Is There Such a Thing As a High Dividend Yielding Stock that Is Too Ripe to Hold?

Is There Such a Thing As a High Dividend Yielding Stock that Is Too Ripe to Hold?

Earlier this month, Michael Santoli in his article, "Starting to Smell a Little Ripe" noted, "While it's perfectly reasonable for a mature, no-growth business to redirect what cash it generates to shareholders, the notion of investor-pleasing, dividend-boosting blue-chip stock of a structurally challenged company can't persist forever." Santoli makes a nice case of this argument with Waste Management in his article, but can the same be said for other stable, mature, and high dividend companies?

Generally speaking for conservative investors, Waste Management (WM) seems to be a safe and nice stock to hold in today’s environment, offering stability, low risk, and a rather generous dividend policy at a 4% yield. However, to Santoli, as a company, Waste Management presents what he calls a “sloppy story”.

For years, the company’s revenue, earnings, margins, and cash flow have remained flat. As these numbers remain stagnant over time, the sustainability of high dividend payouts becomes an issue for concern. To investors looking for dividend growth, Waste Management becomes unattractive. Stagnant earnings mean that dividend growth in the future, if any, will be slow and minimal. And sure, a 4% dividend yield is quite attractive in today’s environment as compared to treasuries and bank rates, but for long-term investors, what really matters is the sustainability and growth of this dividend over time. Which brings us to another question, does Waste Management’s case apply to other mature, stable, and high dividend payout companies out there?

Johnson & Johnson (JNJ), with its 3.7% yield and stable earnings is a great example.  Like Waste Management, JNJ has an attractive yield and stagnant earnings over the past few years. Yet having a nice dividend is definitely not the only reason investors should be holding JNJ or Waste Management. As Santoli might say, operating performance matters and it’s important that a company is “structurally” strong.

For Waste Management, Santoli notes, “Pricing power is scant, capital spending to maintain its vehicles and facilities is a ceaseless treadmill, and rates fetched on the recycled cardboard and aluminum it sells have ebbed.” With this, Santoli does point to issues regarding Waste Management’s structure and organization, but the case he makes should not be generalized. Using JNJ as an example, sure, it shares its similarities with Waste Management in terms of high dividend yield and stagnant earnings, but the companies are worlds apart in terms of what they do.

JNJ operates in the drug, health, medical devices and personal care industries, with powerful brands and household names that will continue to generate a rather stable cash flow. However, that’s not the point; stability is not always a good thing for investors looking for growth. What makes JNJ different and perhaps structurally stronger than Waste Management is not only its diversified portfolio of products, but also its engagement in R&D. Constant innovation and entry into new markets pave the way for growth.   

The same case can be made for companies like Procter & Gamble (PG). Like JNJ, the company holds a highly diversified portfolio with many household names, and continues to make high dividend payouts, despite the fact that earnings have been rather stagnant in recent years.

Both JNJ and PG have consecutively increased and paid dividends for over two decades. For Waste Management it’s a 9-year dividend increase streak. Sure, looking at a company’s track record for dividend payouts can be reassuring when it comes to making an investment, but truth is, past dividend growth does not guarantee future growth.

Hence, something to consider before an investment is how much one expects his/her portfolio to grow within a certain time frame. Smart investors don't park all their money in one place. They don’t commit to one thing and they take advantage of economic cycles and market conditions to invest in certain stocks at certain times.

Sure, Santoli may have a point about Waste Management being a structurally challenged company, and question its ability to pay dividends over time, but some investors may simply be holding the stock for its nice dividends and can care less about the company’s margins and organization as long as the company continues paying dividends to investors. Or perhaps, investors are holding onto Waste Management because they see value in the company’s future prospects.

For example, last week, Waste Management entered into a joint development agreement with cellulosic sugar producer Renmatix to explore the viability of converting trash to sugar that can serve as feedstock for biobased fuels and products. If the plan works out, Waste Management and ultimately investors will derive much value from it in terms of revenues and dividends.     

As said before, having a nice dividend is not enough reason to own a company’s stock, but looking into a company’s stock price, business fundamentals, free cash flow, and future prospects is what matters. Both JNJ and PE actually fare quite well in these categories. The nice dividends are just cherries on top of the cake. 

Image: Image courtesy of hywards at FreeDigitalPhotos.net

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