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Seeing dividend payments rolling into your account each and every quarter is a great feeling, but investors can get into trouble by chasing high-yield stocks. All dividends aren't created equal, and for every stock with a decades-long record of consistent dividend increases, there are many more that, for one reason or another, are forced to slash or eliminate their dividends.
Here are three dividend stocks identified by some of our Foolish contributors that are just too risky to consider.
Matt DiLallo: Any time a company's yield is over 10%, it's a warning sign to investors that the payout might not have staying power. One company currently in that category is Plains All American Pipeline , which is yielding 11.6%. While the company has gone on record to say its payout is safe, investors aren't buying it.
This past January, Plains All American Pipeline issued $1.6 billion of convertible preferred units in order to raise the capital it needed to fund its capex plans for this year and well into 2017. It was a transaction the company believed would enable it to maintain its investment grade credit rating, address concerns about its ability to maintain its current distribution rate, and insulate it from having to access the capital markets for the foreseeable future.
That said, the company's underlying operations are clearly feeling the sting of the oil market downturn. Last quarter, Plains reported a 5% decline in adjusted EBITDA due to weaker-then-expected volumes, pushing earnings below the low end of the company's guidance range. Those earnings aren't expected to get much better in 2016, which has the company forecasting to only cover 87% of its distribution this year, meaning it's paying out much more than it currently earns. It's a shortfall the company can't maintain forever, especially as it bets on growth projects and an improvement in market conditions to improve its distribution coverage in the future.
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Because of that, investors are taking a big gamble that Plains All American Pipeline can maintain its distribution if industry conditions don't improve. It's a risk that's better avoided for now, because there are much safer high-yield stocks out there.
Todd Campbell: One big risk that's unavoidable in biopharma is patent expiration, and unfortunately, patent expiration is a very big reason investors should take a pass on GlaxoSmithKline and its 6.6% dividend yield.
GlaxoSmithKline already lost patent protection on its top-selling asthma drug Advair years ago, but generic competition has been kept at bay by patents covering the Diskus inhaler that's used to dispense the drug. Those Diskus patents, however, expire this year, and that's got generic drugmakers licking their chops at the potential to win away billions of dollars in Advair revenue every year.
The impact of Advair on GlaxoSmithKline's financials can't be overstated. Last year, Advair generated $5.2 billion in sales for the company at current exchange rates, and accounted for about a quarter of GlaxoSmithKline's pharmaceutical sales and 15% of its total revenue.
GlaxoSmithKline has a lot of R&D activity going on that could eventually help replace any Advair sales that get lost to generics, and it's unclear when a generic Advair Diskus will win FDA approval, but even if it means passing up on its otherwise compelling yield, a potential drag of this size is just too big of a risk for me to want to own its shares.
Tim Green: Seagate Technology , one of the largest hard disk drive manufacturers, pays an impressive 7.6% dividend. There are only three major hard drive manufactures left standing after years of consolidation, and over the past four years, Seagate has enjoyed lush margins. The stock looks extremely cheap based on 2015 numbers, trading at less than 7 times earnings. But I think Seagate is a lot riskier than it appears.
Global shipments of hard drives declined in 2015, driven by both a weak market for PCs and the rapidly falling prices of solid-state drives. During Seagate's fiscal second quarter, revenue tumbled 19.2% year over year, while operating income dropped by nearly 80%. Analysts expect Seagate to earn just $2.76 per-share on a non-GAAP basis in fiscal 2016, barely enough to cover the $2.52 per share in dividends expected to be paid out over the course of a year.
Predicting how hard drive volumes will evolve going forward is difficult, but it's not difficult to imagine Seagate's earnings falling far more than analysts are expecting. If Seagate's earnings don't bottom out soon, a dividend cut may be necessary. That makes the stock risky, despite the seemingly cheap valuation.
The article 3 High-Risk Dividend Stocks to Avoid originally appeared on Fool.com.
Matt DiLallo has no position in any stocks mentioned. Timothy Green has no position in any stocks mentioned. Todd Campbell has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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