Why These 3 Stocks Have Unsustainable Dividends

First, let’s see what makes a dividend “unsustainable”…

The payout ratio

• By far, the number one indicator of a healthy dividend is a low payout ratio

• The payout ratio tells you how much of a company’s earnings are being paid out as dividends

An example• Consider the case of Microsoft, which pays a

dividend of $1.12 per year (a 2.7% yield)• Microsoft is expected to earn $2.70 this year• So, the payout ratio is • In other words, Microsoft pays out 41% of its

earnings as dividends

The significance of the low payout ratio is that if Microsoft’s earnings

were to drop unexpectedly, the dividend should be safe

Payout ratios of some popular dividend stocks…(Based on 2014 consensus earnings)

REITs: A special case

• Some of the highest-paying stocks on the market are real estate investment trusts (REITs)

• These should have a high payout ratio, as REITs are required to pay out at least 90% of earnings for tax purposes

• Ideally, REITs should have a payout ratio between 90-100%

ARMOUR’s dividend is sustainable

• ARMOUR Residential REIT pays a dividend yield of 13.9%, but the company has a healthy payout ratio

• ARMOUR pays $0.05 per month, or $0.60 per year

• The company is projected to earn $0.62 in 2014, making the payout ratio 96.8%, right in the “good” range for REITs

• So, while ARMOUR’s dividend is high, it makes sense financially, based on the company’s earnings

Other “red flags” to watch for1. Very high debt - especially if the debt

repayment obligations are high, relative to cash flow

2. Lots of layoffs – may be indicative of problems with the business

3. Reduced earnings guidance – means the company might see trouble ahead

4. Dividend cuts by peers

3 Companies with UNSUSTAINABLE

dividends

Western Mortgage Asset Capital Corp (NYSE: WMC)

• The company pays out $0.67 per quarter ($2.68 per year), but is only expected to earn $2.38 annually during 2014 and 2015

• This is a payout ratio of 113%, meaning the company won’t earn enough to cover the dividend

Current Yield: 19.5%

Resource Capital Corp (NYSE: RSO)

• This REIT focuses on commercial real estate debt, and pays $0.20 per quarter ($0.80 per year)

• Projected earnings of $0.52 (2014) and $0.73 (2015)

• This implies payout ratios of 154% and 110% for the next 2 years

Current Yield: 14.4%

Windstream Holdings Inc. (NASDAQ: WIN)

• Windstream offers broadband, phone, and TV services

• The company has paid out $1.00 per year for 8 consecutive years

• However, earnings have deteriorated in recent years

• Just $0.31 per share is expected this year

Current Yield: 10%

Sustainable dividend stocks for your portfolio