MILLBURN, N.J. (Stockpickr) -- Beware of dividend traps.
Dividend traps are stocks that entice investors to take an investment position based on cheap valuation and above-average dividend payouts. Unfortunately, what the investor learns is that the value received from the dividend is more than offset by the depreciation in value of the stock price. In other words, total returns to investors are negative.
>>5 Hated Stocks Poised to Pop on Bullish Earnings
There are several characteristics that dividend trap companies share. One or more of the following will be evident for dividend trap companies:
• Dividend yields are at least 100 basis points above that of the S&P 500.
• The companies tend to operate in a business or segment that is in secular decline -- that is, these are businesses that find that their products are becoming obsolete or irrelevant in the economy.
• The companies have poor management.
• Second Banana Syndrome: These are just inferior companies within their industry.
• Increasing dividend payouts to help shore up the stock price.
• Their PEG ratios – price to earnings adjusted for growth are negative or extremely large
With that in mind, I scoured the S&P 1500 Composite Index for dividend traps that have hurt investors. I looked for stocks using a three-year period ending on June 1, 2012, which allowed me to compare their returns to that of the S&P 500 over an excellent period for the market. On a total return basis, the S&P returned about 44.3% over that period.
Here, then, are seven dividend trap stocks to avoid.
>>ACTIVE STOCK TRADERS: Check out Stockpickr’s special offer for Real Money, headlined by Jim Cramer, now!
SAIC
SAIC (SAI) is a defense contractor that came to market in an IPO in 2006 at a price of $15. Here we are nearly six years later, and the stock is selling for $11 to $12 per share. The company’s IPO, in the fullness of time, can only be deemed as a failure.
Over the past three years, SAIC has delivered significant negative total returns while larger competitors such as Lockheed Martin (LMT) and General Dynamics (GD) have produced positive returns, thought admittedly have also underperformed the S&P 500. Thus, we have to say that SAIC suffers from a combination of poor execution and a difficult environment for defense contractors.
Still, the 4.1% dividend should not be enough to move capital away from Lockheed Martin or General Dynamics which pays dividend yields of 4.7% and 3.2%, respectively.
>>4 Stocks the Pros Hate -- But You Should Love
Frontier Communications
Frontier Communications (FTR) offers both local and long distance voice services, data services and internet connectivity to residential and business customers across the U.S.
Revenues peaked in 2011 at $5.24 billion and are expected to decline in 2012 and 2013. The company is dwarfed by behemoths such as Verizon (VZ) and AT&T (T) as well as other also-ran competitors such as Sprint (T) and even some of the cable operators that offer tripled telecom services.
Pitney Bowes
I can recall when I was a kid while on my summer job, the boss’s secretary or the bookkeeper would send me to the post office to refill our Pitney Bowes (PBI) postage machine. There would be other kids or adults lined up to do the same. Over time, Pitney Bowes introduced mail sorters, office products and printers to try to offset the loss in business from its postage meter and scale business.
With email, faxes and other technological advances saving businesses money, Pitney Bowes is just fighting a battle against a strong upstream current.
>>7 Dividend Stocks That Want to Pay You More Cash
R.R. Donnelley & Sons
R.R. Donnelley & Sons (RRD) is a for the most part a printing and packaging company. Furthermore, the company offers multi-channel marketing services such as magazines, catalogs and directories.
Much what I described for Pitney Bowes can also be ascribed to R.R. Donnelley's problems. Catalog sales are being replaced by internet direct-to-consumer sites. Magazine circulation is off tremendously. Directories are now published on the internet rather than handed out in hard copy.
The company is trying to morph itself into a more modern firm with purchases such as Edgar Online, but on the other hand, the dividend has not been raised since 2003. Since that time, the stock price has dropped about 57%, making R.R. Donnelley what Jim Cramer would refer to as an “accidental high-yielder.”
Supervalu
Supervalu (SVU) operates in the highly competitive supermarket business under store names such as Acme, Albertsons, Farm Fresh, Hornbachers, Save-A-Lot and Shaw’s. The company has to compete with the likes of Wal-Mart (WMT) and Kroger (KR).
I recently detailed some positive characteristics for Kroger in "5 Cheap, Low-Risk Stocks to Buy. Kroger may be the best house on a decrepit street, returning on a total return basis -2.4% over the period under study, but it would be a stretch to say anything positive about Supervalu. Management has not rewarded shareholders for their loyalty.
>>20 Smaller Stocks With Growing Dividends
RadioShack
RadioShack (RSH) is best-known for selling batteries, electronic equipment, cell phones and wires. The company has a long and wonderful history, with investment historians tracing its roots back to the Tandy Company, which was a very successful stock in the 1960s and '70s.
Unfortunately, in the last decade RadioShack has proven that it could no longer be competitive in the face of the dominance of Wal-Mart (WMT), Target (TGT) and Best Buy (BBY). With these companies selling everything or more than "The Shack," RadioShack becomes a destination of last resort.
Avon Products
Avon Products (AVP) can only be best described as a dysfunctional company. In fact, it is a nominee for my annual list of the worst-run companies.
Recently, the company turned down a very lucrative $10.7 billion takeover offer from privately held Coty. Avon's revenues have flattened out over the past several years, and earnings are in decline. Compare that with Estee Lauder (EL), which has grown both revenues and earnings on a consistent basis, with only a slight pause during the Great Recession.
To see these stocks in action, visit the 7 Dividend Trap Stocks to Avoid portfolio.
-- Written by Scott Rothbort in Millburn, N.J.
RELATED LINKS:
>>5 Bargain Stocks With Tons of Cash
>>4 Stocks Poised to Break Out
>>5 Stocks Immune to Europe's Problems
Follow Stockpickr on Twitter and become a fan on Facebook.
At the time of publication, author had no positions in stocks mentioned.
Scott Rothbort has over 25 years of experience in the financial services industry. He is the founder and president of LakeView Asset Management, a registered investment advisor specializing in customized separate account management for high net worth individuals. In addition, he is the founder of TheFinanceProfessor.com, an educational social networking site, and publisher of The LakeView Restaurant & Food Chain Report. Rothbort is also a professor of finance at Seton Hall University's Stillman School of Business.
