The appeal of dividend stocks has been on the rise recently. With treasury yields declining and the Federal Reserve likely nearing its first rate cut, high dividend yielders are catching investors' attention once again. However, Piper Sandler analysts said in a recent note that investors must be picky when choosing which dividend stocks to invest in, citing risks of potential dividend cuts.
Why own dividend stocks
Although dividend stocks have underperformed during the last bull run, they still offer several attractive qualities.
Beyond providing consistent income, many dividend-paying stocks are found in defensive sectors, which tend to be more resilient during economic downturns and exhibit lower volatility. With growing recession fears and concerns about the sustainability of the AI-driven tech boom, diversifying portfolios into quality dividend stocks isn’t the worst idea.
Companies that pay high dividends hold significant cash reserves, indicating financial strength and solid long-term growth potential.
Investors can benefit from dividend stocks in two ways: through capital appreciation as the stock price rises and through regular dividend payments, which are typically made on a quarterly basis.
On average, dividend-paying stocks in the S&P 500 yield about 2.3%, trade at approximately 25 times 2024 earnings, and are projected to grow profits by around 10% annually over the next few years.
10 dividend stocks to avoid
Despite their appeal, investors need to be selective with their dividend stock choices, according to {{0|Piper Sandler}} analysts, particularly given the current uncertainty in global markets, bifurcated earnings, and the delayed impacts of Federal Reserve tightening.
This year has already seen some major companies reduce their dividends, and more cuts are likely on the horizon, the investment bank cautions.
According to the analysts, the current earnings environment is highly unusual.
While mega-cap companies have experienced strong earnings growth, which has bolstered S&P 500 earnings due to their significant index weight, mid and small-cap earnings have been weak at best.
There is no clear evidence of a broad-based earnings recovery. In fact, the analysts note that the recent uptick in the unemployment rate, along with other weak employment indicators, points to further economic softness.
"In this backdrop of bifurcated earnings and a deteriorating labor market, it is especially important to consider the sustainability of dividend payments," analysts said in a recent note.
To assist in identifying stronger companies with sustainable dividends, {{0|Piper Sandler}} utilizes an "Ability-to-Sustain" (ATS) screen.
“High dividend yielding stocks that also have a high ATS ratio consistently outperform the broader high dividend yielding universe,” the investment bank explains.
Within this, analysts highlighted 10 S&P 500 stocks investors should avoid due to the risks of a potential dividend cut. While all of these are high-yield dividend stocks, their ATS ratio is below 1, which {{0|Piper Sandler}} describes as “concerning.”
Specifically, the 10 stocks in question are Walgreens Boots Alliance (NASDAQ:WBA), Pfizer (NYSE:PFE), Crown Castle (NYSE:CCI), Dominion Energy (NYSE:D), T. Rowe Price Group Inc (NASDAQ:TROW), ONEOK Inc (NYSE:OKE), Eversource Energy (NYSE:ES), Evergy (NASDAQ:EVRG), The AES Corporation (NYSE:AES)., and Pinnacle West Capital Corp (NYSE:PNW).