With interest rates at historic lows, retirees and other income investors are more likely than ever to fall into a dangerous trap -- chasing higher-risk dividend stocks to earn more income. This doesn't only occur among do-it-yourself investors. I've seen professionals succumb to this temptation, too.
Sure, this strategy could get you more income. But what good does it do if you end up taking a massive hit to your principal? It's just the sort of thing that can muck up your retirement plans badly.
A prime example is oil and gas exploration and production (E&P) firm Enerplus Corp. (NYSE: ERF). This higher-risk dividend stock has become very popular because of its yield, which has averaged almost 11% during the past five years and is at almost 7%. If you'd bought the stock five years ago, then you'd have lost nearly 9% annually through Sep. 27, 2012 -- and that's with a dividend ranging from $1.10 to $4.75 a share during the same five-year period.
Thus, a $25,000 initial investment in Enerplus would have shrunk to $15,860. If you'd taken out and used the dividend, as retirees often do, then your investment would now be worth a mere $8,750.
If you're an income investor, particularly a retiree, then I urge you to avoid stocks like this. Here are some details on why Enerplus and a few other popular high-yielding stocks will probably always be poor choices for generating retirement income.
First a quick note: The volatility measure I've reported in each case is the beta, a metric that compares a stock's price movement to that of the overall market. A value of 1.0 means the stock moves in line with the market. So Enerplus, with its beta of 1.33, is 33% more volatile than the market. In other words, if the market fell 10%, Enerplus might drop more than 13%.
|1. Enerplus Corp. (NYSE: ERF)
|Industry: Oil and gas
Market capitalization: $3.3 billion
Per-share dividend: $1.10
Recent stock price: $16.67
Five-year cumulative return: -65%
|2. Frontier Communications Corp. (Nasdaq: FTR)
|Industry: Telecommunications services
Market capitalization: $4.9 billion
Per-share dividend: $0.40
Recent stock price: $4.90
Five-year cumulative return: -66%
Although it\'s only a tad less volatile than the market, this stock has cost shareholders a bundle in principal the past five years as it has struggled to manage heavy debt and incorporate nearly 5 million badly neglected rural customers acquired from Verizon Communications Inc. (NYSE: VZ) in July 2010. Since the Verizon deal, the per-share dividend has fallen 60%, from $1 to 40 cents, and I don\'t think the cuts are necessarily over. With earnings per share declining at an astounding rate of 30% a year, from 65 cents in 2007 to 11 cents in 2012, Frontier may be hard-pressed to service its $8.3 billion debt load. Of this, $2.5 billion is due during the next five years, so dividends are likely to take a back seat for at least that long. The stock price could fall a lot further, too.
|3. Diamond Offshore Drilling, Inc. (NYSE: DO)
|Industry: Oil & gas drilling
Market capitalization: $9.2 billion
Per-share dividend: $0.50
Recent stock price: $66.12
Five-year cumulative return: -42%
What many investors may not realize is that Diamond\'s dividends are mainly special, one-time payouts approved by management on a case-by-case basis. These have fallen dramatically in 2012, and are likely to remain much more sparse for years. That\'s because Diamond has made the same mistake as Enerplus and neglected equipment upgrades. Now it\'s stuck with one of the oldest rig fleets in the offshore-drilling industry, with an average rig age of nearly 30 years.
As a result, the company recently began pouring cash into repairs and new equipment, dropping $1.8 billion on three new rigs in 2011 and another $1.3 billion in 2012 for upgrades and new purchases. Further capital spending near these levels will be necessary if Diamond is to become more competitive with industry leader Transocean Ltd. (NYSE: RIG). As such, there probably won\'t be much cash available for special dividend payments and I don\'t expect the total payout to go much beyond 60 cents a share through 2017.
|4. Telefonica SA (NYSE: TEF)
|Industry: Telecommunications Services
Market Capitalization: $60.7 billion
Per-share dividend: $0.67
Recent stock price (yield): $13.30 (5.1%)
Five-year cumulative return: -50%
Of the dividend stocks I\'ve described here, this one if faring worst because of Europe\'s economic troubles. Indeed, analysts expect earnings per share for the Madrid-based telecommunications giant to drop 15% in 2012 to $1.73, compared with $2.02 in 2011. What\'s more, earnings per share are projected to continue falling slightly, perhaps by about 1% a year through 2017. As a result, management has opted to suspend the dividend and resume it in the third quarter of 2013. Assuming that occurs -- and I\'ll believe it when I see it -- shareholders can probably expect much smaller amounts than the $1.27 to $2.07 a share they enjoyed during the past few years. Something in the range of 2012\'s 67-cents-a-share may be the best they can hope for during the next five years.
Action to Take --> Scan your portfolio for the four stocks I've described or others like them -- that is, stocks with a reputation for paying high dividends but that are fraught with high risk and long-term debt. If you have any of these retirement wreckers, then consider eliminating them. You might at least be able to use any losses to offset taxable gains elsewhere.
Also, consider putting the proceeds toward much safer dividend payers, such as Philip Morris International Inc. (NYSE: PM) and Intel Corp. (Nasdaq: INTC). These stocks are so dependable that you can buy and hold them "forever," just like the ones StreetAuthority Co-Founder Paul Tracy covers in his monthly newsletter, Top 10 Stocks. "Forever stocks" may not always sport eye-popping yields, but they typically have long histories of reliable dividends and much better price stability.