Danger Lurks for These 3 High-Yield Dividend Stocks

These three stocks need to learn to "live within their means."

Rich Smith
Rich Smith
Jun 22, 2017 at 7:12AM
Consumer Goods

High-yield dividend stocks are the Holy Grail of income investing -- stocks that don't cost a lot yet pay dividends far above the market average, which is currently just 2.1%. But to paraphrase the Grail Knight from Indiana Jones and the Last Crusade, you must choose your high-yield dividend stocks wisely, for while the true Grail will bring you profits, the false Grail will take them from you.

Fat dividends are certainly nice while they last. But if a company isn't earning enough profits to pay for its dividend, eventually, you know that dividend is going away -- or at least getting cut. And this is the danger that stalks shares of Seagate Technology (NASDAQ:STX), Barnes & Noble (NYSE:BKS), and Waddell & Reed Financial (NYSE:WDR).

A tiger prowls through the jungle.

There's a predator in the bush, and it could be stalking your dividend. Image source: Getty Images.

Here are a few numbers that will help you see why.



Dividend Per Share

Earnings Per Share

Seagate Technology




Barnes & Noble




Waddell & Reed Financial




DATA SOURCE: S&P Global Market Intelligence.

Out of money, out of the gate

Let's begin our review of stocks living beyond their means with Seagate, a computer hard-drive maker and generous dividend payer that's maybe just a bit too generous with its payouts.

I've spoken positively of Seagate in the past, with its robust free cash flow, its strong growth prospects, and, of course, its big 6% dividend yield. That said, it may be worth looking at the other side of the coin, and examining the risk that this dividend may not be all it's cracked up to be. Seagate has been riding a rising tide of demand for computer memory, boosted by constrained supply of flash memory in particular. As its fortunes have risen, so has its dividend -- up nearly threefold in size over the past five years, according to data from S&P Global Market Intelligence.

But here's the thing: Seagate suffered a big revenue decline last year, down 19% year over year, which did a number on its profits as well -- down 84% from 2015 levels. Although earnings rebounded nicely at the start of the New Year, it still leaves Seagate with less in earnings per share than it's currently promising to pay out in dividends.

Granted, if earnings continue to rise this year and next, as analysts expect them to, Seagate should quickly grow itself out of this problem. Situations can change quickly in the tech sphere, however. Dividend investors should be aware of the risk if projected growth doesn't materialize.

Selling books? That's still a thing?

Amazon's invention of the Kindle, and the spread of e-books to iPads and similar devices, has not been good news for booksellers such as Barnes & Noble. The stock pays an impressive 8.8% dividend yield, but mostly that's because as its dividend has remained constant at $0.60 per year since 2015, its stock price has collapsed -- falling by nearly half over the past year and thus swelling the size of the dividend relative to the stock price.

In my experience, this is the kind of situation that usually ends up with management deciding to "right-size" its dividend back to where it was before its stock collapsed. And in Barnes & Noble's case, that would imply that a dividend cut of perhaps 50% or more could be coming down the pike.

What might be the catalyst that causes management to make such an unpopular decision? Here's a clue: Barnes & Noble has lost money in four of the past five years, and its trailing-12-month earnings currently stand at just $0.05. That's enough profit earned in 12 months to pay for about one month's worth of dividend checks. With cash running low -- less than $12 million cash on hand, versus $18 million in long-term debt -- I'd expect Barnes & Noble management to cut its dividend sooner rather than later.

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You'd think bankers would be smarter about money

Rounding out our terrible three dividend payers today is Waddell & Reed Financial, an investment banker with a serious dividend problem. Waddell & Reed is halfway into its third year of declining revenue, and profits for the past 12 months are down more than half from what Waddell & Reed was earning as recently as 2014.

Yet as revenue has run down and earnings have dried up, Waddell & Reed has continued to raise its dividend, to the point where it's now paying out $1.07 in dividends for every $1 it earns. While it's certainly possible that business will improve, and that Waddell & Reed will one day earn enough to afford its generous dividend payout, that day may not arrive soon. Analysts who follow the stock tell S&P Global that they expect Waddell & Reed's profits to be down again this year -- and next year, and the year after that as well.

In fact, based on projections of adjusted earnings, Waddell & Reed won't be earning enough profit to cover its entire $1.84-per-share dividend before 2022 at the earliest, and perhaps not even then.

Sooner or later, something's got to give. My guess: It will be the dividend.