When investors look for dividend stocks, they should generally avoid companies in fading industries (like big tobacco), companies that regularly pay out over 100% of their earnings or free cash flow (FCF) as dividends, and companies that only pay high yields because their stocks have been crushed. Checking those three boxes will help you avoid some high-yield traps.
But investors should also be wary of companies with shifting priorities, stagnant businesses, and unusual dividend payout models. Here are three high-yield stocks that fit those three categories, respectively -- Intel (INTC +1.29%), Xerox (XRX +1.76%), and Nintendo (NTDOY +0.00%).
Image source: Getty Images.
1. Intel
Intel pays a forward yield of 2.5%, its dividends consumed just 29% of its FCF over the past 12 months, and the chipmaker has raised its payout annually for six straight years -- and its stock trades at just 12 times forward earnings. But it's cheap for obvious reasons.
A series of manufacturing missteps caused its internal foundry to fall behind Taiwan Semiconductor Manufacturing (TSM 1.42%) in the "process race" to create smaller chips in recent years. As a result, its rival Advanced Micro Devices (AMD +0.62%) -- which outsources its production to TSMC -- now sells more advanced chips than Intel.
Intel's previous CEO, Bob Swan, was a former CFO who prioritized cost-cutting measures, big buybacks, and continuous dividend payments instead of resolving the company's pressing R&D issues. Swan also considered outsourcing more of its chips to third-party foundries like TSMC.
But Intel replaced Swan with Pat Gelsinger, an engineering veteran and former CEO of VMWare, earlier this year. Instead of abandoning Intel's foundry business, Gelsinger doubled down on expanding the company's U.S. plants with a $20 billion investment. Intel is also reportedly interested in buying GlobalFoundries, AMD's former foundry partner, for $30 billion to accelerate those efforts. But it will require a lot more spending for Intel to catch up to TSMC.
TSMC remains roughly two chip generations ahead, and it is gearing up to spend $100 billion over the next three years to boost its overall capacity. Therefore, investors shouldn't be surprised if Intel reduces its dividend -- which consumed $5.6 billion in cash last year -- to save its core business.
2. Xerox
Xerox pays a forward yield of 4.4%, and it spent just 53% of its FCF on those payments over the past 12 months. The stock trades at just ten times forward earnings. However, Xerox hasn't raised its dividend since 2017, and its two core businesses could be in serious trouble.
Xerox's equipment sales, which primarily consist of printers, copiers, and their related supplies, have declined in recent years due to lengthy upgrade cycles, the rise of paperless offices, and competition from generic ink and toner suppliers. As a result, its post-sale business, which generates revenue from installation, maintenance, financing, and add-on service fees, has also withered.
Activist investor Carl Icahn tried to push Xerox to buy HP (HPQ +1.81%) last year, but HP resisted the hostile bid and Xerox gave up earlier this year. Meanwhile, Xerox's FCF growth remains tepid, especially if we exclude the cash it gained from exiting its Fujifilm (FUJIY 1.50%) joint venture in 2019:
Source: YCharts
Analysts expect Xerox's revenue and earnings to rise 3% and 33%, respectively, this year against an easy comparison to the pandemic. But next year, its revenue is expected to dip 2% as it resorts to aggressive cost-cutting measures and buybacks to boost its EPS -- which might rise 18%.
Xerox probably won't cut its dividend anytime soon, but the secular decline of its core business suggests it would be smarter to reduce its dividend -- which consumed $230 million in cash last year -- and invest in fresh ways to grow its long-term revenue again.
3. Nintendo
Nintendo paid a trailing yield of 3.6% over the past 12 months. However, the Japanese gaming giant's semi-annual dividends fluctuate every year based on its operating and net profits.
Specifically, Nintendo's interim dividend equals 33% of its consolidated operating profit in the first half of its fiscal year, while its year-end dividend is based on the higher of two numbers -- 33% of its consolidated operating profit or 50% of the net profit attributable to its shareholders.
That payout structure has enabled Nintendo to pay consecutively higher annual dividends over the past four years. But all of that growth can be attributed to the launch of its popular Switch console in 2017.
Nintendo's revenue surged 34% in fiscal 2020, which ended in March, as its net profit jumped 88%. That growth was partly attributed to the pandemic, which drew more gamers to the Switch and popular games like Animal Crossing: New Horizons and Mario Kart 8 Deluxe.
But this year Nintendo expects its revenue and earnings to decline 9% and 29%, respectively, as the pandemic passes, new consoles compete for attention, and the global chip shortage limits its production of new Switches. Nintendo's new Switch OLED console may cushion the blow when it arrives this October, but its lower profits will inevitably reduce its total dividends this year.
