Make sure your retirement account stays full by avoiding these stocks. Image source: TaxCredits.net.
There are two things a retiree needs out of a dividend paying stock: (1) Stable income (2) that will grow over time. Stability is a must because there are bills to pay, while growth is important because inflation isn’t going away. While there are a lot of dividend stocks that can meet both of those needs, many do not. Here are three we think retirees should avoid.
The main reason is that even as Intel is the most advanced chip maker on Earth, it has long faced secular headwinds in several core markets, the most obvious one being the PC market, which has been stagnating for years. The PC’s current state is entirely expected as a mature product category, but Intel undoubtedly flubbed the shift to mobile. The data center business is growing well, but those gains are mostly just working to offset declines in the client computing business.
None of this is to say that Intel is a bad company, or that its dividend is in danger. Quite the contrary, Intel’s dividend payout ratio is a modest 41%, so even if the business deteriorated and earnings took a hit, Intel could still likely maintain its solid dividend payouts. Operating cash flow is strong, too, it’s just that Intel’s best years may be behind it.
Todd Campbell: It’s tempting to think that a high-dividend-yielding stock equates to a better investment, but far too often, it’s the best dividend yields that expose investors to the most risk. Why? Because companies often offer high yields to entice investors who might otherwise avoid owning shares.
For example, take a peek behind the curtain of a 7.4% dividend yield, and you discover that Innoviva (NASDAQ:INVA) may be racking up solid sales growth, but those sales come from royalty payments from GlaxoSmithKline (NYSE:GSK) that will eventually stop coming.
Specifically, Innoviva earns royalties from GlaxoSmithKline on sales of the respiratory drugs Relvar/Breo and Anoro Ellipta. Innoviva gets 15% of the first $3 billion in Relvar/Breo sales and 5% of sales above $3 billion. Its royalty rate on Anoro Ellipta ranges from 6.5% to 10%, depending on overall global sales.
Right now, that’s not a bad deal. Sales are growing as GlaxoSmithKline tries to convert patients away from Advair Diskus ahead of its patent expiration. COPD patient demand should keep growing because of an aging population, too.
Further out, though, the situation gets murkier. Competition is always angling for market share, and the royalty spigot could slow. If so, then the $748 million in long-term debt on the company’s books could become a heavy weight.
And just because investors get a hefty dividend doesn’t mean they can’t lose money. Last year, Innoviva was trading at $19.50, or 45% higher than it is now. Overall, Innoviva may be a good fit for some income investors, but not all of them, and for that reason, retirees might want to look elsewhere.
Matt DiLallo: With a current yield just shy of 14%, Plains All American Pipeline (NYSE:PAA) certainly catches the eye of income seekers. However, as Todd mentioned, with a higher yield often comes higher risk, and that’s certainly the case for Plains All American. Not only is its payout unlikely to grow for quite some time, but there’s a very real risk it could be cut if conditions in the oil and gas industry continue to weaken.
Unlike most MLPs that derive the bulk of their cash flow from fee-based assets, Plains expects only 78% of its earnings to come from fee-based assets this year. While that’s up from 75% last year, it still leaves the company quite exposed to commodity price volatility. That volatility should have a significant impact on its cash flow in 2016, with the company only expected to produce enough cash flow to support 87% of its distribution. Said another way, it’s paying out all of its cash — and then some.
The company is funding that shortfall, plus its expansion capital, via a $1.6 billion preferred offering it completed earlier this year. Its hope is that this cash will get the company though the worst part of the downturn. There are those who would argue that hope is not a viable business plan.
Bottom line: There’s a real risk that Plains All American Pipeline could eventually reduce its distribution. That’s a situation retirees will want to avoid by steering clear of this company.
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Evan Niu, CFA, has no position in any stocks mentioned. Matt DiLallo has the following options: long January 2017 $25 calls on Intel. Todd Campbell has no position in any stocks mentioned. The Motley Fool recommends Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.