5 dividend red flags

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Matt Frankel, Investment Planning

5 Signs Your Dividend Stocks Might Be In Trouble

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• Many investors look at dividend stocks as a safe way to invest

• While this may be true for many stocks, there are many red flags to be aware of

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April 18, 2023

1. High payout ratio

• A stock’s payout ratio is the percentage of its earnings it pays out as dividends

• For example, if a certain company earns $1.00 per share and pays dividends of $0.40 annually, its payout ratio would be 40%

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• The lower the payout ratio, the easier it is for a company to sustain its dividend.

• In general, I like to invest in companies with payout ratios below 50%

• Be particularly wary of companies whose payout ratios are close to or more than 100%

• (Note: certain stocks, like REITs, are required to pay out the majority of their earnings, so a high payout ratio isn’t necessarily bad for these companies.)

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• As a point of reference, here are the payout ratios of some popular, healthy dividend stocks (2014 – full year)

Company (Symbol)

Earnings Per Share

Dividends Paid Payout Ratio

Apple (AAPL) $6.45 $1.85 28.7%

Johnson & Johnson (JNJ)

$6.39 $2.76 43.2%

Procter & Gamble (PG)

$4.02 $2.53 62.9%

Wal-Mart (WMT) $5.07 $1.92 37.9%

Coca-Cola (KO) $2.04 $1.22 59.8%

Exxon Mobil (XOM)

$7.36 $2.70 36.7%

April 18, 2023

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• GlaxoSmithKline (NYSE: GSK) has a payout ratio that should be a red flag

• The company earned $3.02 per share in 2014, and paid out $2.65 per share (88% payout ratio)

• Earnings are expected to drop to $2.31 in 2015 and $2.57 in 2016, which means that the company will either have to cut its dividend or pay out more than 100% of its earnings

A dangerous payout ratio…

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April 18, 2023

2. Increasing debt / High leverage

• If a company’s debt starts to increase dramatically, it should be a red flag for dividend investors

• High debt payments can eat into a company’s ability to pay dividends and force cuts

• Also, companies whose business models involve high uses of debt (leverage) to achieve profitability tend to be volatile dividend stocks

• Mortgage REITs are a good example

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• A good way to monitor a company’s debt is its debt-to-capital ratio

• Many analysts consider a ratio of 0.3 or lower to be extremely healthy

• However, it’s important to compare the debt-to-capital levels of companies in the same industry, as well as to monitor your stocks’ ratios over time

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April 18, 2023

• Consider the debt-to-capital ratio of these large tech companies

• While none of these companies have “unhealthy” debt levels, this information lets us know that IBM relies more on debt to finance its operations than other tech companies

Company Debt-to-capital (MRQ)

Apple (AAPL) .302

Intel (INTC) .187

Facebook (FB) .004

Microsoft (MSFT) .306

IBM (IBM) .737

• Much of IBM’s debt is “global financing debt”, which is actually backed by receivables

• Corporate (non-financing) debt actually declined 26% over the past year

• While this is just one case, it’s important to look for extenuating circumstances when it comes to high debt levels

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On the other hand, these companies’ debt-to-capital ratios should be red flags for new investors

Company Debt-to-capital (MRQ)

Sirius XM (SIRI) .920

Sonic Corporation (SONC)

.962

Avis Budget Group (CAR)

.961

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April 18, 2023

3. An “unhealthy” industry

• Trouble within an industry can be a good signal that dividend cuts are on the way

• For example, the energy and commodities industries are weak right now

• The companies that have already chopped their dividends include:– Freeport McMoRan– Chesapeake Energy– LINN Energy– Transocean

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April 18, 2023

4. Recent dividend cuts• If a company is forced to

make a dividend cut, it is usually a strong indicator of something fundamentally wrong with the company

• Or, if the company has historically increased its payout every year, not doing so all of a sudden can be a sign of trouble

• Companies cut dividends for a variety of reasons including– Falling revenue– Increasing expenses– Decision to reinvest

more capital in the business

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• While a dividend cut isn’t necessarily the wrong move in 100% of cases, it is certainly cause for further investigation

• For example, many energy companies have slashed dividends in the wake of plunging oil prices (bad news)

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• On the other hand, some companies experience temporary cash flow issues and choose to reduce the dividend rather than take on more debt

• Wynn Resorts (WYNN) is a good example of this, in my opinion– In April, Wynn cut its quarterly dividend from $1.50 to $0.50 per

share, on the heels of declining revenue in Macau and slow growth in Las Vegas.

– The company is investing $5 billion in new resorts over the next few years, and Steve Wynn refuses to use debt financing to pay a dividend.

– Instead, the company will focus its cash on creating long-term value for its shareholders.

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April 18, 2023

5. Slowing growth and decining profits

• If a company’s revenue stops growing, it may have trouble increasing its dividend in the future, without making its payout ratio too high

• Great dividend stocks grow their revenue year after year no matter what the economy is doing -- like Wal-Mart during the recession and after

2006 2007 2008 2009 2010 2011 2012250

270

290

310

330

350

370

390

410

430

450

Wal-Mart Revenue ($ billion)

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Declining profitability

• Declining profits (earnings per share) can be a red flag that something is wrong

• Profits can fall, even if revenue continues to rise

• Potential reasons for lower profitability include– Litigation expenses

(like most of the banking industry over the past several years)

– Increased regulatory costs

– Poor management of operating expenses

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