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Stay Away! 3 Dividend Stocks That Are Yield Traps

By Timothy Green – Apr 24, 2017 at 3:00PM

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A high dividend yield doesn't mean much if the dividend is slashed down the road.

High dividend yields can be tantalizing, especially with interest rates so low. But a high yield sometimes comes with the risk that the dividend could be slashed. Not only will that cut into your income, but the stock price will likely fall as well, a double whammy for dividend investors.

Avoiding high-yield stocks that have an elevated risk of dividend cuts is a good idea, even if it means missing out on some dividend income today. Here's why Mattel (MAT -0.68%), GameStop (GME -11.69%), and Verizon Communications (VZ -1.94%) should be avoided.

A hand reaching for money in a mouse trap.

Image source: Getty Images.

A struggling toy maker

Embattled toy maker Mattel has so far maintained its generous dividend, even as sales and profits continue to sink. Total revenue dropped 8% year over year during the critical holiday quarter, driving a 19% plunge in net income. This weak performance left retailers with elevated levels of inventory, reducing new orders during the first quarter and leading Mattel to report a 15% decline in sales. The company posted a net loss of $113 million during the seasonally weak quarter, more than 50% bigger than the loss during the prior-year period.

Mattel stock has tumbled since peaking in early 2014, driving the dividend yield up over the 6% mark. That certainly looks tempting, but earnings haven't been sufficient to cover that dividend since 2013. This is a situation that can go on for a while, but not forever. If Mattel can't improve its bottom line substantially in the near future, a dividend cut will become necessary.

Mattel has some things going for it. The company owns popular brands like Barbie, Hot Wheels, and Fisher Price, and its recent revenue shortfalls are partly due to the one-off loss of the Disney Princess license. In the long run, Mattel has a good shot at eventually turning things around. If you're a dividend investor, though, best to stay away. That juicy dividend may not be long for this world.

A disappearing core business

Video game retailer GameStop is already preparing for the possibility that video games one day go completely digital. The company is expanding its fleet of stores that sell consumer electronics and collectibles while reducing its massive footprint of video game stores. But GameStop remains heavily dependent on selling physical games, particularly used games. During 2016, used and value games accounted for more than one-third of the company's gross profit.

GameStop may well survive past the point when console games go fully digital, but it will be a completely different company. GameStop stock looks like a bargain, trading for less than seven times earnings, but those earnings are generated by a line of business that may not exist five or 10 years from now. The dividend also looks enticing, yielding about 6.5%, but it won't survive if GameStop's core business falls apart.

Buying GameStop stock is a bet that a retailer with more than 7,600 stores, the vast majority of which sell physical games, will be able to adapt to a world where games are going digital and where retail in general is in upheaval. That's not a bet I'm willing to make, and investors shouldn't be tempted by a dividend that will look perfectly sustainable right until the rug is pulled out from under them.

Big trouble for the leading wireless company

Verizon's dividend may seem safe, given its long-held status as the leading provider of wireless service in the U.S. But competition is catching up. Verizon reported its first net decline in wireless customers ever during the first quarter, losing over 300,000 to scrappy rivals like T-Mobile. The company was forced to reintroduce unlimited plans to keep up with the competition, a move that prevented an even bigger decline in subscribers. But revenue fell by 7.3% year over year, and net profit plunged 20%.

Verizon stock sports a dividend yield of 4.75%, and until recently there wasn't much concern that the dividend could be at risk. But Verizon paid out $9.3 billion in dividends last year compared to just $5.1 billion in free cash flow and $13.6 billion in net income. The era when Verizon could charge premium prices and still post healthy subscriber gains appears to be over. If subscribers keep fleeing, Verizon will be forced to slash prices, and that will hit the bottom line.

A big acquisition could be in the cards, which would likely saddle the company with even more debt. Verizon may look to diversify away from wireless, but the balance sheet already has $105 billion of long-term debt, more than double compared to 2012. The dividend may be harder to maintain if even more cash must go toward interest payments.

There's a lot to dislike about Verizon at this point, and dividend investors shouldn't assume that the dividend is safe. A dividend cut is far less likely with Verizon compared to the other two companies above, but it's still a risk.

Timothy Green has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Verizon Communications and Walt Disney. The Motley Fool recommends T-Mobile US. The Motley Fool has a disclosure policy.

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