Dividend stocks are often an attractive investment since they can generate a lot of recurring cash flow for your portfolio. However, if investors simply look for stocks with the highest yields and don't do their due diligence on those companies, they could be taking on a big risk and end up on the losing end of an investment when the unsustainable dividend payouts get cut.
Let's take a look at three stocks that are currently high-yield dividend plays that you should think twice about investing in.
1. Vermilion Energy
Vermilion Energy ( VET 0.98% ) is a Canadian oil and gas producer currently paying its shareholders a whopping 13.9% yield on its annual dividend. It's hard to imagine that a payout like that can be sustainable, but management says it has no plans, at least for now, to make any changes to it.
After the company's stock price declined over 30% during the quarter and ended up pushing the dividend yield to about 14%, Vermilion said in its earnings release on Sept. 30, "While we are certainly disappointed with our share price performance, we would like to stress that Vermilion's dividend policy is not based on the market price of our shares. Our dividend policy is based on the fundamental economic sustainability and free cash flow generation of our business, which remains strong."
It's a valid point that the drop in Vermilion's share price is the main reason for the company's high yield. However, given the challenges that Canadian energy companies are facing today with pipelines not getting approved and multiple governments' policies not being friendly to oil and gas, things may not be getting any easier for Vermilion anytime soon. Over the past four quarters, the company has generated free cash flow of 198 million Canadian dollars. That hasn't been enough to cover its dividend payments, which totaled CA$394 million during the same period.
In the short term, Vermilion's dividend may be OK, but it's not a payout I'd assume will be safe for years.
Macy's ( M -3.25% ) dividend yield isn't as high as Vermilion, but at around 9.7%, it's still quite high. The company is coming off a quarter where it beat earnings expectations but sales failed to do the same. The bigger problem for investors is that Macy's also reduced its forecast for the remainder of the year, trimming what it expects for both its top and bottom lines. In addition, same-store sales are forecast to be down 3.5% from the prior-year quarter.
These are not good signs for the retailer heading into the peak shopping season of the year. Macy's stock has lost half of its value this year and a poor showing in Q4 could send it even lower. While the company is still posting a profit, the problem is that it may not be generating enough cash flow to keep its dividend going. Over the past four quarters, it has generated $411 million in free cash flow, well below the $465 million that it has paid out in dividends. If things don't improve, Macy's may have no choice but to cut its dividend.
3. Targa Resources
Targa Resources ( TRGP -2.29% ) is the second oil-and-gas stock to make this list, but it did so for a somewhat different reason. With its shares basically flat so far this year, Targa's dividend hasn't hit high levels all of a sudden. Instead, its share price began to nosedive in the spring of 2015 when the downturn in the oil-and-gas industry began and has yet to recover. In Q3, Targa disappointed investors again as it failed to meet expectations for revenue in what was yet another unprofitable quarter for the company. In each of the past four quarters, Targa has recorded losses totaling $203 million. And with negative free cash flow of $2.4 billion over the same period, investors should be concerned about the dividend and its current 10% yield.
Management believes that cash flow will improve in future quarters with key growth projects now complete. However, it would have to be a significant turnaround for cash flow to break even. Although Targa's payouts look enticing, investors are likely to find the stock to be a bit too risky despite the company's optimism.
Takeaway for investors
High-yield dividend stocks are always going to be a risky play. While their dividend payments may appear to be stable today, only a company's management knows whether a cut to its payout is imminent. Rather than take a chance on these investments, investors may be better off looking at other dividend stocks with stronger financials.