Dividend investing has long been a haven for investors who want to receive a reliable stream of income rather than wait for capital gains to materialize. Having those dividends deposited in your account each quarter alleviates concerns that you might have to sell stock at the wrong moment in order to generate income. Instead, you keep on collecting dividends even when the market is down.
Unfortunately, investors sometimes forget that not all dividend stocks are created equal. As tempting as it may be to zero in on the yields offered by Guess?, (NYSE:GES), Darden Restaurants (NYSE:DRI), and Starwood Hotels and Resorts Worldwide, (NYSE:HOT), the business prospects of each company are uncertain enough to make them dangerous stocks to hold in conservative dividend portfolios.
It's anyone's guess if this company will turn around
Guess? distributes about half its earnings as a dividend and offers a 3.75% dividend yield. That sounds great if it's all you know about the company. However, Guess? is going through a challenging period. Operating income is down 44% over the past two years and gross margin declined five percentage points in two years. The company reported weakness across the board in last month's second-quarter earnings release. Guess? desperately needs to get back in front of fashion trends so that it can stabilize earnings.
Although Guess? might pull off a turnaround, it's not the type of stock that many dividend investors would want. If you're just looking to collect payments each quarter, you probably want a big and safe dividend. A blue chip retailer like Nordstrom might be more appropriate for a dividend portfolio because of its stability.
Desperate for diners
Like Guess?, Darden Restaurants has an enticing dividend with a dividend yield at 4.6% -- close to an all-time high. The company's stock price is down 9% so far this year, making it an interesting candidate for contrarian investors. However, dividend investors may want to steer clear despite the stock's apparent attractiveness.
High unemployment and stagnant wages for low- and middle-income households limit Darden Restaurant's ability to drive customers to its locations. Olive Garden – which generates more than half of Darden Restaurants' total sales – experienced declining traffic and lower same-store sales in every month of fiscal 2014.
The traffic problem is so bad that Olive Garden is resorting to gimmicks like its latest giveaway: $100 for seven weeks of pasta. USATODAY reports that all 1,000 "Never Ending Pasta Passes" sold out in 45 minutes. The company plans to promote more giveaways in the coming weeks, according to the newspaper.
No matter how much buzz the giveaways generate, Darden Restaurants' long-term financial health depends on a strengthening economy. Dividend investors ought to wait for same-store sales to improve rather than tempt fate to catch a falling knife.
The risk might be too big
Unlike Guess? and Darden Restaurants, Starwood Hotels is producing near the high end of its potential. The company earned $3.28 per share in 2013, its best result since 2006. The stock's 1.7% yield may be tempting given the company's financial success, but investors should be cautious. Starwood operates in a highly cyclical industry where earnings – and dividends – rise and fall with the economy.
Although the company is expanding its geographic footprint, almost half of Starwood's available rooms are located in the United States. This could provide upside in the event that the domestic economy continues to improve, but it exposes investors to significant downside risk in another recession. In any event, dividend investors who abhor the thought of a dividend cut should avoid Starwood altogether.
Guess?, Darden Restuarants, and Starwood Hotels are not necessarily bad investments just because they have some hair on them. but these stocks are probably not appropriate for dividend investors who seek safety of principal in addition to high dividends. If this sounds like you, you might want to look elsewhere.
Ted Cooper has no position in any stocks mentioned. The Motley Fool recommends Guess?. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.