Avoiding A Risky Dividend Stock Is Just As Important As Picking A Good One

Includes: ALSK, CTL
by: Roger Nusbaum

CenturyLink (NYSE:CTL) cratered 22% last Thursday after reporting weak earnings, weak revenue, a poor outlook and a cut in its dividend. A few years ago CTL bought the much larger Qwest Communications. The company has a huge debt load and for a long time popped up regularly on stock screens and articles about dividends for its high yield, which before the price drop and the coming dividend cut, was about 7% compared to 5% for AT&T (NYSE:T) and 4.6% for Verizon (NYSE:VZ) (which some clients own).

It is typical for telecom companies to carry a lot of debt but CTL has a lot of debt relative to its peers. During the day I got an email from a PR firm for the AdvisorShares Ranger Equity Bear Fund (BEAR) noting that the fund is short CTL because "We knew the company's dividend was at risk. The company did a capital lease that overstated its free cash flow. There's no way they could cover the dividend," among other reasons.

I don't follow the stock so I'll take their word for it. A point I have been making here for years is the extent to which dividend yields can be a signal of how much risk shareholders are taking. CTL is one kind of example with this.

Another more striking example is Alaska Communications (NASDAQ:ALSK). This first popped up on my radar a few years ago after getting a favorable mention in Barron's. It had something like an 8 or 9% yield. The dividend was very steady for quite a few years without much growth, then it was cut dramatically before being eliminated. The stock price was somewhat volatile, trading from $8 to $16, back down again and then up to around $11 a couple of years ago. It is now under $2.

It is probably a leap to say the CTL is headed the way of ALSK but it is not a leap to have realized that CTL paid a much higher dividend and had a lot more debt than its peers and so wouldn't have taken a lot of time to decide to leave it alone.

It is important to understand the relative nature of this stuff. A 5% yield isn't crazy for a telecom company but maybe it is for something like a gold miner.