Dividend Disasters And What I Learned From Them

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Includes: ARCH, AVP
by: Larry Harnar

I've been reading Seeking Alpha for a few years now, and I really enjoy the wide variety of topics that are covered. Of particular interest to me is the dividends and income section and the idea of building a portfolio of dividend growth stocks that will provide for me down the road.

I have learned so much about dividend growth investing from reading the awesome and powerful works of great investors like Chuck Carnevale, David Fish, David Van Knapp, and David Crosetti.

However, I guess I still have a knowledge deficit, because I continue to hold two of the worst performing stocks in recent memory in hopes of getting back to even. Today, I'd like to talk about the dividend disaster that is Arch Coal (NYSE:ACI) and the potential dividend disaster in the making, Avon (NYSE:AVP).

Arch Coal (ACI)

U.S.-based Arch Coal, Inc. is a top five global coal producer and marketer, with 155 million tons of coal sold in 2011. Arch is the most diversified American coal company, with more than 20 active mining complexes across every major U.S. coal supply basin. Its core business is supplying cleaner-burning, low-sulfur thermal and metallurgical coal to power generators and steel manufacturers on five continents.

Current Price: $7.23

TTM Earnings per Share: $0.43

FY 2013 Projected Earnings per Share: $0.09

Current Annual Dividend: $0.12

Annual Dividend Yield: 1.66%

Payout Ratio Based on TTM Earnings: 28%

Payout Ratio Based on 2013 Projected Earnings: 133%

Cash Per Share: $0.55

Years of dividend increases prior to cut: 8

My original position started at 351 shares, but I have sold all except for 100 shares. My average cost basis is now $23.97. My yield on cost is 0.50%.

Yes, there may be potential for a turnaround, especially with increased currency printing here and overseas, higher inflation, rocketing natural gas prices, or if aliens finally land and demand that we trade them all of the coal on our world for all of the gold on their planet. It's pretty clear that the fundamentals of the energy market have changed and coal is no longer the best choice.

Arch Coal recently cut their dividend from $0.44 annually to $0.12 annually and based on a forward payout ratio of 133%, they may have to cut the dividend again. As a very small part of a portfolio, Arch Coal may make sense as a speculative turnaround story, but it's not a dividend growth stock anymore.

Avon (AVP)

Avon, the company for women, is a leading global beauty company, with over $11 billion in annual revenue. As the world's largest direct seller, Avon markets to women in more than 100 countries through approximately 6.4 million active independent Avon Sales Representatives.

Current Price: $16.59

TTM Earnings per Share: $0.90

FY 2013 Projected Earnings per Share: $1.22

Annual Dividend: $0.92

Annual Dividend Yield: 5.55%

Payout Ratio Based on TTM Earnings: 101%

Payout Ratio Based on 2013 Projected Earnings: 75%

Cash Per Share: $2.86

Years of dividend increases prior to freeze: 22

My original position was 203 shares, but I have sold all except for 53 shares. My average cost basis is $18.03. My yield on cost is 5.10%.

Avon is another example of dividend growth gone wrong. A long and strong history of earnings growth powered this consumer products company to raise their dividend for years before finally freezing it in 2012 at a $0.92 annual rate.

Now, the fundamentals of Avon aren't nearly as dire as those of Arch Coal. They have some cash on the books and their forward earnings are projected to grow. If earnings began to grow again substantially in the future, they may begin growing the dividend again. However, you can see the risk is there for a dividend cut if the restructuring of the company does not produce the desired results.

So what did I learn from these two companies?

I have learned that dividend growth investing is "buy and monitor", not "buy and forget". I've seen this point mentioned so many times in other articles and it's so true.

When a company encounters problems, you have to decide what the impact of those problems will be on the future dividend growth of that stock. Looking at the fundamentals, such as projected earnings growth and forward payout ratios may offer the investor a clue that trouble lies ahead.

I have learned from experience that the surest way to lose money on a dividend stock is to continue to hold it after the dividend has been cut or frozen.

Disclosure: I am long ACI, AVP.