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Dangerous Dividends Flash Warning Signs

Dangerous Dividends Flash Red Lights

Alert investors avoid crashing dividend stocks by watching for warning signs that flash before a dividend cut happens.

Be Alert For Dividend Dangers

Investors must notice when dangerous dividends flash their warning signs! Dangerous dividends are ones that attract income seeking investors with high but unsustainable returns. Investors can avoid the disaster of losing both the dividend and equity by knowing the warning signs of dangerous dividends.

Consider the case of Renegade Petroleum (RPL-V). This high dividend paying Venture Exchange darling traded in the $4 range. Then warning signs of trouble began to appear. Over time, multiple operating and business issues turned a growing dividend payer into a money loser.

In time, the inevitable announcement came; operations were in serious trouble and the dividend was drastically cut from $0.23 to $0.10. Anticipating serious trouble, investors had already sold the stock down to trade in the $1 range. Well before the announcement, most of the shareholder’s equity had evaporated in that stock price decline!

On the day of the announcement, the stock fell less than 1%! Wise investors expected the cut and therefore already “priced in” that drastic dividend reduction. The smart money and alert investors were long gone.

Renegade can teach us a good lesson on doing basic homework and taking care to do due diligence. The RPL dividend cut announcement was acknowledgement that there was good reason equity dollars turned into quarters. How did the smart money and alert investors know there was trouble coming?

Dangerous Dividends Flash Warning SignsStop Dangerous Dividends

  1. Excessive dividend
  2. Interim Chief Financial Officer
  3. Management change

What were the clues? The biggest red light was the huge 19.66% dividend itself! That juicy return came with extraordinary risk. It was unsustainable. RPL did not make money, it lost money! There was real danger that the company could not sustain itself let alone pay a big dividend!

Dividend payments larger than company earnings are unaffordable and unsustainable. That is the single biggest warning sign of a coming dividend cut. Always make sure the company can afford to pay the dividend from earnings.

Don’t be tempted into collecting a big dividend at the risk of losing both it and much of your capital.

Anyone checking the RPL financial statements would see the problems began a very long time ago. Always check that the company makes more money than it pays out as dividends. If it does not, it can not afford to pay the dividend.

Other red flags included, an interim Chief Financial Officer, financial advisors appointed, a change in business plan, a special committee of the Board and finally a management change. Each, not necessarily bad by itself, but reason for extra care when you check out the company. Be especially careful when multiple possible negative signs appear together. The multiple signs of trouble at RPL were clear for many months.

Analysts Can Be Dangerous To Your Wealth

Another cautionary note. All investments need care, caution and homework including any recommended by an analyst. Analyst’s reports are not substitutes for basic fact checking. We must check the financial basics even when considering investing in a dividend paying stock recommended by several analysts.

At the time of the RPL dividend cut, all 10 analysts that tracked the company had it wrong:

  • Buy Recommendations – 2 analysts recommended buying this disaster

  • Outperform Recommendations – 3 analysts expected this loser to do better than the market

  • Hold Recommendations – 5 analysts recommended staying with this financial black hole 

  • Underperform Recommendations – 0 analysts picked up any evidence of this coming train wreck

  • Sell Recommendations – 0 analysts warned of the clearly visible financial danger

  • No Opinion – 0 analysts issued such a signal

Never base an investment decision only on an analyst report. Doing so risks capital. Always do your own investigation of the basic numbers. And very importantly, do your own thinking.

That is not suggesting reports from analysts be ignored. Rather, read the reports as a very good source of information. However, check the basic facts about the company yourself. Analysts are workers in the financial industry. They are not working for you.

Analysts do get it wrong and at times multiple analysts come to bizarre conclusions. Analysts are slow to react to negative news. I have never known an  analyst to give warning of trouble in stocks they track. All the information needed to check the basic facts is public and readily available.

Where Are They Now

Capitalism recycles assets by favoring strong hands over weak ones. Moving assets from the weak RPL hands began with a merger. Dissident shareholders seeking to take over Renegade Petroleum lost the battle. The victors merged with Alexander Energy (ALX-V) at a valuation at $1.55 or a 65% premium but still well below the $4 range. Alexander Energy Ltd. then became Spartan Energy Corp. (SPE-V) which continues to trade on the TSX Venture Exchange.

Spartan management acquired other new assets, raised substantial financing and issued revised positive guidance. The latest evolution is a very different venture than the old Renegade. It is also a long way from a proven, stable dividend payer that a conservative investor would consider. Spartan is a positive junior energy play and can now be considered a good speculation. It is not an investment for income seekers or for conservative investors.

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2 Responses to Dangerous Dividends Flash Warning Signs

  1. Dave June 10, 2014 at 7:17 pm #

    We always want to believe the best about the companies we have invested in.
    Far too often we do not see the facts in front of us and ride the price down in the
    hope of a return to former stock prices. You have given us good advice.

    • Bryan Kelly June 10, 2014 at 7:30 pm #

      Thanks Dave, so easy to get it right in hindsight!

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