3 Dividends on High Alert

Dividends are once again in vogue. But unlike the return of skinny jeans -- particularly for males -- I'm pretty stoked about dividends.

I think there are a host of reasons that this seeming relic of the investment world is once again being prized. For one, it's tough to be a company primarily skilled in financial shenanigans and consistently pay a dividend. After all, when you make your distributions you actually have to distribute cash to your shareholders.

Another reason the payout once again has the power is that after a market crash the likes of which we haven't seen for decades, investors like to see a path to returns that doesn't rely on Mr. Market. And we certainly can't overlook the fact that dividend yields have plumped up recently while Treasury yields are nothing short of pathetic.

Don't get lazy
Dividends have a reliable, dependable feel to them. They probably remind you of your grandpa and Werther's Originals. That's why we like them, they're nice and easy.

But hold on there bucko, they're not that easy. Don't think you can just point to a few stocks that post a dividend yield and then nod off in front of the TV like Gramps used to. That's right, you actually need to pay attention to which dividend stocks you're picking.

Get discerning
As I noted above, good dividend payers can offer you peace of mind and reliability. Great dividend payers can offer you that, plus steady growth in the payout.

But there are dividends floating around out there that are neither good nor great. These are payouts coming from companies that have hefty debt levels, short operating histories, and not enough cash flow to maintain their payout -- along with a host of other yellow and red flags.

Below are three such questionable dividend payers that I wouldn't recommend to you and I definitely wouldn't recommend to grandpa.

Company

Current Yield

Payout Ratio

Debt to Equity

Three-Year Dividend CAGR

Chimera Investment (NYSE: CIM  )

17.6%

69%

131%

n/a

Huntsman (NYSE: HUN  )

3.8%

NM

235%

26%

KB Home (NYSE: KBH  )

2.2%

NM

285%

(37%)

Source: Capital IQ, a Standard & Poor's company, and Yahoo! Finance.

Now these aren't necessarily bad companies, but the dividends they pay aren't for the faint of heart and they're certainly not for investors that want to count on reliable, growing payouts year-in and year-out.

Digging in
Chimera's business model is enough to send shivers down the spine of most investors. The company focuses on buying mortgage-related debt, but unlike Annaly Capital Management (NYSE: NLY  ) -- whose management company runs Chimera's portfolio -- the company targets debt that isn't guaranteed by Fannie Mae and Freddie Mac and often isn't even investment-grade paper. The company also looks at other areas of the mortgage-investment buffet including prime and Alt-A mortgage loans, commercial mortgage-backed securities, and collateralized debt obligations.

The payout ratio and debt levels are both purposely kept at elevated levels -- the payout ratio because Chimera is a REIT and the debt levels to juice the company's returns. But just because there's a method to the madness doesn't necessarily make it safe for investors.

And as for the dividend growth, we can't measure it. Like the company, Chimera's dividend doesn't have much of a history for us to go on. But let's just say consistency hasn't been a hallmark of the payout.

Chemicals specialist Huntsman doesn't offer much comfort through cash flow. Over the past 12 months, nearly $350 million in cash was spent in Huntsman's operations, and that's before almost $170 million in capital spending. That isn't always the case for Huntsman, in fact, 2009 saw a big cash inflow, but it highlights the volatility that tends to haunt the chemicals industry. And if dividends have an archrival, it'd have to be financial volatility.

And that brings us to KB Home. Do I really need to say much about this one? Sure, cash flow has been good as KB works off its housing inventory, but the company has more debt than it has inventory. And with a wash of vacant homes across the U.S., KB's business is going to be, at best, a slog for years to come.

KB has already slashed its dividend in recent years, but as it looks around at competitors like Hovnanian (NYSE: HOV  ) and Beazer (NYSE: BZH  ) that don't pay out a dime, KB may start to wonder why it's not hanging on to all of its cash.

Fortunately for dividend lovers, there are plenty of companies out there that are in a much better position to make investment portfolios shine with reliable, growing dividends. You just have to be willing to get up off that davenport and do a little work.

Looking for the antidote to these scary yielders? Check out this dividend play for a lifetime.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.


Read/Post Comments (5) | Recommend This Article (10)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On August 10, 2010, at 4:48 PM, aspd3815900 wrote:

    I'm not too worried about Huntsman's dividend. They have a large cash position and Mr. Huntsman's charitable giving is derived somewhat from those dividends. In addition Mr. Huntsman recommended purchases of the stock for the Huntsman Cancer Foundation back when the stock was at $9. Not necessarily insider information but his Cancer Institute is one of his life works and I don't think he would have them put 10 million into something that was on it's way to a less than bright future.

  • Report this Comment On August 10, 2010, at 6:03 PM, TMFKopp wrote:

    @aspd3815900

    Huntsman may well prove me wrong, but part of the problem is that we don't really have much of a publicly-traded history to base that on. Though we can say that the dividend has been basically flat so far (yes, the table above says that it's grown 26%, but once it hit the $0.40/yr level in 2007 is stopped in its tracks).

    Also Huntsman's cash position isn't overwhelmingly large. At June 30 it was at $766 million, but the company has close to $4 billion in debt and an annual interest expense of $229 million (with rates currently low...). It also appears that the company has recently been spending less on capex than it normally does. On the flip side, the current dividend commitment is actually relatively small. But I wouldn't place all my bets on the balance sheet cash carrying the day.

    As to Mr. Huntsman's actions... There a lot of investors (and a lot of Fools smarter than I) that put a lot of weight on what insiders are doing. I tend to not put quite as much weight. Insiders do have a better/closer view of the business, but they're also the ones manufacturing the Kool-Ade so it's very easy for them to drink it as well. I'm sure Mr. Huntsman's recommendation for the Cancer Institute was with the best intentions, but I shy away from seeing that as a sure "buy" signal.

    Matt

  • Report this Comment On August 11, 2010, at 10:48 AM, stevenudge wrote:

    If you're worried about dividend cuts, or there isn't much dividend history available (like Huntsman), why not invest in a Dividend Aristocrat?

    There are no guarantees, but at least you know the dividend payout increased over the last 25 years.

    http://www.dividend.co.nr

  • Report this Comment On August 12, 2010, at 10:05 PM, 1caflash wrote:

    Matt, Thank You for another enlightening article. I'm GLAD Chimera's investments Are NOT backed by Fannie Mae and Freddie Mac. I sleep fine. Huntsman is also in my accounts. I had a leaky-heart-valve repair which was much scarier than investing in Cim or Hun. Doctors called that "Elective Surgery", yet advised me to have it. Five years later, I still wonder about that terminology but the operation was successful and I expect similar results from Chimera and Huntsman.

  • Report this Comment On August 13, 2010, at 10:48 PM, stpaulguy wrote:

    how can it be????????matt is recommending CIM..AND A few days earlier another writer from the MOTLEY FOOL was saying NO to it...What is it???????? please tell me....

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