Investors love dividend stocks, and for solid reasons. Not only do dividends provide regular income to investors, but companies with big and growing dividends have proven their ability to outperform the market in the long term. However, you need to be careful when picking dividend stocks, and a high yield does not necessarily mean a smart investment. In this roundtable, our contributors highlight three particularly risky dividend stocks to stay away from.
Andres Cardenal (Philip Morris): Tobacco is a remarkably profitable industry, and Philip Morris (NYSE:PM) owns the international rights to powerful brands such as Marlboro, Parliament, L&M, and Chesterfield, among others. This competitive strength allows Philip Morris to compensate for the decline in cigarette sales volume with pricing power, so the company is still managing to sustain sales growth on a constant currency basis.
Sales excluding currency fluctuations and excise taxes increased 5.6% during the third quarter in 2015, and management is expecting currency neutral earnings per share to rise between 11% and 12% during the full year. Since the stock is paying a high dividend yield of 4.8%, Philip Morris could look like a compelling purchase for dividend investors.
On the other hand, the cigarette industry's sales volume has been declining for years, and Philip Morris is expecting a 2.5% decline for 2015. Price increases and cost cutting can only go so far in the context of falling demand. Besides, Philip Morris is currently distributing nearly 90% of earnings as dividends, so it does not have much room to continue increasing payments at a faster rate than earnings in the future.
Unless the company can find sustainable venues to drive sales growth in the long term, investing in Philip Morris sounds like a risky proposition.
Daniel Miller (Noble Corporation): You can run but you can't hide. That pretty well sums up the offshore drilling industry following the plunge in the price of oil. About a decade ago, offshore drillers were a key growth area for the oil industry, but the optimism around them has taken a beating over the past year, and Noble Corporation PLC (NYSE:NE) is struggling. That struggle means investors are dealing with a high-risk stock and a dividend in peril.
Nobody knows when to expect oil prices to recover, but offshore drilling will very likely take even longer to recover and it's a real possibility that it won't happen within this decade. It's clear to investors that the offshore rig market is in a severe downturn and profitability is going to be increasingly difficult to achieve going forward, especially as rig contracts that were signed prior to the collapse in oil prices expire in the years ahead.
As Noble understands that the offshore rig business is in for a bumpy ride, it proactively cut its dividend late last month from $0.375 per share to $0.15 per share. Though it was the company's first dividend slash since mid-2012, this shouldn't give investors any confidence that the dividend, which now yields roughly 4.3%, won't be cut further.
Todd Campbell (GlaxoSmithKline): Sure, GlaxoSmithKline's (NYSE:GSK) 5.8% dividend yield appears downright delicious, but a fast-approaching patent expiration makes this one dividend stock that may be best to avoid.
The company's best-selling medicine is the asthma drug Advair Diskus, and next year, the patent that is keeping generic versions of it off the market will expirie.
The patent in question covers the Diskus inhaler, and assuming that the FDA follows through on prior guidance to generic manufacturers stating that their inhaler doesn't have to be an exact match to the Diskus, and those generic players are able craft versions that pass muster, then about $2.4 billion of GlaxoSmithKline's U.S. revenue will be up for grabs.
Granted, GlaxoSmithKline is working diligently on drugs that it hopes will make up for those declines, but it's too soon to say that it'll be able to overcome this big risk to its bottom line. Because of that, this stock makes my list of high-yielding companies that are too unhealthy to buy.
Andrés Cardenal has no position in any stocks mentioned. Daniel Miller has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. 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.