Dividend stocks are among the greatest investment tools for building wealth in the long run, as they not only provide a steady flow of income but also offer the benefits of compounding on reinvested dividends. However, not every stock that pays a dividend is worth your money. A high-yield dividend could even trap you if the company is struggling.
Case in point: Ferrellgas Partners (NYSE: FGP) and CVR Partners (NYSE: UAN). There are strong reasons to avoid these two dividend stocks and buy a dividend ETF like PowerShares S&P 500 High Dividend Low Volatility Portfolio (NYSEMKT: SPHD) instead. Read on to learn why.
CVR Partners' 12.1% Yield Is As Risky As It Can Get
You might expect CVR Partners to have done well, considering it specializes in nitrogen, the most important and most widely used crop nutrient. But you'd be wrong. Its profits have tanked in recent years, so much so that it's swung to a $55 million loss over the trailing 12 months from a profit of $112 million in fiscal 2012. Aside from deteriorating nitrogen markets, as declining crop prices have hit farm income and demand for nutrients, CVR Partners' competitive advantages have eroded, its cash flows have dwindled, and it continues to bear the burden of debt that's eating into its bottom line.
As a dividend stock, CVR Partners is sought after because it's a master limited partnership that pays most of its profits to shareholders in the form of dividends. But because CVR isn't making a profit, it didn't pay a dividend in two out of its past four quarters. Over the years, CVR's dividends have tanked along with its profits.
If you're still enticed by CVR's eye-popping 12% dividend yield, especially after the stock's 36% drop year to date, you might want to think twice, lest you risk falling into a value trap.
Don't Get Swayed By Ferrellgas Partners' 7% Yield Yet
A stock that's lost 70% of its value in one year is an unlikely candidate for a dividend portfolio, but Ferrellgas' hefty 7.1% dividend yield continues to lure income investors. Many believe the worst is over for the propane supplier, which might be true to some extent. But as a dividend stock, Ferrellgas is best avoided for more reasons than one.
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Ferrellgas' strong run ended late last year, when it announced a shockingly dismal report for fiscal 2016 and topped it with more unnerving news. Ferrellgas' diversification outside propane into midstream oil logistics and water-solutions businesses backfired, forcing it to write down hefty amounts of its Bridger Logistics acquisition. With warm weather further hitting its propane business and earnings drying up, Ferrellgas faced a severe liquidity crunch and ran the risk of triggering its debt covenants. The company's CEO stepped down in the wake of all these troubles.
For income investors, the biggest blow came when Ferrellgas slashed its annual dividend by a staggering 80% to $0.40 per share last year. Even now, Ferrellgas' free cash flow payout is well above 100%, and there's no chance of a dividend increase anytime soon. I'm not even ruling out the possibility of another cut, a management finds itself stuck with the uphill task of getting the company's debt to serviceable levels in a challenging business environment.
Long story short, much as with CVR Partners, Ferrellgas' high dividend yield is a result of tumbling stock prices amid serious business concerns. There are far more reliable and solid dividend candidates to look at than these two. Let's consider one.
This ETF Offers Diversification, Stability, And Security
I could easily recommend some solid, high-yield real estate investment trusts to you, such as Welltower and Iron Mountain. But I'd urge you instead to consider a dividend ETF instead that holds several stocks including these two but trades just like a common stock. Invesco's PowerShares S&P 500 High Dividend Low Volatility Portfolio comprises exactly what its name suggests: a bunch of high-yield stocks that are also less volatile. That's a winning combination for long-term income investors.
High yield is fine, but how does the fund decide which stocks are less volatile? Well, this ETF tracks the S&P 500 Low Volatility-High Dividend Index, which comprises the 50 "least-volatile high-dividend-yielding" stocks in the S&P 500, determined on the basis of the standard deviation of daily stock prices during the trailing 252 trading days. This investing theme has proved pretty lucrative, going by the ETF's total returns versus the S&P 500 in recent years.
The ETF's top five holdings today include Iron Mountain, Phillip Morris International, Welltower, Entergy Corp., and PPL. Because the PowerShares S&P 500 High Dividend Low Volatility Portfolio holds stocks from nearly every sector you can think of, buying it today is equivalent to creating a hugely diversified strong dividend portfolio in one shot. With an SEC-defined yield of 3.75%, there's little reason not to like this dividend ETF.
This article originally appeared on The Motley Fool.