The market has pretty much been flat in June, but the same can't be said for the five dividend stocks I'm investigating today. Though seeing a dividend payer on sale might be tempting, I'll show you why you should stay away from all five companies. But I won't leave you high and dry; there will be access to a special free report with dividend stocks I do like at the end of the article.



4-Week Return

Dividend Yield

Arch Coal (NYSE: ACI)Energy(20%)2%
Diamond Foods (Nasdaq: DMND)Food(18%)1%*
EXCO Resources (NYSE: XCO)Energy(13%)2.4%
Frontline (NYSE: FRO)Shipping(24%)1.9% 
Nokia (NYSE: NOK)Mobile(26%)7.4%

Sources:; Yahoo! Finance. Return from May 28 to June 25 and includes dividends. *Trailing yield; dividend has been suspended.

Before even diving in, we can throw Diamond Foods off the list. I included it because any individual investor using a screener might have it pop up as a dividend payer. In reality, the company has suspended its dividend.

On top of that, the CEO and CFO were shown the door earlier this year for making improper payments to walnut growers. Fellow Fool Tamara Rutter offers a more comprehensive look at why Diamond Foods is definitely not a buy at today's prices.

Declining business models
One reason to avoid our four remaining companies is that their business models are in long-term decline.

The cheap price of natural gas has created a double whammy. Arch Coal has seen demand for its product decline over the past year, thanks in part to the fact that natural gas is slowly replacing coal for energy production. But that hasn't been enough for natural-gas producers, either, as the supply glut still has prices near historical lows, helping explain why EXCO Resources is down as much as it is.

But natural gas isn't the only instance where a supply glut is hurting business. The shipping industry, which went on a massive build-out before the Great Recession, is also suffering from having far more supply (ships) than demand (stuff to ship). Though things may eventually pick up, the glut has to be worked through first.

And though there's nothing wrong with Nokia's business model per se, it's getting crushed by Apple and Google in the smartphone world. Maybe the company's new Lumina 900 can boost sales, but my money's not riding on it.

Poor balance-sheet health
Beyond declining business models, dividend investors need to take a thorough look at a company's financial statements. Specifically, a company shouldn't be using more than 80% of its free cash flow to pay out dividends. If that's the case, the dividend is likely unsustainable. Take a look at how our four companies stack up.


Free Cash Flow Payout Ratio

Arch Coal550%
EXCO ResourcesNM

Source: Yahoo! Finance. *2011 Cash flow and dividend payments. NM = not meaningful due to negative free cash flow.

Normally, having payout ratios of 284% and 550% would put you at the bottom of the pack, but at least Arch Coal and Nokia have positive free cash flow. The same can't be said for Frontline or EXCO, which saw more money flow out of their coffers over the past year than come in.

In fact, over the past five years, EXCO hasn't had one instance where it was free-cash-flow positive. And 2009 was the last time Frontline was able to boast positive free cash flow.

In the end, if you're a dividend investor, it's simply not smart to invest in companies with these kinds of characteristics -- no matter how low the price is today.

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