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 returns. But they may come with dividend dangers when those returns are unsustainable. Those are dangerous dividends that investors learn to avoid. And by learning to avoid dangerous dividends, investors can avoid the financial pain and disaster of losing both the dividend and equity. To do that, know the warning signs of dangerous dividends.
Frequently Asked Questions about Dangerous dividend warning signs
What is a good dividend yield?
Investors use two dividend benchmarks when evaluating yields: the average yield of all dividend-paying stocks and the ten-year U.S. Treasury note.
Any yields below that standard are poor; above 2% is fair, but 10% plus is excessive. While 4-6% returns are good, higher yields require caution.
Investors must remember that returns vary as market conditions change.
What are dividend red flags?
Rule of thumb, solid dividend-paying companies retain 50% of their profits for growth and operations and distribute the balance. Those paying more send CAUTION signals that DIVIDEND DANGERS may lurk.
Investors can check for the DIVIDEND Danger Signs, including,
1. Dividends paid from capital or debt when earnings/profits are 0 or low.
2. Any fall in cash flow is a significant sign of dividend and business risk.
3. Bad financials come in groups, so poor numbers signal more trouble.
4. High debt or a falling credit rating signals more financial weakness.
5. An outdated business, product, or service is a dividend risk.
6. Falling stock prices that produce record-high yields are signals to sell!
7. Suspended stock buybacks often signal coming dividend cuts.
What happens when a dividend payout is negative?
A negative dividend payout means the company's dividend is larger than the earnings. That signals severe financial trouble, saying the company can't afford the payment!
That means management has used company capital, operating cash, or borrowed money to pay dividends. All those are poor business choices that increase the company's financial risk.
Alert investors sell fast and run because few managers who get companies into financial trouble can solve the problem. Any shareholder hoping for better days must know there are solutions in hand before deciding to stay. Most fail. So, wise investors sell and move on.
What is better, dividend or growth stocks?
Both dividend and growth stocks have advantages and wealth-building value. Income investors like dividend stocks, while traders seek faster returns with growth stocks.
Learning income investing is an easy, secure way to build long-term wealth in all market conditions and takes minimum time to manage.
Trading grows wealth faster by outperforming in strong bull markets. However, consistently effective trading strategies take more time to learn and manage. Trading profits are more elusive when markets go sideways and all but impossible in down markets.
Between the two approaches, income investing is the consistent long-term wealth-building winner. However, savvy investors get the best results by mixing these strategies in response to market conditions.
How do you know if a dividend is safe?
The dividend payout ratio is the percentage of earnings paid as dividends and a fast dividend check with established companies distributing 30-50% of their profits as dividends and retaining funds for growth.
A company paying more than 50% of its profits needs further scrutiny to help investors avoid unsafe dividends. However, a rapidly growing business uses all its earnings to pay for expansion. While not paying dividends, their growth rewards investors.
On the other hand, those that are unprofitable, obsolete, or underperforming cannot afford to pay dividends. Any such companies paying dividends are high-risk and avoided by prudent investors.
What are dangerous dividend warning signs?
Dangerous dividend warnings are signals that a company can't afford to pay dividends!
Topping the list are companies paying dividends from capital funds or borrowing to pay because they do not have any or enough profit to share.
In other cases, a falling cash flow signals weakening financial fundamentals.
Also, alert investors must check the cause of any substantial share price drop. A suspended share buyback or credit downgrade is a severe yield warning. Share price declines can also warn of a yield cut, which may signal substantial financial danger!
Savvy risk-averse investors stick to the facts and do their homework but sell when the results do not meet the company's promises.
How do investors recognize dividend dangers?
Dividend dangers have many hiding places, including poorly managed companies or those with declining cash flows.
While well-managed firms allocate a percentage of earnings to dividends, any that pay them out of capital or debt are sending warning signals. And any that tap into cash flow instead of paying a portion of profits require closer scrutiny.
Monetary woes like falling cash flow can quickly balloon, worsen credit ratings, and trigger a stock selloff.
So astute investors keep their portfolios free of dividend dangers by selling at the first serious dividend danger sign. That avoids capital losses and portfolio drama.
The Ten-Point Dividend Safety Check
Assessing the safety of a dividend must consider the finances and factors related to the company paying the dividend, including:
1. Dividend Payout Ratio
This important measure of a company's earnings paid to shareholders is critical. Companies paying lower portions retain more earnings for reinvestment, unexpected expenses, which makes dividends safer.
2. Earnings Stability
Look for a consistent, stable, or increasing earnings history that indicates the company can sustain dividend payments over time.
3. Cash Flow
Check that the company generates sufficient operating cash flow to cover dividend payments.
4. Debt Levels
Check the debt-to-equity and interest coverage ratios to ensure that no short-term debt burden affects the company's ability to pay dividends.
5. Industry and Economic Conditions
Check the company's industry and economic environment for business or economic cycles that may impact its ability to pay or sustain dividends.
6. Dividend History
Check for a long track record of consistent dividend payments and growth, although past performance does not guarantee future results.
