free cash flow, bears claimed, eventually, the bill would come due.
STON bulls pointed to a steady business, the nature of StoneMor’s accounting and an attractive dividend stock as counters to that argument. But in October, the bulls won. StoneMor cut its dividend 50% after seeing a tough third quarter, and the stock fell by a similar amount. STON now yields more than 14% — but it seems just as unsustainable as the ~10% yield did before October’s plunge.
Meanwhile, StoneMor has replaced its CEO and CFO, and is delinquent in its SEC filings. What information has been released shows declining sales and profits … and operating cash flow still shy of supporting the reduced dividend.
There is a case for STON as a high-risk, contrarian play. But income investors looking for stability should look past the yield and avoid StoneMor.
Ford Motor Company (NYSE:F) has a new CEO, a single-digit earnings multiple, and a 5%-plus dividend yield. That seems an attractive combination for a titan of American industry.
But I remain skeptical that it’s enough.
New CEO Jim Hackett has his work cut out for him, and he alone can’t solve Ford’s problems. “Peak auto” is a major problem for F stock, and there’s a very real chance that Ford’s earnings have reached a top — for good.
As far as dividend stocks go, Ford might look safe. But as a new CEO, Hackett will have the buy-in from investors to cut Ford dividends if the company wants to put more cash into catching up in autonomous driving. The payout ratio is only at a reasonable ~40% at the moment. But earnings declines, pension expense and technological investments could squeeze Ford’s payout.
There is a case to buy Ford stock, but as a contrarian play, not simply for its high-yield dividends. There’s a reason both Ford and General Motors Company (NYSE:GM) are trading so cheaply. It’s because profits for both companies seem to set to decline — and that’s bad news for both companies’ dividends.
CenturyLink Inc (NYSE:CTL) has mostly avoided the bloodbath in the wireline telephone business. Frontier Communications Corp (NASDAQ:FTR) has declined 74% over the past year. Windstream Holdings, Inc. (NASDAQ:WIN) has been halved. Yet CTL shareholders actually are up modestly over the same period, including a dividend that now yields over 8%.
CenturyLink’s relative prosperity may be set to end, however. A class-action lawsuit filed this week suggests an unauthorized account problem similar to that seen at Wells Fargo & Co (NYSE:WFC). The pending merger with Level 3 Communications, Inc. (NYSE:LVLT) adds a mountain of debt and potential disruption (though, admittedly, there is an opportunity as well if CenturyLink can execute).
Still, CenturyLink is a heavily indebted company that still has substantial exposure to the declining wireline industry. That’s a combination that can turn south quickly — as FTR and WIN shareholders have learned over the past few quarters.
CenturyLink may not be in line for a similar decline in 2017, or see a near-term dividend cut like Frontier did. But it’s a very risky play, 8% yield or not.
The story at New Media Investment Group Inc (NYSE:NEWM) sounds dangerous.
New Media is raising debt — and issuing equity — to buy local print newspapers. New Media’s pitch is that its model is better. The company argues that its “hyperlocal” content, as it deems it, is superior to and longer-lasting than papers from a national company like Gannett Co Inc (NYSE:GCI), owner of USA Today, or a regional operator like McClatchy Co (NYSE:MNI).
There’s a couple of problems with that argument.
First, revenues and cash flow are declining, at least on an organic basis. Acquisitions are masking the decline, but buying more declining businesses doesn’t seem a healthy growth strategy. The distinction between local and regional content hasn’t been all that large over the past decade. In fact, both industries have seen substantial revenue declines.
Most notably, New Media management used a similar strategy last decade with GateHouse Media. That company wound up in bankruptcy, with its assets becoming the core of the “new” New Media.
From that standpoint, NEWM’s 10% dividend yield hardly seems sustainable. If the company backs off an acquiring new papers, cash flow will decline, in which case the dividend will need to be cut eventually. If it continues M&A, it will need to fund that activity somehow, which similarly could pressure the dividend or require another equity offering (diluting shareholders).
This simply isn’t a story that quite adds up, and it seems to imply some risk to New Media’s share price and dividend over the next few years, if not the next few quarters.
There was a time not long ago when I thought GameStop Corp. (NYSE:GME) was a good buy. The company’s legacy video game business is declining — but modestly. And the increasing focus on the “Technology Brands” segment, including wireless reselling and a Simply Mac business, seemed to give GameStop a way to grow profits even as brick-and-mortar video game sales declined.
I’m much more skeptical on that strategy, however, and on GME stock as a result.
Tech Brands operating earnings actually declined year-over-year in Q1 — a worrisome problem given the capital spent on new stores and a multi-year growth target in that business. Intensifying pricing competition between wireless providers Verizon Communications Inc. (NYSE:VZ) and AT&T Inc. (NYSE:T) could pressure the reseller business. Meanwhile, collectibles and Mac sales move GameStop out of the digital frying pan into the e-commerce fire.
GME stock is cheap, and it’s possible there’s a way out of its current predicament. But truthfully, I’m skeptical of the bull case. At the least, that case requires a lot more than a 7%-plus yield.
Multi-year lows have created a number of high-yield stocks in the retail industry.
Kohl’s Corporation (NYSE:KSS) offers a seemingly huge 5.9% at the moment — but that’s not close to the top yield in the industry. Macy’s Inc (NYSE:M) has a 6.7% yield, while smaller retailers Guess?, Inc. (NYSE:GES) and Cato Corp (NYSE:CATO) offer 7.7% and 7.3%, respectively.
All four dividends have a reasonable chance of being cut.
