Certainly, you’ve already seen many times where very high dividend yields were touted as a reason to buy a stock. This, however, is usually a fallacy. Together with a high dividend yield, there must always be some kind of analysis performed on its sustainability. Without such analysis, a high dividend yield is more of a predictor that the dividend most likely will be cut than a prediction of returns to come. Dividends are paid from net earnings, so one of the most important variables when deciding which dividends might be sustainable is obviously the dividend payout, which tells us what percentage of the net earnings are going towards paying dividends.
Obviously, if this creeps past 100%, those dividends will be in danger of being cut. It might also pay to check the direction of earnings – falling earnings will sustain a high dividend only for so long, debt and the evolution of earnings estimates. Below is an analysis of the stocks on the S&P500 that have very high dividend yields (6%) together with a dividend payout over 100%. These dividends are obviously good candidates for suffering cuts.
Frontier Communications Corporation (FTR) Frontier Communications Corporation provides unregulated local and long distance telephone services in the U.S., together with other telecom services, and has a market capitalization of $4.9 billion, and is trading at a TTM P/E of 32.80 with expected earnings growth of 8.33%, taking it to a forward P/E of 18.92 next year. The TTM P/E means FTR trades at a premium to the S&P500 TTM P/E of 13.0. The PEG (Price/Earnings Growth) stands at 5.40, and this could suggest overvaluation. FTR has a low Price/Book of 1.03. There are studies that indicate that low Price/Book stocks outperform over time, although sometimes the low Price/Book is also an indication of risk or permanently bad profitability. FTR's dividend yield is generous at 15.24%; this equates to a dividend payout of 498.46%. The dividend exceeds the S&P500 dividend yield, presently at 2.1%. The dividend is higher than the yield on the 10 year bond, presently at 1.90%. The ROE is just 2.97%. Although FTR still has some predicted earnings growth year-over-year, the company is quite under pressure as evidenced by the falling revenues, which are predicted to continue falling next year. This, together with the dividend payout and the large debt load, make it likely that the dividend will be cut or cancelled down the road. FTR is down by -43.77% year-to-date.
CenturyLink, Inc. (CTL) CenturyLink, Inc. is also a telecom services company, with a market capitalization of $21.8 billion, that is trading at a TTM P/E of 19.81 with expected earnings growth of 1.55%, taking it to a forward P/E of 13.46 next year. CTL still trades at a premium to S&P500 TTM P/E. The PEG stands at 3.22, this could suggest some overvaluation. CTL has a low Price/Book of 0.99. CTL's dividend yield is 8.22%, for a dividend payout of 223.16%.The ROE is 4.35%. CTL shares the same problems as FTR, with a predicted fall in revenues, large debt load and excessive dividend payout. Also, CTL's predicted earnings growth is minimal to negative. CTL is down by -17.77% year-to-date.
Windstream Corporation (WIN) Windstream Corporation is also a telecom services company, though more focused on high-speed internet access, it has a market capitalization of $6.0 billion, and is trading at a TTM P/E of 22.71 with expected earnings growth of 7.89% taking it to a forward P/E of 14.12 next year. WIN also trades at a premium to S&P500 TTM P/E. The PEG stands at, a level which is usually seen as attractive. The Price/Book is 7.28. WIN's generous dividend yield is 8.64%, for a dividend payout of 198.22%. The ROE is high at 35.79%, but this is partly due to very low book value, since the stock is trading at a Price/Book of 7.28. Although WIN seems more apt to grow its business, the dividend still seems unsustainable in light of the debt load, dividend payout and general lackluster market the company moves in. Still, of the three it has perhaps the best chance of keeping the dividend, albeit that still being an unlikely outcome. WIN is down by -11.87% year-to-date.
Conclusion Sometimes high yielding stocks trade at a premium to the market because of their dividends, and when those dividends come under fire, such stocks then suffer a lot. The risk is real that the same thing could happen to these 3 telecom stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.