If you're an investor, there's no more direct route to sharing in the wealth of corporate profits than dividends. Owning a slice of a company earns you money on a regular basis. Not a bad deal, if you ask me.

But it's not always as simple as that, and many a dividend investor can be lured into buying shares of companies that offer huge dividend yields. Two months ago, I warned investors that Midwestern grocery chain Roundy's (NYS: RNDY)  dividend looked too good to be true. At the time, it yielded 14.4%. The company has since cut it,  and its stock price has fallen 25%.

There were two things working against Roundy's:

  • The company's dividend simply wasn't sustainable.
  • The underlying business was in no way quality enough to lead one to believe that rosier times were ahead.

Below, I'll share three more companies with big dividends that I'm not so certain about. Read all the way to the end, and I'll offer up access to a special free report detailing nine rock-solid dividends for your portfolio in 2013.

Is this sustainable?
Let's start off by just looking at the numbers. When a company offers a dividend, there are generally two ways to measure how sustainable the dividend is. The first is the payout ratio from earnings. In the most basic sense, this measures how much of a company's profit is used to pay out dividends. The closer the number is to 100%, the more dangerous it is, as the company is paying out more than it takes in.

But that metric alone isn't enough. You see, because of some funny accounting rules I won't get into here, the term "earnings" doesn't exactly represent how much money a company has brought in. Instead, we can look to free cash flow for a more realistic picture of how much money a company has brought in. Then, we can check to see how much of that money is being used to pay out dividends.

Below are the three dividend companies I'll be avoiding in 2013, and the important metrics to be aware of.

Company

Dividend Yield

Payout From Earnings

Payout From Free Cash Flow *

Windstream (NAS: WIN)

12%

400% 

101% 

Vector Group (NYS: VGR)

10.2%

571% 

113% 

United Online (NAS: UNTD)

7.3%

100% 

93% 

Source: Yahoo! Finance, SEC filings. Payout from FCF is based on the first nine months of 2012.

Like I said, I find the payout ratio from free cash flow to be the most important number. And though United Online is resting just below the 100% threshold, I don't think these three companies' dividends are safe right now.

Is there a future for this telecom?
I've already called out Windstream once before as being a dangerous dividend. The company provides broadband Internet services to primarily rural areas. Though the company's residential numbers are lagging, some Fools believe  that Windstream's new focus on business customers could revitalize the company. Of course, it doesn't help when the company competes against such bigwigs as Verizon (NYS: VZ) .

The company's latest earnings release wasn't promising, either: Overall revenue for the company was down 1%, while net income is down 16% on the year. And even though service and product sales are up 51%, that number has been far outpaced by an 80% increase in costs.  

The cigarette company you've probably never heard of
Vector Group offers more than 118 different combinations of cigarettes under various brand names. Things haven't been going well for the company lately. So far in 2012, revenue is down 4%, while earnings are down a whopping 79%. 

Even more alarming, the losses would have been even steeper if the company hadn't raised the prices of its Pyramid-brand cigarettes . I already have qualms about investing in cigarette companies, but with trends like this, I'm absolutely avoiding Vector.

A hodge-podge of mediocre businesses
United Online has three business divisions: FTD floral network; Internet service brands Juno and NetZero; and social websites such as Memory Lane, Classmates, and StayFriends. I've never heard of FTD floral, any of the social websites, and only vaguely remember NetZero commercials from over a decade ago.

Apparently, I'm not alone. Over the first nine months of 2012, revenue for the combined companies was down 4%, while earnings per share have taken a 36% dive. Though the company got a boost earlier in the year when it announced plans to spin off the FTD branch, there's still no way I'm going to be touching this company.

A better way
I'll be backing up my assertions by giving all three of these companies a bearish CAPScall on my All-Star profile throughout 2013.

If you're interested in some better dividend ideas for 2013, The Motley Fool has compiled a special free report outlining our nine top dependable dividend-paying stocks. It's called "Secure Your Future With 9 Rock-Solid Dividend Stocks." You can access your copy today at no cost! Just click here to discover the winners we've picked.

The article 3 Big Dividends to Avoid in 2013 originally appeared on Fool.com.

Fool contributor Brian Stoffel has no positions in the stocks mentioned above. The Motley Fool owns shares of United Online. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2012 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Behavioral Finance

Why do investors make the decisions that they do?

View Course »

Basics of Diversification

Learn one of the fundamental concepts of building a portfolio.

View Course »

Add a Comment

*0 / 3000 Character Maximum