More and more investors have been drawn to dividend stocks after the financial crisis of 2008, as they seek the comfort of a regular cash income, and at the same time, the prospect of capital appreciation on these investments. Yet, investors often make the mistake of looking solely at the dividend yield when deciding on buying a stock.
By ignoring other factors that may lurk behind the façade of a high dividend, investors may still burn their fingers on a stock, which they thought was 'safe' simply because it offered a good yield. These factors include changes in company's underlying business, improper cash management, and sudden equity dilutions.
In this article, we look at five high-yielding dividend monsters (we call them 'monsters' if the yield is in excess of 5%) that are best avoided.
Chimera Investment Corporation (CIM): Price $2.37, Dividend yield 18.6%
Chimera Investment Corporation invests in residential mortgage-backed securities (RMBS), residential mortgage loans, real estate-related securities and various other asset classes with the objective to provide attractive risk-adjusted returns to investors over the long term, primarily through dividends and secondarily through capital appreciation.
Though the yield looks attractive with the price quoting at very low levels, note that the company's dividends have been consistently falling—from $0.62 paid in 2008 to an estimated $0.40 in 2012. Quarterly dividends declined from $0.18 in September 2010 to $0.09 in June 2012. Yet this REIT had a latest pay-out ratio of 116%, which appears to be high and beyond the statutory 90% distribution rate.
Moreover, analysts are of the opinion that earnings could grow by just 1.67% over the next five years, resulting in a ceiling on dividend growth in the company. There is also the risk of equity dilution to raise additional funds, such as the recent case of CYS Investments where the sale of shares took place at 3% below the level the shares traded at before the offering.
RadioShack Corporation (RSH): Price $3.98, Dividend Yield 19.20%
RadioShack is a retailer of wireless devices and consumer electronics, having a network of 7,300 locations across the U.S. and abroad. The company paid a steady annual dividend of $0.25 through quarterly distributions from 2002 to 2010. It paid $0.50 in 2011, and that level may be maintained for 2012. But operating margins have fallen from 8.98% in 2007 to 3.54% in 2011. Its payout ratio is 223%, and this may not be sustainable in the future, more so as analysts estimate earnings to decline 2% over the next five years.
The company may be affected by Amazon.com Inc.'s (AMZN) recent move to set up physical warehouses in major states and do away with its controversial sales tax advantage. However, this may not be that long-sought advantage for physical retailers.
Nokia Corporation (NOK): Price $1.84, Dividend Yield 14.3%
Nokia offers smartphones and smart devices, feature phones, and related services and applications across the globe. Nokia's dividends gradually rose from 0.2546 in 2001 to 0.7802 in 2008, but thereafter fell to the 0.5180-0.5453 range over 2009-2011. In 2012, the dividend was halved to 0.2632.
The company's operating margin fell from 4.88% in 2010 to 2.78% in 2011, when it also reported a net loss. In 2011, Nokia paid dividends in excess of operating cash flow. Nokia has continuously lost market share to Apple Inc. (AAPL) and Samsung, and its recent partnership with Microsoft Corporation (MSFT) may not be enough to stem the tide. The company is rapidly burning up cash, and analysts estimate it may run through its cash pile some time in 2013.
Boardwalk Pipeline Partners, LP (BWP): Price $28.07, Dividend Yield 7.6%
Boardwalk Pipeline Partners, LP, through its subsidiaries, is involved in the operation of integrated natural gas pipelines and storage systems in the United States. Dividends rose from $1.3188 in 2001 to $2.0950 in 2011, and could be around the same levels for 2012.
Operating margin has fallen to 34.48% in 2011, compared with 39.39% in 2010, though quarterly margins have been improving since the last four quarters. Lower gas prices have impacted the company's business due to the underutilization of its transportation infrastructure, though the storage business benefited from the recent warmer-than-usual winter.
Payout ratio is a very high 191%. However, operating cash flows have covered dividends adequately between 2009 and 2011. What is of concern, however, is that analysts' consensus on EPS growth for the next five years is only 3.25%. This leaves limited scope for growth in dividends over this period.
Arch Coal Inc (ACI): Price $6.67, Dividend Yield 5.9%
U.S.-based Arch Coal is a top five global coal producer and marketer, and a highly diversified American coal company that boasts of over 20 mining facilities present in every major coal belt in the U.S.
Arch Coal's dividends rose from 0.12 in 2000 to 0.43 in 2011. Unfortunately, the coal industry is going through a tough time, which forced Arch Coal to slash its quarterly dividend down to $0.03. Fundamental factors in the company's business have changed dramatically for the worse in recent times. The month of April was a watershed for the energy industry in the U.S.—for the first time ever, power plants running on natural gas generated as much electricity as coal-fired plants.
The sea change can be appreciated from the fact that gas-based power generation in the country a decade ago was only about 25% of overall generation, while coal represented almost half. There was a glut of cheap gas obtained from the new technology known as 'fracking,' and it is no surprise that Patriot Coal landed into bankruptcy recently. We think Arch Coal may eliminate its dividend entirely if low natural gas prices persist.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.