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Investing in dividend stocks has traditionally been an investment strategy for those with a lower tolerance for risk. Not only do dividend stocks provide the safety of a cash return that is separate from stock price appreciation, but dividend payers are typically companies on much more stable financial footing than its non-dividend-paying peers. That doesn't mean that every dividend-paying stock is a sure thing, though. Some have payouts that are subject to the whims of the market, while others may be compromised because of management decisions.
With this in mind, two stocks you should probably avoid if you are a dividend investor are Barrick Gold (NYSE: ABX) and Energy Transfer Equity (NYSE: ETE). Just so you aren't left with all bad news, one stock that you should consider is W.W. Grainger (NYSE: GWW). Here's why Barrick and Energy Transfer aren't worth your time but Grainger is.
Too cyclical to be a solid dividend investment
There are ways to invest in commodities that can provide consistent dividend payment over time, but that isn't the case with gold. That's why if you are looking for a regular, growing dividend check, you shouldn't be looking at Barrick Gold.
To be clear, for those interested in buying gold-related stocks as a hedge against market declines or a weakening dollar, Barrick Gold is probably one of the better investments. The company has some of the lowest-cost operations among its peers with an all-in sustaining cost -- a common metric in the gold mining industry similar to operational profits that also includes lifecycle costs such as mine closure and remediation -- of $831 per ounce in 2015. So, when the price of gold increases, Barrick is likely to generate windfall profits that may even lead to dividend hikes.
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The problem, though, is that the company and the gold mining sector in general have struggled to maintain a certain level of profitability and dividend payments through the ups and downs of the commodity cycle. Since 2000, it's raised its dividend only four times, and today that payout is less than one-fifth of what it was at the turn of the century.
Investing in Barrick Gold is, by and large, a pure commodity play that struggles to generate enough cash to pay investors when gold prices are weak. That makes Barrick a bad income investment.
Payout on shaky ground
If you were to look at Energy Transfer Equity'spayout today, you might think that you were in pretty safe hands. The company's distribution coverage ratio -- a common metric to evaluate the security of a master limited partnership's payout -- was a healthy 1.15 times. That is a level at which most investors in this industry will sleep well at night. Here's the problem, though. Energy Transfer Equity's payout security is coming at the expense of its subsidiary partnerships.All of Energy Transfer Equity's revenue comes from the distributions it receives from ownership stakes in its subsidiaries, and the payouts for those subsidiaries are looking very suspect as of late.
|Company||Distribution Coverage Ratio*|
|Energy Transfer Equity||1.15x|
|Energy Transfer Partners (NYSE: ETP)||0.91x|
|Sunoco Logistics Partners||0.8x|
|Sunoco LP (NYSE: SUN)||0.93x|
Data source: Company earnings releases.*Most recent quarter.
Both Energy Transfer Partners and Sunoco carry dividend yields greater than 10%, which suggests that Wall Street is pricing in a payout cut. Since Energy Transfer Equity's payout is inextricably tied to the payout of its subsidiaries, though, any cut from one part of the business would mean a subsequent cut from Energy Transfer Equity. At a yield of 6.3%, Energy Transfer Equity's yield looks to be in the range of its peers that are in a better financial position, but the financial health of the pillars under that payout look much less stable than its yield suggests.
A solid base with a big growth lever to pull
Buying dividend stocks doesn't always mean buying high-yield stocks, sometimes it's about buying companies with a decent yield with lots of room to grow that payout. One that stands out as a company with a solid payout today and room to grow is industrial supplier W.W. Grainger (NYSE: GWW).
For more than 40 years, the company's bread and butter has been supplying medium and large businesses with equipment ranging from laboratory, testing, and safety supplies to motors and transmissions. Much of the success under this model has been through established customer relations and recurring revenue. Today, though, the company is now tapping a new market with online sales to smaller businesses through its online platforms. Over the past three years, it has generated fantastic rates of growth and returns.
Image source: W.W. Grainger investor presentation.
These high rates of return on online sales have helped to boost Grainger's already high returns on equity in recent years that has also led to a 85% increase in its dividend over the past five years.
Grainger's current dividend yield of 2.1% isn't much to write home about, but the company's high rates of return and fast-growing online sales suggest the company has lots of room to grow that payout over the coming years that should tempt every dividend investor.
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