Want proof that we're not out of the woods just yet? Last
Thursday, the Dow fell as much as -9.2% in just minutes before
snapping back nearly as fast. One eight-minute span during the day
wiped out almost $700 billion in equity before the market
rebounded, according to Bloomberg.
Now, normally I'm hunting down the brightest spots for you to lock
in income streams and capital gains. For instance, I predicted
that European stocks being dragged down proved to be a big winner
in light of the EU bailout.
But with the recent happenings, I wanted to do something a little
different this week.
If you've read this newsletter for long, I'm sure you'll remember
my "Safest Dividend in the S&P" article. I published an updated
version a few weeks ago, and it proved to be one of the most
But there's a flipside to that coin. If you now know the safest
dividends in the S&P, shouldn't you also know the least safe...
especially given the clear signals that the economic rough patch
isn't through yet?
With this in mind, I've taken the criteria I used to uncover the
safest stocks, and put it to use to uncover which S&P 500
stocks might be the most in danger of a dividend cut.
Safety Criteria #1: Yield
It only makes sense that our search starts with the most important
factor -- yield. There may be some stocks out there currently
yielding 2-3% and in danger of cutting their dividend, but those
don't really catch my attention.
Instead, I sorted through all of the S&P 500 common stocks to
find those yielding above 6% -- these are the stocks that income
investors are likely to have in their portfolios.
If you remember back in March, 13 stocks in the index yielded above
that mark. Today, that number has risen to 15 (3% of the S&P).
Now that we've found a select few companies to focus on, we can
move to our next factor of dividend safety: earnings power.
Safety Criteria #2: Earnings Power
It's "Dividends 101" that a company's earnings are what fund its
payments. So if we're looking for sick dividends, it only makes
sense to find those companies seeing problems with their earnings.
Now, some people simply use net income for this step, but I prefer
to look at operating income . Operating income is the profit
realized from the company's day-to-day operations, excluding
one-time events or special cases. This metric usually gives a
better sense of a company's growth than earnings per share, which
can be manipulated to show stronger results.
Taking our original 15 candidates, I searched Bloomberg for those
that have seen negative operating income growth over the last year.
Eight members of our original list have seen a drop:
|Frontier Communications (
|Federated Investors (
|Diamond Offshore (
|Reynolds America (
|Pepco Holdings (
|Qwest Communications (
Keep in mind that just because a company shows up on this list,
it doesn't mean their dividend is in danger -- it simply means they
are high yielding and operating income dropped over the last year.
Safety Criteria #3: Dividend Coverage
No measure of dividend safety carries as much weight as the payout
ratio . By comparing the amount of profit earned against how much
is paid in dividends, we can know whether a company can continue
paying its current yield, even if conditions worsen.
Below, I've listed those stocks with payout ratios above 90%.
Remember, anything above 100% means the company is paying out more
than it earns, increasing the likelihood of a future cut.
|Diamond Offstore (
|Pepco Holdings (
|Qwest Communications (
|*Ratio for most recent
Safety Criteria #4: Outlook and Other Factors
Simply because a company is seeing slowing business conditions and
a high payout ratio doesn't automatically mean a cut is coming. In
fact, many companies have a sense of pride in maintaining their
dividend payouts -- even in the face of adversity.
So to pinpoint what could be the shakiest dividend in the S&P
500, I decided to take a look at a few different factors that could
give a hint to a future cut. This includes earnings forecasts, cash
positions, dividend history, and anything else that might tip the
scales one way or another.
paid out slightly more than it earned in the first quarter
(for a payout ratio of 100%), but I think the chances of a cut are
doubtful. The company has more than $2.6 billion in cash it can
use, and also has a proud history of rising payments to investors.
Factor in that depreciation costs (a non-cash charge that impacts
earnings, but not cash available to pay dividends) are substantial,
and I think the chances of a cut are further reduced.
, an energy company, is certainly an interesting situation. The
company paid out $60 million in dividends in the first quarter, but
only earned $36 million. While that raises a red flag, the company
has more than $1.2 billion in retained earnings , which it can dip
into if needed to fund any shortfall. Given that the first quarter
performance appears to be an aberration, that Pepco has plenty of
retained earnings, and a track record of maintaining the dividend,
I think the payment is safe for now.
, which has paid out as much or more in dividends than it has
earned for nearly a year, almost took the crown as the shakiest
dividend. But it does sit on more than $1 billion in cash -- and
recently announced a takeover by
. With the cash hoard and a takeover on the horizon, the chances of
a dividend cut now appear slim.
Which brings us to our final candidate --
Diamond Offshore (
Diamond Offshore, an oil and gas drilling contractor, earned $2.09
per share in the first quarter while paying $2.00 in dividends, for
a payout ratio of 96%. Meanwhile, earnings are estimated to fall
more than -15% this year, according to Yahoo! estimates.
In fact, the company has already beat me to the punch -- cutting
quarterly dividends to $1.50 per share to compensate for the
less-than-rosy outlook. While that certainly helps, I'm not so sure
it's positively the end of dividend cuts.
The biggest drag is the cloudy outlook on offshore drilling given
the recent disaster off the coast of Louisiana. Diamond has heavy
exposure to the region, and there's no telling just yet what (if
any) new regulations will be imposed and how they will impact
business. In fact, the share price has already fallen from about
$90 to $75 on the fears.
Diamond Offshore does carry a large cash balance of nearly $1
billion, which should help secure the dividend for the time being,
but with clouds on the horizon, this is one income stream that I
would pass up for now.
Editor: High-Yield Investing, High-Yield International, Dividend
P.S. There is still plenty of hope for income
investors. Carla has uncovered several picks
with secure dividends that are yielding up to 21.1%. For more
on these picks just follow this link.
Disclosure: Carla Pasternak does not own shares of any security
mentioned in this article.