Big dividend-paying stocks can be great investments. Well-established companies with strong cash flow that distribute their income to shareholders tend to outperform other stocks and provide a less bumpy ride over time. However, some of those dividend payers aren't what they seem.
As fellow Motley Fool contributor Matthew Frankel points out, warning signs include lots of debt, a dividend payment that exceeds profit, and declining cash flow. Three stocks that could be yield traps are Gannett (NYSE: GCI), IDT Corporation (NYSE: IDT), and Tupperware Brands (NYSE: TUP).
Continue Reading Below
Good news, bad news
USA Today parent company Gannett sports a 6.3% dividend yield. A seemingly stable media and marketing business paired with that kind of payout may look like a great income generator. But investors, beware. This business isn't as stable as it may seem.
Gannett's 2017 revenue increased 3% over 2016, and its digital news and advertising transformation continues, with sales from that segment rising to 32% of the total in 2017 and 35% in the first quarter of 2018. However, playing catch-up in a world that increasingly relies on electronic devices to consume information may not be good enough. Operating revenue fell 6.5% year over year in the first quarter, led by a double-digit decline in print advertising. These declines show no signs of letting up. Add to that rising interest expense from debt, and the overall picture doesn't look great.
Management's own guidance says as much; revenue is expected to decline as much as 7% this year. A challenged print media industry is declining faster than Gannett can replace it with new digital outlets. The good news is that for now, Gannett generates more than enough free cash flow to cover its dividend. However, a declining business doesn't bode well for the dividend or share price in the long run.
A telecom treading water
IDT Corporation operates the Boss Revolution and net2phone services, enabling internet-based communications and money transfers around the globe. The small company has been under pressure from larger telecom and technology offerings for years. In spite of IDT's investments to improve its flagship businesses, revenue and cash flow continue to decline.
This has taken a toll on the stock over the years, which in turn has pushed the current dividend yield to an attractive-looking 6.2%. That's even after the company reduced its quarterly per-share payout from $0.19 to $0.09 at the end of last year. Investors face a risk of further cuts to the dividend, though, considering that free cash flow is currently negative.
As a result, IDT changed its payout classification to "return of capital" at the beginning of 2017. A return of capital isn't taxable like a dividend because it's considered a return of a shareholder's initial investment into the company. Because business operations aren't generating adequate cash flow to pay the dividend, retained earnings are used instead. That reduces cash on a company's balance sheet and can restrict its ability to invest for growth in the future. Such is the case at IDT right now, making this "dividend" payer a high-risk proposition for investors.
Is kitchen storage in trouble?
Tupperware Brands has been in free fall for years. The global manufacturer and social seller of kitchen storage has had declining revenue and free cash flow in what has been a challenging environment for many retailers. And 2018 got off to a rough start when management called for another 2% year-over-year decline in sales for the quarter ended June 30.
Though business has been in a slide, Tupperware has maintained its dividend payment, which now yields a cool 6.5%. That may look too good to resist, but it's not a reason for potential investors to jump aboard. Dividends paid are exceeding free cash flow, and with sales expected to be flat at best in 2018, the current payment may be unsustainable.
Tupperware has embarked on a revitalization plan that includes asset sales and a revamp of its product lineup. But to date, that hasn't helped reverse its negative trends. Management has said that it will maintain the dividend anyway, plus spend $200 million repurchasing shares. Unless the company can turn the tide and rekindle overall top-line growth, these moves probably won't pay off for shareholders.
While high-yielding stocks can be a great source of income and provide steady growth in investors' portfolios, not all of them are good deals. Some carry high risk and are more a bet on a rebound than on stability. Thus, income investors should exercise caution and make sure a company can adequately support its payout before buying shares.
10 stocks we like better than GannettWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Gannett wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of June 4, 2018