In the case of GES and CATO, at the least large cash balances provide some cushion. For Kohl’s, however, the stock has held up better than M stock or rivals J C Penney Company Inc (NYSE:JCP) and Sears Holdings Corp (NASDAQ:SHLD). A 10-plus forward EPS multiple is higher than department store rivals, but so far, Kohl’s has outperformed in terms of managing sales and earnings declines.
“So far” is the key phrase.
There’s little reason to suggest that Kohl’s has found the “secret sauce” to avoid the e-commerce competition led by Amazon.com, Inc. (NASDAQ:AMZN). And if there has been one lesson of retail over the past few years, it’s been that “cheap” stocks generally only get cheaper.
That seems likely to be the case with KSS at some point. And with the dividend payout ratio already at 60% of estimated FY17 EPS, any further pressure likely means a dividend cut and further declines in Kohl’s.
The classic “high-yield play versus yield trap” argument the last few years has been in the mortgage REIT sector.
So-called mREITs are leveraged portfolio of mortgage securities. They borrow money at lower variable rates and buy (generally) fixed-rate mortgages with the proceeds. As Fed rates rise, in theory that spread narrows. Given that leverage amplifies profits, narrowing spreads mean lower earnings and lower dividends — and usually a lower share price.
The largest mREIT, Annaly Capital Management, Inc. (NYSE:NLY), has for the most part had success with its model. But there has been some volatility, notably in 2013, when a dividend cut sent shares plunging 40%. Over the past 10 years, NLY has returned roughly 200% including dividends, handily beating the market. Over the past five years, however, a 30% total return has badly lagged.
At the moment, NLY certainly looks like a dangerous dividend stock. The stock’s price to book value has exceeded 1x, a rare occurrence. At 1.1x, Annaly’s P/B multiple is its highest in almost six years. Fed rates are rising, though Treasury yields remain muted. If that continues, the hugely beneficial low-interest-rate environment that has benefited NLY could become much more difficult.
That means a 9.7% yield — actually low by Annaly’s historical standards — could be unsustainable.
Like some other stocks on this list, there is a bull case for NLY stock. But investors expecting steady payment of a nearly 10% yield for years to come at this point likely are being far too optimistic.
Seagate Technology PLC (NASDAQ:STX) has taken investors on a roller-coaster ride the past few years, climbing from $10 in 2011 to nearly $70 in late 2014, before falling back below $20 last year and then gaining another 150%.
Over that period, STX has become a nice high-yield play, raising its dividend 250%.
Further hikes might be tough, though, and further weakness in STX might overwhelm a current 6% dividend. Seagate’s hard disk drives seem at risk from the shift to the “cloud” and increasing demand for solid-state drives.
With the stock trading at roughly 9x 2017 and 2018 analyst consensus EPS estimates, some of that risk is priced in. But declining businesses generally don’t raise dividends — they cut them. And while a cut from STX likely is a long ways off, long-term income investors seeking high-yield stocks could be setting themselves up for disappointment down the line.
With a reported dividend yield of more than 17%, BP Prudhoe Bay Royalty Trust (NYSE:BPT) looks like a fantastic high-yield opportunity for income investors. BPT offers investors exposure to royalty interests from BP plc (ADR) (NYSE:BP) operations in the Prudhoe Bay basin in Alaska.
The mechanics are complicated. Trustholders receive royalties on a maximum of 90,000 barrels per day. Costs are taken out from royalties based on an escalating calculation. Alaska state taxes have an impact as well. But, simplistically, BPT trustholders receive a piece of each barrel drilled in the field.
That sounds like an exceptional deal, but there are two major problems.
The first is that the 17.3% yield is based on the past four payouts, but the past two were outsize compared to the payouts of the past couple years — no surprise given a modest spike in oil prices during Q4 2016 and Q1 2017. Those oil prices are coming down quickly, and so will BPT’s payout.
The larger problem is that the trust liquidates at a price close to zero once royalties diminish. Amazingly, the most recent 10-K forecasts that no royalties will be paid after 2018.
That’s just a forecast, to be sure, and a spike in oil prices could extend the lifespan of the trust — and raise BPT’s real value. But in the current oil price environment, investors are facing losses as high as 60%-70% in receiving just a few quarters of sub-$1 distributions in exchange for a $20 unit price that will eventually turn to zero.
If ever there was a “yield trip,” and a stock whose high yield is largely illusory, BPT would fit the bill.
Dividend Yield: 3.3%
Up front, The Coca-Cola Co (NYSE:KO) stock isn’t nearly as dangerous as some other stocks on this list. Many readers might even sneer at its inclusion on this list.
After all, Coca-Cola is one of the more stable and most widely-owned dividend stocks in the market. It has raised its dividends for 55 consecutive years. Even Warren Buffett loves both Coke and KO stock, with the latter one of the biggest holdings of his Berkshire Hathaway Inc. (NYSE:BRK.B).
But KO stock looks dangerous at the moment, and there seems a real risk that a decline in the stock price could more than offset at 3.3% yield.
Coca-Cola’s revenue has dropped for four consecutive years. While some of that decline has come from the company selling or exiting most of its bottling business, organic sales have been pressured as well. Diet Coke, in particular, has seen plunging sales, and overall sparkling beverage volumes were down year-over-year in 2016.
Soda taxes and health concerns seem likely to persist — and further pressure Coke sales. And unlike rival PepsiCo, Inc. (NYSE:PEP), which owns Frito-Lay, Coca-Cola doesn’t have diversification away from beverages. That beverage business doesn’t seem attractive at the moment. With KO stock trading at an expensive 23x 2018 analyst EPS estimates — roughly the same multiple as Facebook Inc (NASDAQ:FB)! — a correction seems likely.
At the least, the multi-year underperformance of KO versus PEP seems likely to continue.
As of this writing, Vince Martin held a short position in NEWM.