Don't Touch These 5 Slaughtered Dividend Stocks

The market has pretty much been flat in June, but the same can't be said for the five dividend stocks I'm investigating today. Though seeing a dividend payer on sale might be tempting, I'll show you why you should stay away from all five companies. But I won't leave you high and dry; there will be access to a special free report with dividend stocks I do like at the end of the article.

Company

Industry

4-Week Return

Dividend Yield

Arch Coal (NYSE: ACI  ) Energy (20%) 2%
Diamond Foods (Nasdaq: DMND  ) Food (18%) 1%*
EXCO Resources (NYSE: XCO  ) Energy (13%) 2.4%
Frontline (NYSE: FRO  ) Shipping (24%) 1.9% 
Nokia (NYSE: NOK  ) Mobile (26%) 7.4%

Sources: Fool.com; Yahoo! Finance. Return from May 28 to June 25 and includes dividends. *Trailing yield; dividend has been suspended.

Before even diving in, we can throw Diamond Foods off the list. I included it because any individual investor using a screener might have it pop up as a dividend payer. In reality, the company has suspended its dividend.

On top of that, the CEO and CFO were shown the door earlier this year for making improper payments to walnut growers. Fellow Fool Tamara Rutter offers a more comprehensive look at why Diamond Foods is definitely not a buy at today's prices.

Declining business models
One reason to avoid our four remaining companies is that their business models are in long-term decline.

The cheap price of natural gas has created a double whammy. Arch Coal has seen demand for its product decline over the past year, thanks in part to the fact that natural gas is slowly replacing coal for energy production. But that hasn't been enough for natural-gas producers, either, as the supply glut still has prices near historical lows, helping explain why EXCO Resources is down as much as it is.

But natural gas isn't the only instance where a supply glut is hurting business. The shipping industry, which went on a massive build-out before the Great Recession, is also suffering from having far more supply (ships) than demand (stuff to ship). Though things may eventually pick up, the glut has to be worked through first.

And though there's nothing wrong with Nokia's business model per se, it's getting crushed by Apple and Google in the smartphone world. Maybe the company's new Lumina 900 can boost sales, but my money's not riding on it.

Poor balance-sheet health
Beyond declining business models, dividend investors need to take a thorough look at a company's financial statements. Specifically, a company shouldn't be using more than 80% of its free cash flow to pay out dividends. If that's the case, the dividend is likely unsustainable. Take a look at how our four companies stack up.

Company

Free Cash Flow Payout Ratio

Arch Coal 550%
EXCO Resources NM
Frontline NM*
Nokia 284%*

Source: Yahoo! Finance. *2011 Cash flow and dividend payments. NM = not meaningful due to negative free cash flow.

Normally, having payout ratios of 284% and 550% would put you at the bottom of the pack, but at least Arch Coal and Nokia have positive free cash flow. The same can't be said for Frontline or EXCO, which saw more money flow out of their coffers over the past year than come in.

In fact, over the past five years, EXCO hasn't had one instance where it was free-cash-flow positive. And 2009 was the last time Frontline was able to boast positive free cash flow.

In the end, if you're a dividend investor, it's simply not smart to invest in companies with these kinds of characteristics -- no matter how low the price is today.

If it's solid, dependable dividend stocks you're looking for, our team of analysts has found three Dow dividend stocks that fit the bill. Click here to get your copy of the report and find out what companies they are, absolutely free!

Fool contributor Brian Stoffel owns shares of Apple and Google. You can follow him on Twitter, where he goes by TMFStoffel.

The Fool owns shares of Google and Apple. Motley Fool newsletter services have recommended buying shares of Apple and Google, and creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (6) | Recommend This Article (6)

Comments from our Foolish Readers

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 June 26, 2012, at 11:57 AM, BCSkier wrote:

    I agree that if you follow a dividend focused strategy, ACI is not the stock for you, but I disagree that it should be avoided. If you can ride out these next six to twelve months, this is an excellent entry price on a bargain stock with huge growth potential. Coal isn't going anywhere anytime soon, and with the sizzling summer, low oil prices, and increasing price of NG, I think it will be making a rebound sooner rather than later. Buy where there is blood in the streets, and the coal sector is a blood bath.

    Long - ACI; ARLP; BTU;

  • Report this Comment On June 27, 2012, at 1:07 AM, thethreestooges wrote:

    NOK 7.5% divident yield? WOW WOW WOW

  • Report this Comment On June 27, 2012, at 2:00 AM, GETRICHSLOW2 wrote:

    In addition to BCSkier, If obummer gets another four(god help us!) his out-of-control EPA will have a few things to say about fracking and king coal will see positive things happen. It is simply too cheap and too abundant in an energy starved world.

  • Report this Comment On June 27, 2012, at 8:06 AM, rsinj wrote:

    You have the correct view on XCO - avoid.

  • Report this Comment On June 27, 2012, at 8:28 AM, ravens9111 wrote:

    Most coal power plants are converting to natural gas. The EPA has made it clear that any power plants running on coal will make costs soar. It only makes sense that these power plants are converting to natural gas at an alarming rate. Coal companies have been getting slaughtered for good reason. Talk about catching a falling knife. Although most coal stocks have compelling P/E ratios, it is a poor measure to value a stock's price when FUTURE earnings will plummet. Coal power plants that have already converted to natural gas will not go back.

  • Report this Comment On June 27, 2012, at 8:47 AM, brewersfan81 wrote:

    @thethreestooges-

    Remember that sometimes, high dividend yields exist because investors don't think the stock is very safe.

    In 2008, NOK had a dividend three times larger than today's, but the yield was under 3%. Investors were confident in the business back then.

    No more today, which explains why the yield (but not necessarily the absolute dividend amount) is so high today.

    Brian Stoffel

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