2 Dividend Stocks to Avoid (and 1 to Buy)

By Markets Fool.com

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These days, it's tough to be a senior citizen approaching retirement. In the past, you could count on safe government bonds to help maintain your nest egg by yielding at least a few percentage points. Not so anymore: Yields have now gone negative on 10-year U.S. Treasuries.

As an alternative to bonds, many have turned to dividend-paying stocks, which tend to offer higher yields and the potential for capital appreciation -- though they also carry the risk of capital losses. Below, I'll discuss two such stocks that lookappealing but, upon closer inspection, seem fundamentally broken. Then I'll finish by offering up a low-yielding yet promising dividend stock that deserves consideration for your portfolio.

Cigarettes usually make a good investment, but not this time

Over the past 30 years, no industry has been better to investors than big tobacco. Altria, for example, has returned a whopping 330,000% in the last three decades, including dividend payouts.

But the sun seems to be setting on Vector Group (NYSE: VGR), parent company of discount cigarette brands Pyramid and Grand Prix. While the company's current dividend yield of 7.1% might seem enticing, given the addictive nature of its product, you should steer clear of Vector.

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Between 2011 and 2015, revenue from tobacco sales dropped 10%. That trend seems to be continuing, as tobacco sales fell 3% during the company's first fiscal quarter of 2016.

Over the past three years, the company has paid out more in dividends than it has brought in as free cash flow.


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Vector has taken this approach for quite a while. Back in 2010, for instance, the company brought in $44 million in free cash flow and paid out $117 million in dividends. The practice has only been sustainable because management has issued enough debt every year to more than cover the difference. That's simply not a healthy, sustainable practice.

Sensing that the company was struggling as a cigarette maker, management branched out into New York City real estate years ago. While management claims that the move should improve cash flow -- which it seems to have done -- this seems well outside the company's circle of competence, and it hasn't resolved the dividend's unsustainability.

Telecoms are supposed to be safe, right?

Like tobacco companies, telecoms are often seen as ultra-safe dividend payers. But the world is changing quickly, and so is the way we communicate. That's why I think investors should stay away from Windstream Holdings (NASDAQ: WIN), a company whose primary business is providing rural telephony, video, and broadband.

Recently, Windstream spun off its networking assets into a new company, Communication Sales & Leasing. Management promised the move would help make the company's 6.5% dividend yield more sustainable, but history would suggest otherwise.


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The company's spinoff helps explain why the dividend payment itself went down, but even before that mid-2015 event, the company was in the danger zone. In 2013 and 2014, the company used 87% and 89% of its free cash flow, respectively, to pay the dividend. When a business is growing, such a high payout ratio might be sustainable. But that's not the case with Windstream, as both revenue and earnings have been falling for years.

Unless you think there will be a huge boom in the rural U.S. population, I think you're better off avoiding Windstream and its enticing dividend.

A strong company with lots of room to grow

On the other end of the spectrum is Lowe's (NYSE: LOW), the well-known home improvement store. Although the company's stock only yields a paltry 1.7% dividend, there's more to the story. Unlike our two previous stocks, Lowe's has seen robust growth in both revenue and earnings coming out of the Great Recession.

Furthermore, the company's payout is very safe and has tons of room for growth.


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What's more is that the company has been continually raising its dividend for 54 consecutive years and counting.In 2006, a share of the company's stock offered up a $0.20 dividend. In 10 years, that payout has jumped to $1.40. To put that in perspective, that's an average annual dividend raise of 21% per year.

Shareholders who bought back in 2006 at $30 per share were only getting a 0.7% dividend yield. If they have held those shares, however, then they're getting a 4.7% dividend yield this year. That's a big deal, and there's no reason to doubt that the company can't continue upping its dividend.

The most important thing for investors to remember is that the benefits of dividend stocks don't usually show up overnight. It takes time for your reinvested dividends to accelerate your compound interest -- but the more time goes by, the faster your gains will grow. Making sure you have healthy dividends is the best way to ensure that you willnotice a difference in your retirement savings.

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Brian Stoffel 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.