The energy sector is a dangerous place for dividends right now. Image: Flickr user Ian Burt.
Retirees are always looking for ways to boost their portfolio income, but in today's market environment, not every dividend stock is a smart holding for conservative investors. If you're not careful, you can get in over your head with an ill-suited dividend stock and end up with a sizable capital loss. To help prevent any nasty surprises, let's take a look at three dividend stocks that retirees should think twice about before jumping into right now.
Denbury Resources is a high-risk oil gamble
Plunging oil prices have hammered stocks throughout the energy industry, and the resulting share-price carnage has taken what used to be fairly modest dividend yields and turned them into impressive high-yielding stocks. Denbury Resources (DNR +0.00%) is one example, with its modest $0.0625 per share quarterly dividend now working out to a yield of more than 6%, because of the stock's 75% drop since late last year.
Denbury is far from a lost cause, as its technology for tertiary recovery still gives it an impressive competitive advantage against other energy companies. Yet with about $3.5 billion in debt and about a year's worth of hedge protection for future production, Denbury really needs to see oil prices regain at least part of their lost ground in the near future to avoid what could become a cascading liquidity event. If that recovery comes, Denbury shares could skyrocket, but the risk involved is higher than many retirees will want to take on even with such a huge potential reward.
Annaly Capital could still end up falling with the Fed
Real-estate investment trusts that invest in mortgage-backed securities were huge winners in the recovery from the financial crisis, as falling interest rates allowed them to make big profits from their leverage-financed portfolios. Yet what retiree investors have figured out is that even though Annaly Capital (NLY 0.73%) has consistently sported double-digit dividend yields, its share-price losses have been large enough to wipe out the positive impact of its dividend payments. Investors have seen a negative total return over the past four years, and the Federal Reserve hasn't even made any moves to raise short-term rates yet.
Mortgage REITs can take steps to protect themselves against higher rates by lowering levels of leverage and being more conservative in their investing. Yet long-term investors will remember that Annaly has been through this part of the business cycle before, and the stock lost nearly half of its value when a long period of low interest rates finally came to an end. If Annaly were to adjust its strategy, it could find ways to mitigate losses in an upward-trending interest rate environment, but retirees shouldn't take the risk that the mortgage REIT will just keep the status quo and plan for the long run.
Source: KB35, Flickr.
Coca-Cola is too fizzy
My last pick is controversial, as blue-chip beverage giant Coca-Cola (KO +0.34%) is a well-known favorite among many investors who point to the company's track record of 53 consecutive years of raising its dividend every single year. Coca-Cola also carries an attractive 3.2% yield, which is well above the average for the Dow Jones Industrials (^DJI 0.26%), of which it is a member.
Where Coca-Cola runs into problems is with its valuation. The company trades at 24 times trailing earnings, and even based on forward 2016 estimates, Coca-Cola stock fetches an earnings multiple of 20. That wouldn't be so bad if the company's earnings were growing, but most investors expect Coca-Cola to have a flat bottom line this year, and long-term growth estimates are in the low- to mid-single digit percentages. Paying such a high multiple for a low-growth company is fraught with peril, eating into the beverage giant's reputation for being a defensively positioned stock. When interest rates start to rise, conservative investors will likely see an exodus away from Coca-Cola stock that could result in substantial capital losses.
Retirees need to be careful in assessing dividend stocks, because an attractive yield can often hide problems that can blossom into full-blown crisis situations that produce substantial losses. By being picky about choosing dividend stocks, you can protect yourself as much as possible from potential future carnage.
