Dividends can have a huge impact on investor returns over the long term, so dividend-paying stocks have increasingly become mainstays in investment portfolios. However, not all dividend stocks are created equal, especially when considering companies with high-yield dividends. Sometimes those payouts just aren't sustainable, which can make investing in companies like these two a bit more risky.
Dan Caplinger: One dividend stock that I'm particularly worried about is Transocean (NYSE:RIG), which on a trailing basis now has the highest yield of any stock in the S&P 500. The offshore driller's stock has plunged by 60% just since midyear, and Transocean now faces the plunge in the price of crude oil from above $100 per barrel to below $60.
Based on backward-looking numbers, Transocean's $0.75 per share quarterly dividend doesn't look ridiculous, especially since the company is on pace to earn between $4.50 and $5 per share in 2014. But if oil prices don't recover, then Transocean's deepwater drilling customers are likely not to renew contracts to use its rigs, and that could crush the company's future profits. Already, investors expect 2015 profit to be down by nearly half from 2014, and as more long-term contracts come up for renewal, Transocean can't expect to keep bringing in the cash flow it has in the past. As revenue dries up, Transocean will have little choice but to reduce its dividend payout to better match its finances.
Already, rival Seadrill has completely suspended its dividend, and many energy analysts believe Transocean will have to follow suit in the near future. Even if Transocean retains some payout to shareholders, don't expect the current 17% yield to last very long.
Windstream pays a forward annual dividend yield of 10.9%, but it has paid out nearly 400% of its earnings over the past 12 months as dividends. The company only posted earnings of $0.06 per share over the first three quarters of fiscal 2014, yet paid out a whopping $0.75 per share in dividends. Analysts at Morningstar expect Windstream to earn a mere $0.14 per share in 2014 (a 65% year-over-year decline), which fails to justify a $1 annual dividend payout. Things look slightly better from a free cash flow perspective; Windstream paid out 81% of its free cash flow as dividends over the past 12 months, but its trailing 12-month free cash flow still declined nearly 10% over the past five years.
Windstream plans to spin off its network assets into a publicly traded real estate investment trust, which is required to pay out 90% of its profit as dividends. But Windstream expects dividends at both companies to decline ($0.60 for the REIT, $0.10 for the services), which translates to a 30% dividend cut for original shareholders. That transition would require solid leadership, but CEO Jeff Gardner, who led Windstream since 2006, abruptly resigned earlier this month.
Simply put, huge payout ratios, weak earnings, and an unexpected CEO departure are bright red flags indicating that additional dividend cuts could be right around the corner.
Dan Caplinger has no position in any stocks mentioned. Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Seadrill. The Motley Fool owns shares of Seadrill and Transocean. 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.