7. Dividend Policy
Check for a formal dividend policy commitment to maintain dividends to gain insight into management's intentions regarding dividend safety.
8. Competitive Position
Check the company's competitive position, market strength, advantages, and barriers to entry that support sustainable dividend payments.
9. Management's Guidance and Communication
Check management's guidance on dividend sustainability and updates on financial performance, capital allocation plans, and prospects.
10. External Factors
Check external factors such as regulatory changes, geopolitical events, and shifts in consumer behavior that could affect the company's future.
Analyzing these factors helps investors evaluate dividend safety and make informed investment decisions.
Warning Dividend Disaster!
By way of an example, we use an old dividend disaster story, the case of Renegade Petroleum which was a high dividend paying Venture Exchange darling that traded in the $4 range. Then warning signs of dividend trouble began to appear. As most often happens, over time, multiple operating and business issues signaled this dividend paying darling stock was turning into a money loser.
In time, the inevitable announcement came; company operations were in serious trouble and the dividend was drastically cut from $0.23 to $0.10. But the sharp investors were already long gone. They were able to anticipate the serious trouble by knowing and paying attention to the dividend danger warning signs. Those informed investors had already sold the stock before it had taken a fall to trade in the $1 range. In most cases that sharp cut in equity value will never be recovered. So well before the announcement of a dividend cut, wise investors carefully watch for the dividend warning signs and sell to avoid seeing their shareholder’s equity evaporate in an inevitable stock price decline!
In the case of our example, on the day of the announcement, the stock fell less than 1%! That was because wise investors, expecting the cut were long gone and avoided that severe loss of equity. From the market point of view, the stock had already “priced in” that drastic dividend reduction. But the long gone smart money and alert investors avoided the pain.
Our Renegade example can teach us a good lesson on doing basic homework and taking care to do due diligence. By doing that, RPL shareholders could get alerted to the pending dividend cut announcement that acknowledged that there was good reason shareholder equity dollars were turned into quarters. It helps us to learn how did the smart money and alert investors know there was trouble coming!
Dangerous Dividends!
Warning Signs Flash!
The Renegade warning signs that wise investors notice include,
1. Excessive dividend
- Interim Chief Financial Officer
- Management change
What were the clues of a dividend danger? 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!
Avoid dangerous dividends by avoiding stocks that can not afford to pay you dividends.
When dividend payments are larger than company earnings there is no way a company can afford to keep up such a high level of payment. When dividends are unaffordable and unsustainable, investors are getting a huge warning sign! In fact, that is the single biggest warning sign of a coming dividend cut. It is important for an investor to know the company paying them a dividend can afford to keep paying. If they can't, it is time to sell! Wise investors 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. No investor can afford to be the shareholder of such a company. Sell!
And the dividend problem is not hidden. Anyone checking the RPL financial statements would see the problems began a very long time ago, well before the dividend cut came or the stock price dropped so drastically. Wise investors always check, and keep checking, that the company makes more money than it pays out as dividends. If it does not, it can not afford to pay the dividend. Sell!
Other significant dividend danger red flags included,
In each case, the change is not a screaming warning or necessarily bad news by itself. However, each is a signal to look more closely and ask why. Each is a reason for extra care when you check out the company. That include being especially careful when multiple possible negative signs appear together. When multiple signs of possible trouble happen, most often they are over many months. In the case of RPL, the warning did happen over many months.
Analysts Can Be Dangerous To Your Wealth
Investors need to be aware of another cautionary note when is comes to analysts and their reports. Analysts can indeed be a danger to your wealth. Just as all investments need care, caution and homework, investors do need to be careful about accepting any recommendation by an analyst. In particular, analyst’s reports are not substitutes for basic fact checking. As investors, 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 beat the market
Hold Recommendations
– 5 analysts recommended staying in this black hole
Under-perform Recommendations
– 0 analysts saw any evidence of a coming train wreck
Sell Recommendations
– 0 analysts warned of this visible financial danger
No Opinion
– 0 analysts opted out of sending 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 completely ignored. Rather, read the reports as a very good source of information. However, check the basic facts about the company yourself. And form your own opinion. Analysts are work in the financial industry and are use as parts of the sales and promotion process. They are not working for you or any other investor.
As well, analysts do regularly 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.
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. But it is not an investment for income seekers or for conservative investors.
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Managing Investment Market Risks, lesson links:
Introduction to Managing Investing Market Risks Lesson 1
Dangerous dividend warning signs Lesson 2
Investor retirement saving dangers Lesson 3
Exotic ETFs blow-up portfolios Lesson 4
Stock scam awareness defense Lesson 5
Best stock scam tips Lesson 6
Bitcoin fraud trust and psychology Lesson 7
Investors hold patient cash Lesson 8
3 Risk or opportunity signals Lesson 9
Option risks, dangers and opportunities Lesson 10
Cautious look at options Lesson 11
Selling low destroys wealth Lesson 12
FAQ about investment market risks Lesson 13
Next lesson 3:
Investor retirement saving dangers
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Bryan
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