Investing in dividend stocks can seem like a great way to pad your portfolio's returns, especially when you're investing in dividend growth stocks that increase their payments over the years. The risk, however, is that investors often look at a stock's track record for paying dividends, and use that as a justification for why it may be a safe income investment to hold for the long term. But the past doesn't predict the future, and while a stock may have been a good dividend stock for years, that doesn't mean it will remain that way.
You only have to look at a couple of big-name dividend stocks as a reminder of that. Intel recently suspended its dividend, and pharmacy retailer Walgreens Boots Alliance slashed its payout by 48% back in January. Both companies are facing headwinds and have uncertain futures.
A couple of dividend stocks that could also be problematic income investments are Johnson & Johnson (NYSE: JNJ) and Altria Group (NYSE: MO). Although they have great track records for paying dividends, here's why you'll want to think twice before relying on their payouts.
Johnson & Johnson
Johnson & Johnson is a Dividend King and it has increased its dividend payments for 62 consecutive years. It might seem improbable that it would suddenly stop raising its dividend but it's a possibility that investors should brace for. There are two main reasons I would be worried about its payout.
The first is that the company is routinely involved in costly legal battles. One of the most troublesome has been the tens of thousands of talc lawsuits that are currently pending. Although the company may attempt to downplay the risks and it has allocated billions to settling the claims, the measures it's taking to limit its liability should underscore just how significant the risk is. The company is trying, for a third time, to bankrupt a subsidiary in an effort to put the matter to rest. As the matter drags out and potentially saddles the business with greater-than-expected costs, it could limit the ability of the business to raise its dividend; currently, Johnson & Johnson's payout ratio is about 73%, which is manageable for now, but that may not be the case if its expenses rise.
Johnson & Johnson also needs to invest in its growth opportunities. The company spun off its consumer health business last year as part of this effort. But growth initiatives can be costly and require a lot of investment in research and development. The company is targeting an annual growth rate between 5% and 7% from 2025 until the end of the decade. This is as the business faces the loss of patent protection for one of its key drugs, Stelara, which is used to treat psoriasis and certain bowel diseases. Johnson & Johnson will need money to invest in its growth opportunities and it may be hard to do that as it's spending money on litigation and an increasing dividend.
For now, Johnson & Johnson's dividend still looks safe, but investors should be careful not to assume things will stay that way. This isn't the reliable dividend stock as it was five or 10 years ago.
Altria Group
A dividend stock that may be more at risk than Johnson & Johnson is Altria. The cigarette maker raised its dividend by more than 4% last month but that doesn't mean there may not be trouble ahead for its payout. Its payout ratio of 68% looks manageable but that would be much higher if the company didn't benefit from a $2.7 billion gain last quarter due to the sale of commercialization rights to its Iqos tobacco heating system. The company's operating income, which doesn't include one-time gains and losses, actually declined by 13% during the period.
Altria's net revenue fell by 5% last quarter to $6.2 billion and the risk is that tobacco sales may continue to decline. Without a more promising future and a business model that doesn't center around tobacco products, it's difficult to make a case as to why this can be a good long-term investment. In the short term, Altria's dividend may be sustainable, but how much longer it can last will likely depend on a declining industry. Currently, 1-in-5 adults around the world consume tobacco compared with 1-in-3 back in 2000, according to data from the World Health Organization.
The future is uncertain for Altria and while it may still be raising its dividend right now, you might be taking a significant risk in assuming that it can continue to pay and hike its dividend in the years ahead.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool recommends Intel and Johnson & Johnson and recommends the following options: short November 2024 $24 calls on Intel. The Motley Fool has a disclosure policy.
