NAVAL AIR STATION LEMOORE, Calif.-A Navy F/A-18 pilot here trains in a simulator that was manufactured and maintained by the Link Simulation and Training Division. Photo credit: L-3 Communications via Wikimedia Commons.
When it comes to investing in dividend stocks, one of the key metrics to look at is dividend yield -- dividends per share divided by current share price, which shows how much cash flow you're getting for your investment. The higher the yield, the more "bang for your buck" you're getting. Then again, sometimes high dividend yields can be a trap. For example, if a company's stock price declines, it's yield increases, but the stock might be declining for a reason. So, with this in mind let's look at one company with an attractive yield that might be headed for trouble.
The bait
L-3 Communications Holdings (LLL) is a prime contractor in aerospace systems and national security solutions. It's also a specialist in electronic systems -- it's largest and broadest business segment that includes things like flight simulators,
The first completed U.S. Navy Lockheed EP-3E Aries II conversion aircraft departs from the L-3 Communications modification facility in Waco (Texas, USA). The aircraft is used for electronic intelligence (ELINT). Photo credit: L-3 Communications via Wikimedia Commons.
cockpit and mission displays, weapons training systems, etc. Indeed, in its latest Annual Report, L-3 Communications reported that in 2014, Electronic Systems brought in $4.6 billion in nets sales, and accounted for 38% of total net sales. Its next highest business segment, Aerospace Systems, had net sales of $4.3 billion in 2014, and represented 36% of total net sales.
More importantly, if you just consider L-3 Communications' dividend, it looks fairly attractive: the payout ratio is 35%, its annualized growth over the last three years is 10.1%, its annual payout is $2.60, it has 11 consecutive years of increases, and its dividend yield is 2.26%, which is above the average Aerospace/Defense Products and Services yield of 2.17%. Simply put, L-3 Communications' dividend looks attractive.
Don't eat the cheese
Unfortunately, looks can be deceiving. Consider the following:
| L-3 Communications | 2010 | 2011 | 2012 | 2013 | 2014 |
|---|---|---|---|---|---|
| Net Sales (in billions) | $13.4 | $13.2 | $13.1 | $12.6 | $12.1 |
| Operating Margin | 11.1% | 10.6% | 10% | 9.6% | 8.9% |
| Diluted EPS | $8.26 | $9.05 | $8.03 | $8.24 | $7.56 |
Source: L-3 Communications' 2014 Annual Report.
As you can see in the above table, L-3 Communications' net sales, and operating margin, have declined every year since 2010. And, diluted earning per share is also declining -- diluted EPS from continuing operations declined by 8% compared to the year ended December 31, 2013. Further, funded backlog declined from almost $10.4 billion in 2013, to $10.2 billion in 2014.
US Government Secure Telephone Equipment (STE) desk telephone. Photo credit: NSA via Wikimedia Commons.
Plus, if you examine L-3 Communications' second quarter report, it's not any better -- L-3 Communications reported a net sales decrease of 7%, an operating income decrease of 31%, and a diluted earnings per share decrease of 6%, compared to the same time last year.
To sum it up, L-3 Communications' sales are consistently declining. This, according to L-3 Communications' 2014 annual report, is mainly due to, "lower sales to the DoD caused by sequestration cuts and the continuing U.S. military drawdown from Afghanistan affected each segment." L-3 Communications' report adds that it's seen a decline in demand for products, due to the above. Moreover, this has undoubtedly had an impact on L-3 Communications' stock price -- as of this writing it's stock is down 12.5% since its high in February 2015.
To sum it up
L-3 Communications' dividend yield seems attractive, but thanks to its decline in profits, margin, and backlog, its stock might be headed for trouble. Consequently, while dividend yield is an important metric to examine when you're considering buying a dividend stock, L-3 Communications is a prime example of why it's important to look a bit deeper. In some cases, you'll find that the yield is justified, but in others, you'll find that the yield is nothing but a trap.
