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3 Red Flags Telling You It’s A Bad Dividend Stock

Are you nervous yet?

I mean, did you finally figure out how to tame the market?

Were you part of investors who lost money in 2018, or were you part of those who "sold right on time?"

Or maybe you are like me and couldn't care less about what is happening daily on the stock market. I don't really mind because I know my dividends are safe and my portfolio will continue to thrive in the future. Here's what I understood after many years being fully invested in the market:

You can't control the market (e.g. it will go up and down all the time), but you can control what's in your portfolio.

But that's obviously easier said than done. How could you sleep well at night when the market is going crazy? (Note: the market is going crazy at least once every 6 months!). While I don't overanalyze what is happening between the U.S. and China and I don't waste my time predicting the price of oil or gold, I do spend a lot of time watching companies in my portfolio and make sure they don't show red flags. Those red flags that announce the company isn't doing so well and that they might eventually cut their dividend. Here is my list of red flags I watch quarterly among all my holdings.

With any red flags, these are not sure shot rules. It's not because you see one of many factors happening at the same time that the stock is an automatic sell. It doesn't mean the company will cut its dividend either. But it gives you a very good idea that this specific stock isn't as strong as others.

Trust the Market - Beware of High Dividend Yield Stocks

My first indication that something is wrong is usually the market. While I don't rely on it, there is still a part of truth speaking from its mouth. When a sector or most of the market follows the same movement, it's hard to understand what the market is telling us. However, when you see companies that are getting beaten down more than others, this is a sign that something is not right.

If you have been reading my blog for a while, you already know I'm not too keen on high-yielding stocks. High dividend yielding stocks (5%+) often offer either a higher degree of risk or poor growth perspectives. Since I'm not looking for an immediate source of income, I don't have to bother with high-yielding stocks. However, whenever I hold a stock where the yield goes over 5% (like Enbridge (NYSE:ENB) for example), I will pay more attention.

Absence of Dividend Growth

Last year, I wrote an article about dividend cuts in disguise. This article discussed how your precious quarterly payments get eaten alive by inflation if the company doesn't increase its payout from time to time. When a company maintains its dividend or barely increases it for a few years, you can raise a second red flag (especially if the dividend is 5%+).

The absence of dividend growth or a minimal increase not covering inflation is definitely a signal that the business isn't doing too well. In 2018, we had some well-known companies announcing dividend cuts. I've taken three of them to highlight my point.

Owens & Minor (NYSE:OMI): The medical supplies distributor had paid uninterrupted dividends since 1977, but was forced to cut its dividend as the business struggled. Over the past 5 years, OMI had increased its dividend consistently for a total of 4% (from $0.25 to $0.26) before the dividend cut.

General Electric (NYSE:GE): Before cutting its dividend twice (ugh) in 2018, GE had increased its dividend from $0.22 to $0.24 (9%) in the past 4 years.

L Brands (NYSE:LB): Victoria's Secret brand maker hasn't increased its dividend since 2016. In November 2018, it announced a 50% dividend cut.

We can see a similar trend on the Canadian market with Cominar (OTCPK:CMLEF) (CUF.UN.TO), Corus Entertainment (CJR.B.TO), and Peyto Exploration (OTCPK:PEYUF) (PEY.TO). Each company stopped increasing its dividend for a while before announcing their dividend cut.

When a company is slowing down its dividend growth policy or simply "forgets" to increase its payment for more than a year, take a serious look at the reasons why it's happening.

Weak Dividend Triangle

The Dividend Triangle is composed of three metrics:

Revenues: A business is not a business without revenue. What is the difference between a company making growing revenue from a company showing stagnating results? Competitive advantages.

Earnings: You can't give money if you don't make money, right? Then again, this is a very simple statement. Still, if earnings don't grow strongly, there is no point of thinking that the dividend payment will increase indefinitely.

Dividends: Last, but definitely not the least, dividend payments are the *obvious* backbone of any dividend growth investors. But I don't mind the dollar amount or the yield, I solely focus on dividend growth.

Companies losing market shares due to the lack of competitive advantages will see its story through its revenue trend. It is very rare to see any business publishing growing revenue year after year. For many reasons, a company could publish weaker results. It could be the end of a cycle, a change in the business model, or simply the economy slowing down. However, if this situation persists for several years and management can't find growth vectors, the red flag must be raised.

The same logic applies to earnings. Since earnings calculations are based on GAAP, we are not talking about real money. This number is far from being perfect. In fact, you are better off combining it with free cash flow or cash flow from operations to see what is really going on. Nonetheless, if a company is unable to generate growing EPS over a long period of time (5 to 10 years), chances are dividend growth will not follow.

Finally, as I discussed earlier in this article, a lack of dividend growth is definitely a sign there is a problem that must be investigated. When management is confident enough to raise their payouts by 4-5% or more each year, I can sleep well at night and I really don't mind what is happening in the market. Sooner or later, the market will bounce back and dividend growers are among companies that will thrive.

There are More Red Flags

If you can avoid all dividend cutters, your portfolio should beat your benchmark easily. Successful investors often avoid dead stocks and dividend cutters while keeping dividend growers in their portfolio. Looking at revenues, earnings, dividend growth and dividend yield are part of the basic red flags that could be raised for any dividend stock. There is definitely more to it.

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