5 Signs Your Dividend Stocks Might Be In Trouble

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Matt Frankel, Investment Planning 5 Signs Your Dividend Stocks Might Be In Trouble 1

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Many investors look at dividend stocks as a safe way to invest While this may be true for many stocks, there are many red flags to be aware of 2

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1. High payout ratio A stock’s payout ratio is the percentage of its earnings it pays out as dividends ???????????? ??????????= ?????????????????? ???????? ?????????????? For example, if a certain company earns $1.00 per share and pays dividends of $0.40 annually, its payout ratio would be 40% 3 August 14, 2015

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The lower the payout ratio, the easier it is for a company to sustain its dividend. In general, I like to invest in companies with payout ratios below 50% Be particularly wary of companies whose payout ratios are close to or more than 100% (Note: certain stocks, like REITs, are required to pay out the majority of their earnings, so a high payout ratio isn’t necessarily bad for these companies.) August 14, 2015 4

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As a point of reference, here are the payout ratios of some popular, healthy dividend stocks (2014 – full year) 5 August 14, 2015

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GlaxoSmithKline (NYSE: GSK) has a payout ratio that should be a red flag The company earned $3.02 per share in 2014, and paid out $2.65 per share (88% payout ratio) Earnings are expected to drop to $2.31 in 2015 and $2.57 in 2016, which means that the company will either have to cut its dividend or pay out more than 100% of its earnings August 14, 2015 6 A dangerous payout ratio…

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2. Increasing debt / High leverage If a company’s debt starts to increase dramatically, it should be a red flag for dividend investors High debt payments can eat into a company’s ability to pay dividends and force cuts Also, companies whose business models involve high uses of debt (leverage) to achieve profitability tend to be volatile dividend stocks Mortgage REITs are a good example 7 August 14, 2015

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A good way to monitor a company’s debt is its debt-to-capital ratio Many analysts consider a ratio of 0.3 or lower to be extremely healthy However, it’s important to compare the debt-to-capital levels of companies in the same industry, as well as to monitor your stocks’ ratios over time August 14, 2015 8

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Consider the debt-to-capital ratio of these large tech companies While none of these companies have “unhealthy” debt levels, this information lets us know that IBM relies more on debt to finance its operations than other tech companies 9 August 14, 2015 Much of IBM’s debt is “global financing debt”, which is actually backed by receivables Corporate (non-financing) debt actually declined 26% over the past year While this is just one case, it’s important to look for extenuating circumstances when it comes to high debt levels

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On the other hand, these companies’ debt-to-capital ratios should be red flags for new investors 10 August 14, 2015

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3. An “unhealthy” industry Trouble within an industry can be a good signal that dividend cuts are on the way For example, the energy and commodities industries are weak right now The companies that have already chopped their dividends include: Freeport McMoRan Chesapeake Energy LINN Energy Transocean 11 August 14, 2015

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4. Recent dividend cuts If a company is forced to make a dividend cut, it is usually a strong indicator of something fundamentally wrong with the company Or, if the company has historically increased its payout every year, not doing so all of a sudden can be a sign of trouble Companies cut dividends for a variety of reasons including Falling revenue Increasing expenses Decision to reinvest more capital in the business 12 August 14, 2015

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While a dividend cut isn’t necessarily the wrong move in 100% of cases, it is certainly cause for further investigation For example, many energy companies have slashed dividends in the wake of plunging oil prices (bad news) August 14, 2015 13

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On the other hand, some companies experience temporary cash flow issues and choose to reduce the dividend rather than take on more debt Wynn Resorts (WYNN) is a good example of this, in my opinion In April, Wynn cut its quarterly dividend from $1.50 to $0.50 per share, on the heels of declining revenue in Macau and slow growth in Las Vegas. The company is investing $5 billion in new resorts over the next few years, and Steve Wynn refuses to use debt financing to pay a dividend. Instead, the company will focus its cash on creating long-term value for its shareholders. August 14, 2015 14

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5. Slowing growth and decining profits If a company’s revenue stops growing, it may have trouble increasing its dividend in the future, without making its payout ratio too high Great dividend stocks grow their revenue year after year no matter what the economy is doing -- like Wal-Mart during the recession and after 15 August 14, 2015

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Declining profitability Declining profits (earnings per share) can be a red flag that something is wrong Profits can fall, even if revenue continues to rise Potential reasons for lower profitability include Litigation expenses (like most of the banking industry over the past several years) Increased regulatory costs Poor management of operating expenses 16 August 14, 2015

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