At the end of 2012, I identified three companies with outsize dividends that I thought were dangerous for investors to be approaching. As you can see, these companies offer up eye-popping yields that would tempt any dividend investor.
| Company | Industry | Dividend Yield |
|---|---|---|
| Windstream Corporation (NASDAQ:WIN) | Telecommunications | 11.2% |
| Vector Group (NYSE:VGR) | Cigarettes | 10.2% |
| United Online (NASDAQ:UNTD) | Mini-conglomerate of businesses | 6.3% |
Source: Yahoo! Finance.
All three companies have released information about how they performed at the end of 2012, and after reviewing the information, I believe that two of them are still dangerous, while one is entering interesting territory.
Windstream Corporation (NASDAQ:WIN)
This is the company that I think may be transforming into a viable dividend option. Windstream has been undergoing a change in business plans over the past several years. Whereas business clients made up about 40% of the company’s revenue in 2010, that same segment now brings in the lion’s share of cash — at just short of 60%.
The strategy to focus on business clients for voice and high-speed Internet needs is crucial. As rural landline customers — who once provided much of the cash for the company’s dividend — slowly disappear, Windstream has been investing heavily to meet the Internet demands of small businesses. These investments explain why, even though revenue has grown by 66% over the past two years, net income has actually declined.
I’m a big fan, though, of investing in smart ways in the present, in order to have a steady and growing stream of income in the future. From where I sit, there’s a chance Windstream is on the right path.
Of greatest importance for dividend investors, the company used 97% of its free cash flow to pay out dividends last year. That was cutting it way too close to the 100% mark — which signifies that a company is giving more away to shareholders than it is taking in.
With the recent earnings release, however, that number has come down significantly, to 87%. If this trend continues, the dividend could end up being a great catch right now.
Vector Group Ltd (NYSE:VGR)
This lesser-known cigarette company, on the other hand, is still in my doghouse. In late January, Vector came out with preliminary results for 2012. In the report, Vector announced it would be taking on debt, and that its annual revenue was expected to shrink by 4.2%.
At the same time, adjusted EBITDA was actually expected to increase, thanks to higher margins on the company’s Pyramid brand cigarettes. While that’s certainly not bad news, shrinking revenue is never a good sign, and I wonder how long those higher margins can sustain themselves.
Vector has yet to announce when full-year results will be given, but based on the information available, it has paid out more in dividends in 2012 than it has taken in in the form of free cash flow. That’s simply a recipe for disaster.
