Yield. Danger ahead.
You won't just see these warnings while on the road this holiday season -- they also relate to some dividend stocks. Investors can be enticed by high dividend yields, but sometimes the stocks themselves are dangerous picks. We asked three of our Motley Fool specialists to identify stocks that fit this category. Here are the stocks they think could have dangerous dividends.
Matt Frankel: One dividend stock that I'm a little nervous about right now is Prospect Capital(NASDAQ:PSEC). It's not even that I'm convinced the company won't have enough money to pay its dividend. It's the strange behavior coming from the company lately that worries me.
For instance, Prospect has traditionally declared its monthly distributions three months at a time, and well in advance. For example, when the company announced its results in May, shareholders already knew how much dividend income they would receive all the way through the end of 2014.
However, the company's latest earnings announcement had no such dividend declaration. Even after hearing shareholder's concerns, the company declared just one more month's dividend, January 2015.
Additionally, Prospect has been selling shares below net asset value, a practice that the company has said is for extreme situations. And, the company is seeking shareholder approval for even more sales below NAV.
Again, the company has given no real indication of a dividend cut, but the recent behavior is a red flag.
However, Frontier slashed its quarterly dividend twice in the past -- from $0.25 to $0.1875 (after acquiring some of Verizon's landlines) in 2010, then from $0.1875 to $0.10 in 2012. Today, Frontier pays $0.40 in dividends per year, but the company only earned a non-GAAP adjusted $0.26 per share in 2012 and $0.24 in 2013. This year, the company is only expected to earn $0.20 per share, giving Frontier a whopping payout ratio of 200%.
Frontier is aware of this problem, and highlights its FCF payout instead, which came in at a healthy 46% last year. However, Frontier's FCF (trailing twelve months) has slumped 4% over the past two years and dropped 17% over the past 12 months. Meanwhile, its top line is stagnant; last quarter, customer revenue dipped 0.5% sequentially as it lost 18,700 (out of 3.07 million) customers.
Therefore, Frontier's history of slashing its dividend, its unsustainable payout ratio, and slumping FCF and revenue should all be bright red flags for income investors.
Keith Speights: On the surface, PDL BioPharma (NASDAQ:PDLI)looks like a great dividend stock. A stellar 7.6% forward annual dividend yield combined with a low 31% payout ratio might seem like an investor's dream. That dream could soon turn into a nightmare, though.
Over 75% of PDL's revenue stems from royalties covered under what is called the Queen et al. patents. The final patent in this group expires in December of this year. PDL BioPharma has been quite straightforward in its message about the potential impact of the patent expiration, stating in its annual filing to the SEC that "if we are unsuccessful in acquiring sufficient new sources of income, we will likely liquidate our business."
PDL BioPharma is certainly trying to find those new sources of income. Just a few weeks ago, the company bought a portion of royalty payments for Cerdelga. The drug, which is used to treat adult patients with Gaucher disease type 1, won FDA approval in August.
So far, though, PDL hasn't come close to plugging the hole that is about to manifest itself. Unless something dramatic happens, this juicy dividend is skating on very thin ice.
Keith Speights has no position in any stocks mentioned. Leo Sun has no position in any stocks mentioned. Matthew Frankel owns shares of Prospect Capital. The Motley Fool has no position in any of the stocks mentioned. 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.