Editor's note: A previous version of this article failed to mention that Carnival Cruise Lines had suspended future dividends for 2009. The Fool regrets the error.
I knew there was something fishy going on last spring, and I'm not talking about tuna. Some companies' dividends were beginning to take on a dot-com appearance. You know the look -- it's a lot like a shiny, soapy ball, holding a whole lot of nothing. And I think some of those companies still have that unfortunate look.
A few of the companies I was watching back then were clearly spending money they couldn't afford to spend, like my neighbor with the two big BMWs did. Yeah, everybody was doing it, but these companies weren't buying widescreen TVs and oversized Toll Brothers mansions like the rest of us.
They were blowing it on those dividends.
My first clue: General Motors
GM might have had its reasons -- the current management could be smarter than it looks. But that tidbit of information got me poking around a little. Lots of people suspected that Lehman Brothers was in big trouble, even back in the spring, but they were still paying dividends -- $0.17 a share, last paid in August. They were buying back their stock, too, as recently as the first quarter of 2008.
Think their creditors might like to have some of that money back?
Why would they do this?
To keep up appearances, maybe -- to try to buy themselves time to dig out of their jam before they got sent down to the Pink Sheets. But it's starting to look as though lots of companies were paying dividends or buying back stock with money they should have put in the bank instead. According to The New York Times: "From the fourth quarter of 2004 through the third quarter of 2008, the companies in the S&P 500 -- generally the largest companies in the country -- reported net earnings of $2.4 trillion. They paid $900 billion in dividends, but they also repurchased $1.7 trillion in shares."
I'll save you the trouble of doing the math: That's $200 billion-with-a-b more paid out than earned. Not all of those companies were in trouble, of course … but I'll bet some had senior executives whose compensation was tied (maybe via stock options) to their company's share price.
What with the past few years being an easy-credit bender, some of that money was probably borrowed -- likely through lines of credit that, like balloon provisions in mortgages, had a few years of easy payments followed by a renewal or refinancing requirement. Such arrangements weren't uncommon.
But you can bet they're less common now. And that's one more reason to be wary of big dividend yields.
Income is great -- if you can get it
When the market is way down and you're worried that it might go down further, dividend stocks start to look attractive. Reinvest those dividends, and your position will grow on its own -- all the faster if the stock's price drops lower for a while. And unlike bonds, good stocks will rise in price once the market gets turned around.
But the catch is obvious: The company has to continue paying the dividend for all of this to work, and being able to do that is far from a given these days. According to Standard & Poor's, 288 publicly traded American companies cut or eliminated their dividends during the last quarter of 2008, versus 239 companies that instituted or raised dividend payments. That's the first time since 1958 that cuts outnumbered raises, and I don't think the next few quarters are going to look a whole lot better.
Sometimes the stocks to avoid are obvious. To me, it's a no-brainer that companies such as GM (24.2% dividend yield), Citigroup
But even reasonable-looking numbers from reasonable-looking companies may be unsustainable. There's a case for buying Intel
Finding yields that are sustainable in the current environment is the full-time focus of the Fool's Income Investor team right now. If you'd like to see their best ideas for new money today, click here for a free 30-day trial. There's absolutely no obligation to subscribe.
