Dividends are a great way to boost your returns in the stock market, and building a portfolio of solid, dividend-paying stocks is often a winning investing strategy.
But dividends don't always survive. Some dividend stocks, especially high-yield ones, can be yield traps -- stocks that attract investors because of their high dividend yields, but those yields are unsustainable and a reflection of weakness in the business.
Dividend investors will want to look at the sustainability of the payout, looking for stocks with consistent earnings growth, and ones with a moderate payout ratio (the percentage of income that goes to dividends). Generally, 80% is considered to be the safety threshold for the payout ratio as other income is needed to reinvest in the business. If the payout ratio goes above 100%, the company can't fund is dividend payments out of current earnings, which is a clear red flag.
With that in mind, let's take a look at three stocks that could soon see their dividends slashed.
Oil prices have tanked over the last two years, taking oil stocks with them. BP (NYSE: BP) shares are down by more than a third since their 2014 peak, and the pullback has made an already juicy dividend payout even fatter, at a yield of 7.3%. The company last raised its dividend in 2014, by 2.6% to $0.60 a quarter. Its payout ratio based on adjusted EPS of $1.25 over the last four quarters is nearly 200%, meaning the company is paying nearly double its current earnings in dividends.
Unlike peers such as Chevron and ExxonMobil, who have also seen their payout ratios spike, BP is not a dividend aristocrat and does not have a streak of dividend hikes to protect. Chevron and Exxon's yields are also about half the size of BP's, making BP's much more vulnerable.
BP has $54.5 billion in cash and long-term investments, but even more in debt: $59.3 billion. Dividends cost the company $6.75 billion last year and are set to cost more than $7 billion this year. By comparison, free cash flow, arguably a better metric to use for the payout ratio than net income, was just $485 million last year. BP has the cash to continue funding its dividend, but if oil prices remain low, it may be prudent for the company to cut back. Management has said before that $60 a barrel oil is the "breakeven" point the company needs in order to fully fund its capital expenditures and dividend. If oil remains below $50, as it is today, that could be a problem.
2. Annaly Capital Management
Annaly Capital Management (NYSE: NLY) shares have tumbled over the last five years, but the mortgage Real Estate Investment Trust still pays a dividend yield of more than 11%; REITs are required to pay at least 90% of their earnings back to shareholders.
Annaly benefits from low short-term interest rates by borrowing debt and reinvesting that money into higher-yielding assets like mortgages. With the Federal Reserve set to increase interest rates, Annaly's profits could get pressured in the coming months.
Increasing interest rates also put pressure on Annaly's $70 billion portfolio of mortgage assets as the values of those securities fall as interest rates rise. The company has estimated that a 75 basis-point increase in interest rates would cause its portfolio to depreciate by 1.3% and its book value per share to fall by 7.3%.
Analysts are expecting profits to fall over the coming years, with EPS slipping from $1.20 last year to $1.17 this year, and $1.13 in 2017. With the company paying out $1.20 in annual dividends per share, that could eventually lead to a cut, especially if the company misses estimates. As a REIT, it should still pay a sizable dividend yield, but investors should be prepared for a cutback.
3. Las Vegas Sands
Unlike BP and Annaly, which have eased off dividend hikes, Las Vegas Sands (NYSE: LVS) raised its dividend at the beginning of the year, despite a payout ratio ballooning above 100%.
The casino operator has struggled to cope with falling revenues from Macau and Singapore, but it raised its dividend as a signal of confidence to investors. In January, CEO Sheldon Adelson said he expected revenues from the Chinese island territory to turn around "in the near future."
However, Las Vegas Sands badly missed earnings estimates in its most recent quarter with a per-share profit of $0.45 against expectations of $0.63, and analysts expect adjusted EPS to fall by 10% this year, making its payout ratio 125% based on this year's expected earnings.
The casino chain also has just $1.7 billion in cash on its balance sheet and nearly $10 billion in debt, meaning distributing nearly $3 billion in dividends a year will not be sustainable without the profits to support it. Last year, dividend payouts exceeded free cash flow by about $800 million.
Considering the company just raised its dividend, it would be surprising to see it slashed so soon, but with falling profits and a dividend yield above 6%, a cut down the road is certainly a possibility.
Jeremy Bowman has no position in any stocks mentioned. The Motley Fool owns shares of ExxonMobil. The Motley Fool recommends Chevron. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.