Dividend stocks are great for the simple reason that they pay you just for being a shareholder. That said, not all dividends are created equal. High yields could be a telltale sign of higher risk, while historically strong dividend stocks could face new challenges throwing their futures into question.
As with many things in investing, nuance can be more valuable than simplicity. That's why deeper dives reveal that investors looking for income stocks should probably steer clear from specialty-ingredient manufacturer Sensient Technologies (SXT 1.03%) and propane distributor Ferrellgas Partners, LP (FGP). Meanwhile, consumer-gardening giant Scotts Miracle-Gro (SMG 0.13%) is worth buying, despite being at all-time highs.
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Stay away from this pair
The cases for avoiding Sensient Technologies and Ferrellgas Partners are simple, albeit unique.
Sensient Technologies is a developer and marketer of colors, flavors, and fragrances for specialty applications such as food, beverages, and cosmetics. While the stock has performed well in the long run and the quarterly dividend has steadily grown to $0.30 per share today, the ability to grow -- or even maintain current operations -- in the future is uncertain.
That's not exactly what investors want to hear, but the performance in the first half of 2017 demonstrates that point pretty clearly. Compared with the year-ago period, revenue dropped 3% while operating income and net income collapsed 25%.
The stock's slide may be driven by short-term jitters, as Sensient Technologies took the opportunity earlier this year to divest certain European assets in the flavors and fragrances (F&F) segment. That resulted in restructuring costs that won't recur in the future.
While the divestiture was part of a restructuring plan announced in 2014, investors shouldn't dismiss the fact that most leading companies in the F&F industry have only maintained margins by reducing headcount. That option is unsustainable for long periods of time. There are opportunities for growth in the medium- to long-term from innovative new technologies, but those aren't proven nor certain.
Meanwhile, investors need a lot of faith to invest in Ferrellgas Partners today.
The company's debt levels began getting out of control in recent years, which forced management to take drastic measures (slashing the distribution by 80%) and funnel as much cash flow as possible to debt payments. Unfortunately, it won't be that easy. Operating cash flow has cratered in recent quarters -- the worst of all possible times.
The biggest obstacle in the past two years has been warmer weather than usual, which has resulted in lower propane sales, Ferrellgas Partners' bread and butter. Luckily, strength in American natural gas markets could allow the company's midstream business to pick up some of the slack in the next few quarters. Investors shouldn't write off the plan's effectiveness for full-year 2017 just yet, but things may get worse before they get better.
Why Scotts Miracle-Gro is worth buying
There's a lot to like about Scotts Miracle-Gro stock. It pays a dividend yielding 2.2% and management has raised its payout 64% in the past three years. When dividends are included, the stock has gained 84% in that period, or nearly 3 times the returns of the S&P 500. But the company has plenty of growth left in the years ahead.
Scotts Miracle-Gro has a portfolio of some of the leading consumer brands in lawn care, ranging from Roundup to Tomcat to Scotts. All are still gaining market share and growing, especially when paired with craft brands in niche markets, including organic lawn care. Management has even selectively partnered with and acquired craft brands to maximize shareholder value.
Meanwhile, the company is about to shed its European and Australian business, which have steadily declined in recent years, to focus exclusively on the North American market, from which most of its profits are derived. That will boost margins for the company and bandwidth for management, creating cash flow and time that can be reinvested in high-growth opportunities.
The first target that comes to mind is the The Hawthorne Gardening Company, which is focused on new markets in urban farming, indoor farming, and industrial-scale hydroponics. The business grew sales 17% in the nine months from October 2016 to this past June, is profitable, and continues to gain new tools and products through acquisitions. It should only be a matter of time before Scotts Miracle-Gro separates it out as a separate business segment in financial filings.
What's the most attractive thing about all of this? The future growth potential comes on the heels of quickly growing operating cash flow.
SMG Cash from Operations (TTM) data by YCharts
If management continues to execute on the strategic vision that incorporates its core portfolio, adding high-growth craft brands, and capturing market share in urban farming and hydroponics markets, then the stock should continue delivering value to shareholders. That's what makes Scotts Miracle-Gro a dividend stock worth buying for any portfolio.
