Dividend stocks are the foundation upon which great retirement portfolios are often built. Inclusive of dividend reinvestment, investors have enjoyed an average return of approximately 7% per year by staying invested in high-quality, dividend-paying stocks over the long run.
Dividends offer a number of key advantages for investors. The most obvious is that they can help hedge against inevitable stock market corrections. However, dividends also act as a beacon to attract investors to high-quality companies. A company would more than likely not issue a quarterly dividend and share a percentage of its profits with investors if it didn't believe those profits were sustainable, or could grow, over the long-term. Lastly, dividends can be reinvested back into more shares of dividend stock, thus leading to a process known as compounding where you wind up with successively more shares of stock and bigger dividend payouts in a repeating cycle.
Unfortunately, it takes more than a dart throw to snag a great dividend stock. Some dividend stocks are akin to wolves in sheep's clothing and could wind up suckering unsuspecting income investors into a potentially bad investment. Remember, yield is a function of stock price, meaning that a company with a struggling or failing business model and a declining stock price can have a growing yield that could, on the surface, look attractive.
With this in mind, here are three high-yield dividend stock that you'd be best off avoiding this fall.
Big-box retailer Staples (SPLS) might seem incredibly attractive, with its 6.5% annual dividend yield, but it's a company that income investors should avoid altogether.
Though Staples looks as if it'll remain healthfully profitable for the next couple of years, it's completely on the defensive thanks to the emergence and dominance of e-commerce solutions, such as Amazon.com (AMZN 1.29%). Amazon provides a channel for small businesses to do their office supply shopping with convenience, and since Amazon doesn't have high brick-and-mortar overhead costs, it can often undercut the price of products at Staples' brick-and-mortar locations. In other words, Staples' core customer is slowly being whittled away by e-commerce competitors, and there isn't much it can do about it.
In response, Staples has been increasing its spending in e-commerce, as well as cutting costs anywhere it can. It's closed 19 stores during the first-half of 2016 and is on pace to close 50 in North America this year. Staples is also experimenting with smaller stores in an effort to focus those stores on products that'll bring in high customer traffic. It's a bit early to tell if it'll work, but it still doesn't address the company's lack of growth. Even its extra effort to promote Staples.com resulted in just 1% sales growth in Q2 on a year-over-year basis. Staples can keep tightening its belt and cutting its spending to keep its operating margins consistent, but there's simply no top-line growth or catalysts to be seen anywhere.
Perhaps the one solution Staples did have was a possible merger with Office Depot. However, regulators threw that idea out the window over fears that it would reduce competition in the brick-and-mortar office space too much. With few strategic options left, Staples' business model appears to be in a slow-motion downward spiral, which makes its stock worth avoiding.
Communications service provider CenturyLink (LUMN 0.51%), which is currently yielding 8.1%, made big waves earlier this week when it announced that it would be acquiring Level 3 Communications (LVLT) for nearly $34 billion. The deal involves CenturyLink paying $26.50 in cash and 1.4286 shares of CenturyLink stock for each Level 3 share. According to CenturyLink, the deal will expand the presence of both companies to more than 60 countries, and it should result in $975 million in annual cost savings.
On one hand, the roughly $10 billion in aggregate net operating losses that CenturyLink is privy to because of its acquisition of Level 3 should allow its cash flow to improve substantially in the coming years and will likely support its extremely high 8% yield.
On the other hand, there are serious concerns about the enormous price CenturyLink is paying for Level 3, a communication services company that's fallen short of Wall Street's profit expectations in each of the past six quarters. If you recall, the story was the same in 2010, after CenturyLink acquired Qwest. The Qwest deal was expected to boost cash flow and be a big earnings boost. Ultimately, CenturyLink wound up having to slash its dividend because it was mired in too much debt, which I believe is a genuine possibility here before the end of the decade.
Per Bloomberg, CenturyLink also has a nasty habit of writing down its assets post-acquisition, which is a nice way of saying it has a tendency to overpay for its acquisitions. Stepping up and paying a 42% premium for Level 3 in a highly competitive space just doesn't seem prudent.
My suggestion would be to hang up on CenturyLink and focus on businesses with more attractive organic growth opportunities.
GNC Holdings Inc.
Another high-yield dividend stock that income investors would be better off avoiding is GNC Holdings (GNC), the specialty retailer of vitamins, nutritional supplements, and diet products.
In some context, GNC Holdings looks to have relatively minimal downside risk with its stock having lost more than 75% of its value in a three-year timespan, and the company now trading at just six times forward earnings. Assuming GNC can meet already reduced estimates, then its current yield of 6% and forward P/E of 6 would be a steal.
However, not all is well with GNC Holdings. GNC has fallen short of Wall Street's consensus profit estimate in eight of the past 12 quarters, and its most recent results from the third-quarter were no different. Revenue for the quarter fell 8.1%, with both North American and international revenue showing weakness. Same-store sales were even worse, down 8.5% globally, with domestic same-store sales dropping 8.9%.
But, the biggest concern of all just might be what GNC's interim CEO had to say following its disappointing Q3 results. As reported by The Wall Street Journal, interim chief Robert Moran described GNC as a "broken business model," which isn't very comforting. GNC is in the midst of a complete transformation that'll see it abandon bulk sales of nutritional products and align the pricing of its e-commerce and brick-and-mortar locations. There's also been substantial turnover at the top, with management shakeups designed to reignite growth.
At the moment there are just too many question marks and nothing to substantiate a stabilization in sales. Even though GNC Holdings looks cheap, it could very easily get cheaper if its domestic same-store sales continue to drop by nearly 9% on a year-over-year basis.