It's scary out there for dividend investors.
Even with the recent rally, dividend yields are sky-high. According to Capital IQ, there are 1,286 stocks on our major exchanges that have yields of 5% or more. But a lot of these are dividend traps, enticing us with the promise of fat quarterly payouts only to cut them down the road.
As a stark reminder, we can look to General Electric (NYSE: GE ) . Once hailed as the safest of the safe, GE has in short succession gotten government help, cut its dividend to save cash and potentially retain its AAA debt rating, and then lost that AAA status anyway.
It gets worse, though
It's gotten so bad that horrible stress-test results -- mandating billions more in capital infusions -- actually lifted bank shares. Recent dividend cuts, too, have been looked at as favorable events. We can partially blame JPMorgan (NYSE: JPM ) for that. A couple weeks after President Obama declared JPMorgan to be a "well-managed" bank, it slashed its quarterly dividend from 38 cents to 5 cents a share.
Sure enough, shares actually went up on the news that JPMorgan would be shoring up its capital position by reducing its dividend payouts by billions a year.
Fellow banks US Bancorp and Wells Fargo (NYSE: WFC ) took their cue and soon followed suit, citing similar "cutting from a position of strength" arguments. When all the big guys are cutting dividends, I can't see why a smaller player like BB&T (NYSE: BBT ) is still maintaining its 7.6% dividend. Even if it can afford to pay the dividend, why would it? It can save capital without the dire consequences normally associated with a dividend cut.
But I've already given my opinion on the banks. Let's take a look at some non-financial companies that could be headed for a big fall (dividend-ly speaking).
The "5% of nothing" club
Traditionally, a 5% dividend yield has been eye-popping enough to elicit fears of a dividend cut. Now, it feels commonplace. When you see a blue chip like Kraft (NYSE: KFT ) creeping up on a 5% yield, anything short of double digits starts to feel safe. And we start getting a little greedy.
But that greed can turn right back into fear if the great double-whammy curse of high-yielding stocks kicks in. After all, we buy dividend stocks because they provide a large, steady stream of income and have the promise of stock price appreciation. But then:
- In this environment, a susceptible high-yielding company's share price takes a beating (Whammy!).
- In order to preserve precious capital, said company cuts or altogether eliminates its dividend, destroying dreams in the process (Double-whammy!).
As a result, I view any dividend yield as a "too good to be true" situation until I've fully vetted the company. It's a good default stance on any stock you are considering buying, but let's look at two examples:
Nordic American Tanker (NYSE: NAT )
Qwest (NYSE: Q )
Source: Capital IQ, a division of Standard and Poor's.
The story behind the numbers
Wow -- in Nordic American Tanker, you get a 14% dividend on a company with no net debt and years of high-margin earnings.
But before you leap at Nordic American, know this: The company routinely pays out more in dividends than it earns. The company's financing strategy is to pay out earnings (and then some) as dividends and then go to the equity markets for more capital. Even though it was able to float an equity offering this year in a very rough climate, I don't think this is sustainable. At some point, you hit a snag and those equity markets close at the least opportune time.
Qwest's 7.1% yield isn't as eye-popping as Nordic American's, but that doesn't mean it's safe. Qwest has had declining sales for each of the past two years and sports a negative equity position (i.e., more liabilities than assets).
Meanwhile, its dividend-paying history isn't exactly robust. After merging with the dividend-paying US West in 2000, the combined entity ceased dividend payments in 2001 shortly after the tech bubble burst. Then it resumed payouts in 2008 ... just in time for the current credit crisis.
After paying out more than 80% of its earnings in 2008 (I'm usually uncomfortable with anything above 50%), I wouldn't be surprised if Qwest found it wise to pull a JPMorgan and cut its dividend to husband its capital resources.
Which dividends will survive?
It's darn hard to determine the sustainability of dividends in this environment. Due diligence is important in any environment, but it's especially important now when we can scoop up high-dividend plays that could form the core of our portfolios for decades to come.
The team at our Income Investor newsletter does their homework. They look for the most stable companies that pay the highest, most sustainable dividend yields. They've rated Kraft and its 4.6% yield a buy. But for new money, they rank seven sustainable dividend-paying stocks above Kraft. You can see all seven, and try out the entire service, for free with a 30-day trial. Click here to learn more -- there's no obligation to subscribe.
Anand Chokkavelu does not own shares of any company mentioned. Kraft Foods is a Motley Fool Income Investor recommendation. BB&T is a former Income Investor selection. The Fool has a disclosure policy.