Dividend stocks can offer a conservative path into the stock market, providing regular and sometimes rising income and potential for capital gains.
But not every dividend stock is a winner. So Morningstar’s chief U.S. market strategist Dave Sekera recently recommended three high dividend stocks to avoid now.
Xerox, the printing machines and software company
(XRX) -)
Morningstar moat (durable competitive advantage): none. Morningstar fair value: $13. Wednesday price quote: $15.90.
“Its dividend yield is about 7% right now, which is very high in this market,” Sekera said. “The stock does look cheap, but it’s cheap for a reason. I think it’s a value trap.”
In sum, “Xerox is a melting ice cube,” he said. “Its main business, printing, is in a long-term secular decline. Over the past 10 years, revenue has dropped to $7 billion from $20 billion. And we forecast that the top line will continue to deteriorate from here.”
Further, there’ no “real growth trend in earnings,” Sekera said. “It looks like the best for investors to hope for is just to clip that dividend and keep your fingers crossed that the company can raise margins on the declining revenue base to maintain those earnings as long as possible.”
IBM, the information-services icon
(IBM) -)
Morningstar moat: narrow. Morningstar fair value estimate: $126. Wednesday price quote: $146.20.
“I don’t think IBM is really much better than Xerox,” Sekera said. The dividend yield is about 5%. “You have to make some adjustments to earnings,” he said.
“Our adjusted price-earnings ratios are 13-14. That’s higher than Xerox, but lower than the overall market. And again, revenue’s been on a long-term decline.”
Sekera forecasts 2% annual revenue growth on average over the next five years and 6.5% earnings growth. “IBM appears like it’s just going nowhere fast, and we see much better opportunities elsewhere,” Sekera said.
A more appealing stock in the information-technology services sector is Cognizant Technology (CTSH) -), said Morningstar analyst Julie Bhusal Sharma. Its dividend is 1.83%.
Seagate Technology, the hard-disk-drive supplier
(STX) -)
Morningstar moat: none. Morningstar fair value estimate: $55. Wednesday price quote: $67.70.
Its dividend yield is about 4.5%. Seagate’s business is very cyclical, Sekera said. “And you shouldn’t value the company on any one year’s earnings.”
In the PC market, there was “a huge upswing early during the pandemic as you had employees switching to working from home,” Sekera explained.
“But, of course, now that all that demand has been satisfied. PC demand has dropped precipitously, and we forecast it isn’t going to recover until 2025.”
Also, “PCs are incorporating less hard-disk-drive memory in favor of solid-state memory,” Sekera said. “So in the meantime, Seagate has been transitioning its portfolio, trying to focus more on mass capacity drives for the cloud providers.”
Bottom line: “I’d rather invest in stocks with a better growth profile, even if they pay a lower dividend,” Sekera said.
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