It’s understandable why stocks with high dividend yields may look appealing right now, but there are plenty of dividend stocks to avoid.
Many of them are dividend traps, stocks with a high but unsustainable yield. The return isn’t worth the investment at the end of the day.
Think of a company that pays out more in dividends than it earns in net income. Or, a company in a cyclical industry, that may have to cut or suspend its dividend in a more challenging economic environment.
Also, this category includes stocks with high yields, yet minimal upside potential. At first glance, a stock yielding high-single or double digits may still look appealing, despite trading sideways for many years. However, on a longer timeframe, such a stock could end up producing suboptimal returns relative to the market.
Amongst the high yielders (dividend yield of 5% or higher), these seven should be considered dividend stocks to avoid.
|ARI||Apollo Commercial Real Estate Finance||$9.76|
|CCOI||Cogent Communications Holdings||$56.95|
|HCSG||Healthcare Services Group||$16.18|
|ORC||Orchid Island Capital||$2.63|
|VGR||Vector Group Ltd.||$10.46|
Apollo Commercial Real Estate Finance (ARI)
A commercial mortgage REIT (or mREIT), Apollo Commercial Real Estate Finance (NYSE:ARI) has tumbled this year alongside other mREITS as the result of soaring interest rates.
As my InvestorPlace colleague Cristian Docan discussed last month, rising interest rates affect mREIT profitability.
That’s what is expected to happen here with ARI stock. Lower earnings could affect its ability to maintain its current juicy forward dividend yield (13.88%).
That’s not all. ARI has a history of cutting its dividend. Since 2019, it’s lowered its quarterly payout from 46 cents per share to 35 cents per share.
On top of this, there also are potential headwinds from a commercial real estate slowdown. Add it all up, and this is among the stocks to avoid. Trying to collect its double-digit yield could be akin to “pick[ing] up pennies in front of a steamroller,” a metaphor coined by The Black Swan author Nassim Taleb to describe situations with small rewards, but big risk.
B&G Foods (BGS)
A producer of food products, B&G Foods (NYSE:BGS) may look appealing at today’s prices.
For starters, you can argue that it’s a defensive stock, with its business likely to be resilient during an economic downturn. It’s also taken a dive in price in recent months.
As a result, not only has it moved to a low valuation (forward multiple of 13.7x). BGS stock also sports an 8.53% forward dividend yield. Yet before you dive in, keep in mind the caveats.
Food inflation is a risk here. As a Seeking Alpha commentator discussed back in April, input costs for one of its main products (Crisco) have skyrocketed due to rising seed and vegetable oil prices.
Its current dividend payout ($1.90 per share annually) exceeds earnings. Any impact to its profitability could necessitate a dividend cut. In light of this risk, avoid this stock.
Cogent Communications Holdings (CCOI)
With a 6.07% forward yield, Cogent Communications Holdings (NASDAQ:CCOI) may look attractive to income investors.
Take a closer look, however, and this is clearly one of the dividend stocks to avoid as a result of both a high valuation and an unsustainable yield.
What this communications company pays out in dividends exceeds its operating cash flow minus capital expenditures (capex). In 2021, it generated $170.25 million in operating cash flow. It spent around $70 million on capex, and paid out around $150.3 million in dividends.
This may not be sustainable in the long run, especially as much of its long-term debt matures in either 2024 or 2026. When the time comes to refinance this debt, it’ll likely have to pay a much higher interest rate. This could put the squeeze on its cash flow, forcing it to cut its dividend.
Dividend Stocks to Avoid: Healthcare Services Group (HCSG)
Healthcare Services Group (NASDAQ:HCSG) isn’t a household name, but many dividend investors may be familiar with it.
A provider of housekeeping and dietary services to nursing homes and hospitals, its main appeal is its 18 year track record of dividend growth.
Yet while it’s just seven years away from achieving “dividend aristocrat” status, it may not make it. Its current payout (85 cents annually, 5.36% yield) represents 132.6% of its earnings. Admittedly, this largely is a result of the company’s earnings taking a big pandemic-related hit.
That said, even if it does manage to get profitability back to pre-virus levels, there may be little room for it to continue growing its payout. This is a mature, low-growth business. Rising labor costs could put pressure on its margins. With many signs pointing to it being a dividend trap, steer clear.
Joann Inc. (JOAN)
This is a result of fading pandemic tailwinds as well as the inflationary and supply chain affecting retail today.
This more recent negative far outweighs the appeal of JOAN stock as a high-yield income play. Shares may have a 5.09% forward yield at today’s prices, but even as the stock has dropped around 31.25% since its IPO, it could keep dropping.
At least, that’s the takeaway from its latest quarterly earnings release. Declining sales and rising costs meant a big drop in its adjusted quarterly EBITDA, with net income swinging from positive to negative. Also, if such poor performance continues, management may have to rethink maintaining its current dividend. Given the risks, stay away.
Orchid Island Capital (ORC)
Orchid Island Capital (NYSE:ORC) is yet another mREIT that looks like a yield trap. Because of its massive decline in price, this residential mortgage-backed securities (RMBS) company now sports a yield of nearly 20%.
ORC stock has already dropped heavily, as rising rates have reduced the value of its RMBS portfolio, yet that doesn’t mean the impact of the Federal Reserve’s hawkish pivot is priced in.
As rates keep rising, as the Fed tries to fight inflation, not only will this mREIT’s RMBS portfolio continue to drop in value.
Assuming the spread between its short-term borrowing costs and the yield of its portfolio continues to narrow, decreasing net interest income will make it difficult for it to maintain its current 4.5 cent monthly dividend. It’s worth noting that the dividend already has been cut several times since 2020. With risks that far outweigh its super high yield, avoid ORC stock.
Dividend Stocks: Vector Group Ltd. (VGR)
The parent company of discount cigarette maker Liggett Vector Brands, it’s a longtime high-yielder. At today’s prices, it yields 7.65%.
When it comes to price appreciation, it’s been underwhelming with VGR stock. Over the past five years, it’s down 21.5%. During this timeframe, the S&P 500 has gone up by 53.37%. Its 50% dividend cut in 2020 played a role in this, yet after making a comeback in 2021, it could drop in price again.
After spinning off Douglas Elliman (NYSE:DOUG) late last year, Vector Group now has a more levered balance sheet and is dependent entirely on its tobacco business to produce cash flow for dividends. Even if it manages to maintain its dividend, a lack of upside potential may mean subpar returns for long-term investors.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.