With interest rates near historic lows and the S&P 500 yielding around 2%, high-yield dividend stocks offer both higher payouts and the potential for capital appreciation. But blindly buying dividend stocks with attractive yields without understanding the risks is a recipe for disaster. Qualcomm (NASDAQ:QCOM), Target (NYSE:TGT), and General Motors (NYSE:GM) all provide yields in excess of 4%, but all three come with unique risks that must be considered. Here's what you need to know about these high-yield dividend stocks.
It's unlikely that the legal battle between Qualcomm and Apple (NASDAQ:AAPL) will end anytime soon. Apple sued Qualcomm earlier this year, accusing the company of charging excessive royalty payments. The iPhone maker is now withholding payments to contract manufacturers for Qualcomm royalties, a move that has immediate and significant financial implications. Qualcomm expects its third-quarter revenue to be reduced by as much as $500 million as a result, which will knock down adjusted earnings per share by as much as 35% year over year.
Qualcomm is fighting back, asking the International Trade Commission to block some iPhone models from being imported into the U.S. As the company is dealing with this Apple saga, the Federal Trade Commission is moving forward with its own suit, charging Qualcomm with anti-competitive business practices. For Qualcomm investors, these are two big clouds hanging over the company.
These legal issues have hurt the stock this year, with shares down nearly 15% year to date. This has boosted Qualcomm's dividend yield up to 4.1%. Most of the company's profits come from licensing its patents and intellectual property, and there's some risk these lawsuits lead to lower royalty payments in the future. The worst-case scenario could produce a major decline in earnings and put pressure on Qualcomm's ability to continue paying its current dividend.
For dividend investors looking for a stock that they can buy and forget, Qualcomm is probably not the best choice. But those willing to bet that these lawsuits will cause minimal damage can lock in a nice 4% yield.
It's impossible to predict where Target will fit in the retail landscape of the future. Physical stores have value -- Amazon.com wouldn't have acquired Whole Foods if that weren't true -- but traditional retailers will need to master e-commerce to be able to compete. Some retailers, like Wal-Mart, have been aggressive in pursuing online sales. Target's strategy isn't quite as clear.
Target plans to invest in new exclusive brands and small-format stores over the next few years, and all of its stores are set to serve as online distribution centers by 2019. The company has already jumped aboard the mobile-app bandwagon with Cartwheel, which offers coupons for in-store use, and it's experimenting with a one-day shipping program. Whether these steps will be enough to compete with Amazon and Wal-Mart is an open question.
Shares of Target are down 30% this year, with investors becoming increasingly concerned about the company's ability to adapt. The beaten-down stock yields about 4.9%, almost shockingly high given Target's dividend history. The company is a Dividend Aristocrat, having raised its dividend for 46 years in a row.
Target will need to make the right moves if it wants to avoid the fate of once-great retail chains that failed to adapt. The dividend will be at risk if sales and earnings continue to decline, but a successful turnaround will pay off for investors willing to bet that the decades-old retailer can find its way in a new age of retail.
Automaker General Motors recently cut its outlook for U.S. industry sales, providing another piece of evidence that a peak has been reached. The company expects just over 17 million vehicles to be sold this year, down from 17.55 million last year.
GM stock has been held down in recent years by fears that an eventual decline in sales would wreak havoc on its bottom line. GM expects to produce adjusted EPS between $6.00 and $6.50 this year, but the market isn't giving the company credit. GM stock trades for just 5.6 times the midpoint of that range. In other words, the market is pricing in the expectation of a steep earnings decline.
We won't know how GM's bottom line holds up under adverse market conditions until those conditions emerge. GM claims that it can break even in the U.S. if industrywide sales fall as low as 10 million new vehicles per year, so a mild downturn should be far from devastating. GM's sale of its money-losing European business should also help boost the bottom line, and ongoing share buybacks will help prop up the per-share numbers.
GM's dividend currently yields 4.3%, and annual dividend payments account for just 25% of the low end of GM's adjusted earnings guidance. It would take a mammoth decline in earnings for GM's dividend to be at risk. Such a decline isn't impossible, but the likelihood looks low. For dividend investors, this looks like a risk worth taking.
John Mackey, CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Timothy Green owns shares of General Motors. The Motley Fool owns shares of and recommends Amazon, Apple, Qualcomm, and Whole Foods Market. The Motley Fool has a disclosure policy.