Despite there being more than 7,000 publicly traded companies for investors to choose from, dividend stocks tend to be the most lustrous of the bunch, and they often form the foundation of many retirement portfolios.
Dividend stocks are (usually) great
Dividend stocks have three primary advantages. First, as you probably surmised, dividends put money directly in your pocket, which is always a nice alternative to a company simply repurchasing its common stock and hoping the respective improvement in earnings per share will lift its share price. Dividend payments can act as a slight hedge against the inevitable downward moves in the stock market.
Second, dividend stocks act like a beacon for income-seeking investors since they usually signal companies with time-tested business models that are healthfully profitable. Think about it this way: What company would knowingly pay a recurring dividend if its management team didn't believe it would remain profitable and continue to grow?
Finally, dividends can be reinvested back into more shares of dividend-paying stock through what's known as a dividend reinvestment plan, or Drip. This leads to a process investment pros use all the time known as compounding, which increases the number of shares you own, and thus leads to bigger dividend payments, in a repeating cycle.
Ideally, we'd like to buy income stocks with the highest payout possible, but that's not always the best idea. Dividend yields are a function of share price, meaning a rapidly falling share price can distort yields into attractive territory, even if the underlying business model is in trouble. High-yield dividend stocks, or those paying out in excess of 4%, should be examined particularly closely for any underlying problems.
As we prepare to flip the calendar over to 2017, these two high-yield dividend disasters with double-digit dividend yields are probably best kept far, far away from your portfolio.
Wireline, broadband, and internet service provider Frontier Communications (FTR) is an absolute high-yield dividend darling on Wall Street. At last check, Frontier was paying out just north of 12%. But a recent dip in its share price following disappointing third-quarter earnings results has boosted its yield and reminded investors that Frontier's business model is on the wrong trajectory over the long term.
There were a few bright spots in Frontier's third-quarter results. For example, its wireline property acquisition in California, Texas, and Florida from Verizon (VZ 0.45%) is expected to yield $1.4 billion in annualized cost synergies, up from its previously announced $1.25 billion figure in its second-quarter earnings report. Frontier anticipates $250 million more in cost synergies by mid-2017 over what it's achieved thus far in its integration.
Yet, as a whole, the integration has been a mess. Despite tacking on 3.3 million voice customers, 2.1 million broadband consumers, and 1.2 million FiOS video subscribers, the initial integration was plagued by on-demand content and billing issues, as noted by my colleague Dan Kline back in April. Frontier's Q3 report wound up generating a $0.04 per share loss, which was $0.02 worse than expected.
More importantly, Frontier keeps losing customers, which has been a regular trend for the company for years. On a quarter-over-quarter basis, customer churn rose 17 basis points to 2.08%, with roughly 155,000 wireline customers leaving. Average revenue per residence also fell by $0.86. As if that weren't enough, broadband subscribers dropped by 99,000, and it lost 92,000 video subscribers. Frontier is bleeding customers across the board, and no amount of price hikes can seemingly offset these losses.
Adding fuel to Frontier's slumping revenue is its nearly $18 billion in total debt, which is good enough for a debt to equity of 377%. With revenue and profitability declining as a result of customer losses, Frontier is probably going to cut its juicy payout at some point in the future. That makes it a good candidate to avoid in 2017.
On the surface, StoneMor Partners (STON), a master limited partnership that owns cemeteries and funeral homes, looks to have a flawless business model and a delectable 14.9% dividend yield. But, yes, that dividend yield may very well be too good to be true.
One of the prime reasons StoneMor's dividend yield is so high is because its stock has lost more than two-thirds of its value year to date as a result of weakness in the company's core business. To begin with, StoneMor wound up seeing a lot of turnover in its salesforce in recent quarters, which has forced it to spend on a recruiting firm to help hire new workers. Not only does the recruiter cost StoneMor money, but the cost and time it takes to train its new salesforce could mean multiple quarters of weaker revenue and profits still to come.
A secondary issue is that StoneMor Partners' business model generates higher margins on cemetery plot sales as opposed to cremation. Yet, based on projections from the National Funeral Directors Association, the percentage of people being cremated by 2030 is expected to rise to 71%. For context, the percentage of people cremated in 2010 was about 40%. This would mean that, as time passes, StoneMor's margins could be squeezed.
And, of course, how can we forget the coup de grace: StoneMor's management cutting the company's payout by 50% in October. Reducing its dividend, along with previously announced cost-cutting, should lower StoneMor's expenses by $12 million per quarter. However, the real issue is in the fine print. According to CEO Larry Miller:
While we are striving to accelerate the timeline of hiring and training additional sales talent, we estimate that this could take up to an additional six to nine months to attain the level of productivity we expect. We intend to provide monthly updates on the sales team expansion for greater visibility on our progress to the levels we are targeting. At that time, we will reassess the distribution and will look to reset it at the appropriate level.
In other words, StoneMor's dividend could be chopped once again and management has no idea what the "appropriate" level is at this point. StoneMor could be disastrous to your financial health, and you're better off avoiding this high-yield dividend stock in 2017.