Do These Dividends Belong on the Endangered List?

When a corporation decides to cut its dividends, Wall Street tends to throw a temper tantrum and mangle the company's stock price. Knowing this, it's fairly easy for businesses with high dividends and shrinking earnings to find themselves in a dilemma: decrease dividends and feel the wrath of Mr. Market, or keep short-sighted shareholders satisfied and hope things look better in the future. Read on as I tell you about some of the companies I believe are currently in dividend no-man's land -- and whether you need to be concerned.

Look to the West?
Canadian company Penn West Petroleum (NYSE: PWE  ) seems to be digging itself into a dividend ditch. This oil and natural gas corporation boasts a 7.5% dividend yield, but its payout ratio is currently at 136%. That means Penn West is not only handing over all of its earnings to shareholders, but also pulling the equivalent of 36% of earnings from the company's own coffers.

To pay investors, the company is considering $1 billion or more in asset sales, and that's after it already cut its dividend by more than 40%. With natural-gas prices falling, Penn West needs to start looking for a big break in all directions if it wants to remain afloat in the years to come.

1-800-no-mo-div?
Telecom company Windstream (Nasdaq: WIN  ) might be blowing hot air with its 10% dividend yield. A payout ratio of 333% is tough to argue with, but earnings aren't always the best way to judge telecoms. Free-cash-flow payout ratios provide a clearer picture of Windstream's financials, but the picture there also raises concerns. In 2011, it paid out 97% of its free cash flow in the form of dividends -- barely topped by Frontier Communications' 99.8% ratio.

Dividend investors took a major hit this week when mobile carrier Cellcom Israel (NYSE: CEL  ) announced that its dividend will be reduced from 16.3% to zero. Citing heavy competition and plummeting profits, this Israeli company is suspending its dividend in an effort to reinvest in operations and take back some of its lost market share.

So long, dividend. But investors can also kiss Cellcom Israel's 121% payout ratio goodbye. With a 63% quarterly increase in free cash flow, Cellcom may well be making the right move.

REITs: An exception to the rule
Payout ratios are a useful tool to judge the sustainability of a company's dividend, but they don't always tell the whole story. Real estate investment trusts, or REITs, are a special type of security required by law to pay out at least 90% of earnings in the form of dividends. In return, REITs avoid entity-level taxation and can thus pass on more of their profits directly to investors.

But REITs don't always look right. Annaly Capital (NYSE: NLY  ) currently pays out a 13.1% dividend yield, resulting in a whopping 423% payout ratio! Like most other mortgage REITs, Annaly sports a high debt-to-equity ratio of 626%.

If you're looking for a REIT option that could actually maintain its high dividend yield, I'd point you toward Chimera Investment (NYSE: CIM  ) . Investors can enjoy a 15.5% dividend yield at a more reasonable debt-to-equity ratio of 185%. Still, Chimera has also had to cut its dividend several times in recent years. Investors should keep a close eye on Chimera's turnaround opportunity in the years to come to make sure it doesn't take steps backward.

Dividend digging
It's easy for investors to get hungry when decent companies serve up delicious dividends, but wetting your whistle on the wrong stock can get you burned. Know whether earnings or free cash flow is more important, watch out for companies sacrificing growth to prop up their dividends, and remember that even tax-free REITs aren't always right for your portfolio.

The telecom industry is full of high dividends, but behind many of them lurk danger. Is Frontier Communications a safe play or a dividend trap? Find out in the Fool's latest premium report on Frontier, which reveals several perks and pitfalls facing the rural telecom giant. Don't wait; get your report today.

Fool contributor Justin Loiseau has no material interest in any companies mentioned in this article, but wishes his parents had given him an allowance comparable to Windstream's payout ratio. Follow Justin on Twitter, @TMFJLo, and on Motley Fool CAPS, @TMFJLo.

The Motley Fool owns shares of Annaly Capital. Motley Fool newsletter services have recommended buying shares of Annaly Capital. 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 (3) | Recommend This Article (6)

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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 27, 2012, at 8:51 PM, dbtheonly wrote:

    CIM has not filed SEC reports for what a year now? I wouldn't touch it with a 10 foot pole.

  • Report this Comment On August 29, 2012, at 5:07 PM, sosowong wrote:

    Give me a break! You "fools" have been predicting the dividend cut on WIN for 2 years. You might find another stock to short because it does not appear you are going to bring this one to you! FYI....the entire time you've been predicting the dividend cut I've received over $50,000.00 dividend payments.

  • Report this Comment On August 29, 2012, at 5:14 PM, sosowong wrote:

    Hey Justin.....don't quit the day job!

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