I saw an article on Yahoo Finance that I thought had some good advice, and some really bad advice.
The title of the article is “Top 3 Dividend Stocks Offering Stability to your Portfolio in 2016”.
The things the article said that I agree with are:
- to look at dividend stocks,
- a reminder that the advantage of dividends is that you can get income even while the price is flat (or even declining),
- a reminder that dividends are not guaranteed,
- and to do some research on a stock before buying.
The bad advice is to buy Frontier Communications Corporation (FTR) because its yield is 9.6%. A yield that high is usually a red flag, and in this case I think it is. The author looked at price-to-book and price-to-sales. But the PE ratio and payout ratio are basically 0, because they have been losing money for about a year. FTR’s long-term debt and interest expenses went up a lot in 2015. The long-term debt seemed to double, and their interest expenses went up by about a third.
As far as FTR’s dividend, they started paying a dividend in 2004, and kept it constant 25 cents a share until 2010. Then they cut it to 18.8 cents a share. Then in 2010 they cut it again to 10 cents a share. Then in 2015 they raised it to 10.5 cents a share. So they are raising their dividend while they are losing money. How sustainable is that?
At some point, I will write a post on my dividend investment criteria. I admit, I think I am still working it out. But I think my criteria are similar to a lot of dividend growth investors (or DGI). Under these criteria, FTR would not be looked at by many DGIs.
The details are different for different investors, but the basic pattern is as follows:
- A history of dividend increases. Some people want at least 5 years of increases. Other people want at least 10, 15, or more. The longer your time horizon, the stronger the company, but then you have fewer companies to invest in.
- P/E Ratio (or just “P/E”). The historical P/E ratio of the US market is about 16.5. From what I have read, periods of low interest rates have higher P/E ratios, so I am willing to buy a stock with a P/E under 20. It seems like some stocks with lower P/E ratios (like Deere, Caterpillar, the big oil companies) are not looking too good these days. If a company is losing money, Yahoo Finance will list its P/E as “N/A.”
- Dividend yield. Many investors want a company to have a yield of at least 2%. Some want at least 3%. The upper limit depends on the industry. Financial firms, utilities and telecoms have higher yields than other industries, but anything above 6% is a red flag. 9.6% is a blinking red flag that just caught fire.
- Payout ratio. The payout ratio is the percentage of their post-expense cash a company is paying out as dividends. This threshold is also different for different people. I am willing to go as high as 75%, others want it to be under 50%. If a company is losing money, Yahoo Finance will list its payout ratio as “N/A.”
The only criteria for selling that the DGI community agrees on is to sell if a company cuts or eliminates its dividend. Dividend freezes is a point of disagreement. Also, some DGIs sell if a stock’s P/E gets too high.
So maybe FTR has a high dividend. But how long can it last if the company is losing money and is taking on debt? I plan on holding my stocks for the rest of my life and eventually living off the dividends and not selling any shares. That will probably not happen with all of the stocks I own, but there is no way I see it happening with FTR any time in the near future.
The author does recommend Bank of Montreal, which looks a lot more solid. He used a proprietary screening tool to pick these stocks. FTR is such a bad pick I did not bother to look at the third.
Not to brag, but when I started, all I did was spend a little time looking at the financial stocks for all of the then-Dividend Arisocrats on Yahoo Finance. I passed on a couple of stocks that wound up cutting their dividends (Diebold, and Integrys, which is now being bought by Wisconsin Energy).
I think people would be better off learning how to value companies themselves and sticking to dividend growth stocks.
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