When it comes to overvalued dividend stocks to sell, it’s best to think of them as a “picking up pennies in front of a steamroller” type of investment. That is, in exchange for relatively modest steady gains from dividend payouts, you are assuming a big risk. That’s because these types of stocks can be vulnerable to price declines that far outweigh the reward. Admittedly, these types of stocks can stay overvalued for quite some time. As long as the dividend holds steady, or even better, grows over time, yield-hungry investors are more than willing to support their valuations.
However, there are many unforeseen ways the bottom can fall out of these plays. For instance, fundamentally-weak companies with big payouts can all a sudden decide to slash or suspend dividends in order to conserve cash. There are even cases where the dividend stays intact, but the operating results of the company are so horrendous, shares tumble nonetheless, due to fundamentals deteriorating to a degree that outweighs the allure of the stock’s high payouts.
Such risks run high with the following seven overvalued dividend stocks to sell. With each one at risk of big price declines, make your exit now.
American Software (AMSWA)
American Software (NASDAQ:AMSWA), a provider of supply chain and related software, as well as IT staffing services, is one of the older software stocks. It’s also a bit of an obscure name. Nevertheless, many dividend investors may be familiar with it, given the stock’s 4.17% forward dividend yield.Yet while American Software has been paying its shareholders 11 cents per quarter since 2017, don’t assume that AMSWA stock has a steady, safe dividend. Over the past twelve months, dividends paid have exceeded operating cash flow.
Forecasts call for earnings this fiscal year (ending April 2024) to come in slightly below annual payouts, with earnings barely covering the dividend in the following fiscal year. After falling by more than 31.5% over the past year, shares could keep dropping. AMSWA trades for 25.2 times forward earnings. This multiple doesn’t seem sustainable, given the company’s low-growth state.
Cogent Communications (CCOI)
I’ve long believed that Cogent Communications (NASDAQ:CCOI) is one of the top overvalued dividend stocks to sell. As I argued last March, even as the telecom company has continued to raise its payout, consider it best to stay away. Why? Cash dividends from CCOI stock may continue to grow, but these payouts remain in excess of operating cash flow. The clock is ticking. Cogent needs to vastly increase its cash flow generating abilities, ASAP. Yes, this telco has a potential path to greater profits: a successful turnaround of wireline assets it recently acquired from T-Mobile (NASDAQ:TMUS).
However, turnarounds are risky. This is especially the case when it comes to turning around a declining business, like wireline telecom. CCOI has managed to increase its payout (and its stock price) over the past year. Even so, things could play out a whole lot differently in the year ahead.
Digital Realty Trust (DLR)
Among dividend stocks, and in particular among real estate investment trusts (or REITs), Digital Realty Trust (NYSE:DLR) doesn’t have the highest yield out there. Yet it’s quite easy to make the argument that this data center REIT has become one of the dividend stocks to avoid.
It all has to do with the impact of the hype surrounding the rise of artificial intelligence on DLR stock. In recent weeks, shares have bolted higher, thanks largely to “AI mania.” Said mania could keep the stock steady for now, but at some point, DLR’s bad fundamentals could come back into focus. As I discussed a few weeks back, analysts at Hedgeye have pointed to several concerns/risks that may make going short DLR a profitable move. These include an unsustainable dividend, a history of overpaying for assets, as well as the capital-intensive nature of its business compared to other REITs.
FAT Brands (FAT)
It’s one thing for a profitable firm to pay dividends in excess of earnings/cash flow. It’s even worse when an unprofitable firm does the same thing. That’s the story here with fast food franchisor FAT Brands (NASDAQ:FAT).
FAT stock may provide its investors with a fat dividend (7.53% forward yield), yet take a look at the company’s cash flow statements. You’ll see that these high payouts are being funded using debt. In essence, rather than providing shareholders the fat, Fat Brands is cutting to the bone in order to keep its status as a high-yield stock.
Although there may be a liquidity event (a planned IPO of Fat’s fast-growing Twin Peaks chain) that enables the company to get its financial house back in order, other red flags (such as scandals with FAT Brands’ management) also point to this being one of the dividend stocks to avoid.
Kaman Corporation (KAMN)
With a 3.58% dividend yield, Kaman Corporation (NYSE:KAMN) is more of a moderate-yielder than a high-yielder among dividend stocks. Still, I can see why some investors still find this aerospace manufacturer to be a possible buy.
Investors can buy KAMN stock today, collect its steady payout, then cash out if Kaman turns itself around, and becomes materially more profitable. Even some commentators voicing concerns about a dividend cut, such as a Seeking Alpha commentator last month, believe the potential upside is well worth the risk.
However, in my view, the turnaround is already baked into KAMN’s valuation. Shares today trade for 52.4 times earnings. Even if the turnaround is successful, and Kaman meets/beats forecasts for next year (earnings of 80 cents per share), KAMN today trades for nearly 28 times forward earnings. Until valuation comes down, consider it one of the overpriced dividend stocks to dump.
Telephone and Data Systems (TDS)
With a 48-year track record of dividend growth, Telephone and Data Systems (NYSE:TDS) may not seem like one of the high-risk dividend stocks. With this, plus this telecom stock’s nearly 10% forward dividend yield, TDS could appear too tempting to pass up.
But while TDS stock has made it to “Dividend Aristocrat” status, with “Dividend King” status within reach, don’t assume that it is a risk-free vehicle for double-digit returns. Like with many of the overvalued dividend stocks listed above, Telephone and Data Systems is paying out dividends well in excess of the company’s earnings.
That’s not all. TDS shares have tumbled in price to a degree leaps and bounds (more than 50%) above its seemingly-high payout over the past year. While Mario Gabelli, a longtime TDS investor, has recently pushed for strategic changes, with the company family-controlled, don’t assume that “strategic alternatives” such as a sale are forthcoming.
Xerox (NASDAQ:XRX) may not seem like a name to mention when talking about selling overvalued dividend stocks. After all, shares in the workplace technology company trade for just 9.3 times earnings.
However, while XRX stock may look cheap on a screener, with a relatively-high dividend yield (6.67%) to boot, it may actually be pricey. At least, when you consider its lackluster long-term prospects. As InvestorPlace’s John Blakenhorn argued back in April, Xerox has been in decline for many years. The pandemic-driven shift to remote work has accelerated this decline.
Although analyst forecasts call for earnings growth this year and next year, it’s hard to be confident that Xerox will be able to wring out higher profits out of a shrinking business. Even if the company’s earnings remain sufficient enough to maintain $1 per share in annual dividends, XRX shares are likely to decline further, outweighing these payouts.
On the date of publication, Thomas Niel did not hold (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.