People love dividends, and they should. But I always warn on my radio show and in my columns to be careful of the dividend payout ratio, and low or no cash flow.
Two examples of this came out last week.
The first, Cliffs Natural Resources (NYSE: CLF), announced it was cutting the dividend to 15 cents from 62.5 cents, which is a large cut. I know this company well; it was almost a year ago it became a major buy in our portfolio.
This was fortunate, because I waited one more quarter to read the quarterly report on cash flow and the cash balance before I invested in the company. All the fundamentals looked pretty good, but I knew the company paid a high dividend and if it were to cut that dividend, the stock would drop dramatically.
After spending days and weeks reading about the company, I noticed a large decrease in the cash balance and its cash flow turned negative. That was it for me, I knew unless there was some major event coming up for the company that dividend would be cut.
That was about six months ago and last Wednesday the stock declined 17 percent on a quarterly loss and a dividend cut of 76 percent.
Another example: A company about which I’m sure I’ve received calls on my radio show is CenturyLink (NYSE: CTL), which was paying a 6.9 percent dividend. On Valentine’s Day it delivered a box of rocks instead of flowers, announcing it was cutting the dividend 26 percent, from 72.5 cents to 54 cents. The stock fell 22.6 percent that day to close at $32.27; the 52-week high on the stock is $43.43, making the pain even higher for some investors who paid top dollar for this dividend-paying company.
One thing I try and warn investors who chase yields is to think about how many years it will take to get back to even after the dividend rate cut.
Since CenturyLink cut its dividend by 26 percent, investors who were getting a 6.9 percent dividend will now only receive a 5.1 percent dividend based on what they paid for the stock. By doing the math, one will find that if the stock lost 22.6 percent, it will take 4.4 years just to break even.
If investors looked at the fundamentals, could they have saved themselves some money? Looks like the answer to that question is yes.
A couple of things I noticed would have scared me away from this stock. Earnings per share, year over year, is down 41 percent. It has a debt to equity of 103 percent, which is above the industry average. And the big killer for me was a dividend payout ratio of 245.4, a good indication that the company is paying out way more than it is bringing in.
So please, if you’re going to chase yield, understand the business and make sure it can continue to pay out that juicy yield so you’re not left with a company with a loss of principal.
Dianne sent in a request on Brunswick Corp. (NYSE: BC). Dianne says she missed the speed round on Saturday's show, and does not hold the stock.
Diane, I always get excited when I see a company that I remember from my childhood days, thinking of the good old days going to the bowling alley with my friends. But don’t get sentimental and invest in a company just because it brings back good memories. Brunswick is just the type of company that fits into to thiscategory.
First, back out all the intangible assets and there is no value to the company. Sales for the company were up only 1 percent when the industry was up 13.3 percent. Why is the company not keeping up with the industry average in sales? The big reason why I would not want to put Brunswick in my portfolio is because its debt to equity is 734, versus the industry average of 24.
I was so shocked by the 734 percent number that I had to look at the balance sheet to verify the number.
Sure enough, total debt is $572 million, yet equity is only $78 million. This company has a long way to go before the debt to equity is at a level that would give me any comfort.
Have a question or a company you'd like me to take a look at? Email me at brent@wilseyassetmanagement.com.
Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.
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