6 Dividend-Trap Stocks That Could Follow Mattel And GNC's Lead, Cutting Or Suspending Payouts

Living beyond means is always a risky proposition, be it an individual or a business. When companies are cash-constrained, the first thing they will lay their hands on would be dividends, as these are not mandatory payments stipulated by corporate law.

An investor who is lured by the lucre of an additional avenue of income apart from capital appreciation gains in the eventuality of the sale of a stock would have to lick his wounds if the company opts to cut down on dividend, which is usually considered a stable income stream. Haven fallen for the dividend income, the situation resembles one caught in a trap — a dividend trap in this case.

Dividend, Payout Ratio

The surplus profit left after setting aside retained earnings is paid out to investors in the form of dividends if the company has a dividend policy. For example, Company A makes X dollars of profit. Setting aside Y dollars, A intends to plow back into its business, which otherwise is called the retained earnings, a sum of X-Y would be paid out in the form dividends to shareholders, proportionate to the number of shares they hold in the company.

Dividend payout is a financial ratio, which measures the percentage of earnings paid out in the form of dividends.

Mathematically:

Dividend payout ratio = Annual dividend/Net income or annual dividend per share/earnings per share

Companies, which have a payout ratio of over 100 percent, are squanderers, living beyond their means. If a company is pursuing a payout of over 100 percent to appease investors, it might have to cut or suspend its dividend altogether at some point in time, or risk burning all its cash reserves. Once the cash reserves or used up, it might have no recourse but to chop its dividend.

Why Investors Chase Dividend Income?

According to statistics from JP Morgan, dividends account for roughly 40 percent of the total returns from the markets over a longer-term horizon. The firm says dividends vests the triple advantage of upside potential, downside protection and steady income in an environment of increasingly volatile markets and persistently low-interest rates.

The U.S. Federal Reserve has left the fed funds target rate at extremely accommodative levels ever since it lowered it to near zero levels to combat the economic weakness that ensued the Great Recession of the 2007–2008. Although the Fed has begun monetary policy normalization, the interest rate is still at an accommodative 1–1.25 percent.

A low-interest rate environment renders the traditionally safe investment avenues such as money market account, certificate of deposits and even treasury bills unattractive in terms of returns. This, in turn, increases the appeal of dividend paying stocks.

Recent Instances Of Dividend Cuts

Mattel, Inc. MAT recently cut its dividend by 60 percent. The move wasn't unexpected as Mattel has been in trouble for some time now, with the company trailing behind rival Hasbro, Inc. HAS.

Mattel paid out cumulative dividend per share of $1.52 for the trailing 12 months and its earnings per share for the period is $0.79, with the payout ratio at an unsustainable 192 percent.

Taking into account the more reliable free cash flow per share of $1.06 per share, the payout ratio for 2016 was 143 percent.

In the first quarter, Mattel reported a loss of $0.31 a share and revenue fell 15 percent.

GNC Holdings Inc GNC suspended its dividend altogether through an announcement made in February. This eight-decade-old company has been a consistent dividend payer since it instituted a dividend in 2012 and has also been consistently raising its dividend.

The steep drop in GNC's stock price was precipitated by competitive pressure from online nutritional supplement companies and its highly levered balance sheet, according to Seeking Alpha.

GNC Source: Y Charts

Benzinga looked at six companies, which apparently are dividend traps and could do well with a more frugal existence.

1. Seagate Technology PLC STX

The company's dividend for the trailing 12-month period amounted to $2.430 per share and it earned $2.46 on a GAAP basis. The payout ratio works out to around 104 percent.

2. Barnes & Noble, Inc. BKS

This bookseller earned $0.29 per share in the TTM and paid out $0.60 per share for the period. The payout, in this case, is 207 percent.

With the company struggling due to competitive pressure from online stores and the popularity of e-books such as Amazon.com, Inc. AMZN's Kindle, it looks a tall order for the company to maintain its steady stream of dividends, unless fundamentals radically improve.

3. Centurylink Inc CTL

CenturyLink paid out $2.16 in the TTM and earned $1.06, with the payout ratio for the trailing 12 months at 204 percent.

There is precedence, in the company cutting its dividend in 2012, although it has been maintaining the payment since then. However, the company's stock has depreciated notably and fundamentals are shaky, making the dividend payment tenuous.

4. Abercrombie & Fitch Co. ANF

The teen-apparel retailer is suffering due to the industry-wide weakness, stemming from rivalry posed by the online channel. The company's TTM bottom line per share is at -$0.26, while it managed to payout $0.80 per share in dividend during the period.

5. Frontier Communications Corp FTR

Frontier Communications, a telecom company, ran up a loss of $0.42 in the TTM period, although it paid $0.42 per share as dividend.

The company has been steadily losing subscribers, not only in television, but also in broadband. The company's purchase of Verizon Communications Inc. VZ's wireline business in California, Florida and Texas hasn't served it cause any further.

The scenario is flagging a potential dividend cut or scrapping in the near term.

6. AT&T Inc. T

AT&T's dividend payout ratio for the TTM period was 95 percent, given the dividend per share of $1.94 and earnings per share of $2.05.

Out of all the stocks discussed, AT&T's dividend may be relatively safer, given the company's wherewithal to withstand an adverse development, given its size and market positioning.

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