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Three Dividend Stocks to Avoid Like the Plague

Winning at the dividend investing game isn’t just about picking winners. It’s also about avoiding losers.

Unlike a speculator, who can weather a 20%, 30%, or even 50% loss in a single position, we can’t survive such a setback.

Why? Because the loss of capital isn’t the only hit we take. Our ability to generate income is also affected.

Now, many investors try to overcome this double-whammy by taking the capital they have left and investing it in a much higher-yielding investment.

But higher yields equal higher risk. And when we blindly chase after yield to try to recover from a previous misstep, we usually end up compounding our problems by suffering yet another loss.

Can I get an, “Amen”?

Well, I’ve got a sneaking suspicion that there are some D&I readers who find themselves in this precarious position. And that means they’re probably eyeing up three stocks in the S&P 500 Index in particular.

They might not be viewing them as potential long-term holdings. Instead, they’re likely trying to squeak out a quarter or two of higher dividend payments.

If that’s you, listen up! Because it’s a trap.

A Trifecta of Losses Coming

I understand that resisting the temptation of a high-yielding stock can be difficult, if not impossible.

And who wouldn’t like to pocket the income offered by the three highest-yielding stocks in the S&P 500?

At current prices, Windstream Corp. (WIN) sports a tempting 12.4% yield. That’s more than five times the yield of the average stock in the S&P 500 (which is 2.32%, in case you were wondering).

Then there’s Frontier Communications Corp. (FTR), which offers an 8.5% yield.

Last, but certainly not any less risky, is CenturyLink, Inc. (CTL), checking in with a 6.8% yield.

Longtime readers will realize that these companies are repeat offenders. I’ve been warning about them – and specifically, the potential for a dividend cut – since December 2011.

So far, two have obliged…

In February 2011, Frontier slashed its quarterly dividend by nearly 45%, from $0.18 per share to $0.10. (Anyone want to volunteer for a 50% pay cut? I didn’t think so.)

In February of this year, CenturyLink cut its quarterly dividend 26%, sending shares down in price nearly as much in a single day. And the company has yet to recover.

And although Windstream hasn’t cut its quarterly dividend of $0.25 since my original warning, it’s only a matter of time. I say that because the company carries an eye-popping dividend payout ratio (DPR) of 444% over the last 12 months, according to Morningstar data.

Now, investors in the stock will argue that the DPR calculation for Windstream is not entirely accurate. And they’ll offer up alternative methods of calculating it, too.

Kind of like dot-com investors did back in 1999, when they told us that tech stocks weren’t expensive. That is, as long as we focused on alternative metrics like page views and clicks – not on conventional valuation metrics like price-to-earnings ratios.

I’m sorry, but when we have to make excuses to make things look less bad, there’s an inherent problem. So it’s best to avoid investments that require rationalizing why it really is a smart bet. They seldom end up being one.

What’s perhaps most amazing is that Frontier and CenturyLink find themselves back at the top of this list, even after recent cuts. Don’t be fooled into thinking that lightning can’t strike in the same place twice, though.

Both companies carry uncomfortably high DPRs, too. CenturyLink’s rests at 146%, whereas Frontier’s is 517%.

We’re all about safe, high-yield investing here. That’s a package deal, though. We need both, not just one or the other. And these three companies can’t deliver.

So don’t fall into the trap of believing otherwise. No matter how desperate for income you get.

Safe investing,

Louis Basenese

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