Pop quiz time. Would you be interested in investing in a company with the following fundamentals?

  • Sluggish sales growth.
  • Deteriorating earnings.
  • A product or service on a confirmed crash course with obsolescence.
  • And a balance sheet overloaded with debt.

For most of us, I’m sure the answer is, “Hell, no!”

[ad#Google Adsense 336×280-IA]Why is it then, when I reveal that the same company also yields about 10%, we’re suddenly interested? (Admit it. You are.)

Maybe it’s because we’re convinced we can cheat dividend death.

We think we’ll somehow be able to pocket a few dividend payments and bail right before management cuts the payout and/or shares collapse.

Good luck with that.

So, why bring any of this up?

It’s simple really.

The three highest yielding stocks in the S&P 500 Index are getting ready to pay shareholders again. In fact, one is set to trade ex-dividend next week.

And I want to make sure no one gives in to the temptation to buy into these dividend traps.

Instead, we should avoid them like the plague. Here’s why…

Windstream: This Call Could Get Dropped Any Second

A yield is only as strong as the underlying business that’s paying it. When we look underneath the hood of Windstream Corp. (Nasdaq: WIN), its business is sputtering, making its 9.3% yield untenable.

The company is the country’s largest provider of telephone service in rural areas. While the focus used to convey notable competitive advantages – rural areas benefited from little to no competition – that’s no longer the case.

Markets are becoming less rural, not more. As a result, the higher concentrations of people are attracting additional competitors.

Not to mention, people are abandoning traditional phone lines in droves. In the last six months, 86,000 of Windstream’s customers canceled traditional phone service. That’s a trend unlikely to reverse course. Ever. (I abandoned my traditional phone service six years ago and never looked back.)

It’s true, the company’s branched out to provide additional services to businesses, including internet access and cloud computing. But traditional phone service, and the access and subsidy payments associated with these lines, still accounts for about 50% of Windstream’s business.

Plus, the business services aren’t growing fast enough to make up for the consumer losses. In the most recent quarter, they didn’t grow at all. Business revenue fell 2%.

On the earnings front, Windstream’s struggling, too. In the last six months, net income fell 5.8%. And analysts expect profits to decline an average of 1.9% per year for the next five years, compared to double-digit growth for the rest of the industry.

That’s reason enough to avoid the stock. But wait. There’s more…

Regulatory and Integration Risk: The FCC is considering changes that would cut into Windstream’s access and subsidy fees. Any adverse changes would dramatically dent revenue. Windstream’s also digesting several major acquisitions. Since management overpaid for each, we can expect integration charges to cut into earnings in future quarters, too.

Overeating At the Debt Buffet: Since 2009, Windstream’s outstanding debt almost doubled, from $5.4 billion to $9 billion at the end of 2011. Keep in mind, the company trades at a $6.4 billion market cap. Overleveraged would be an understatement.

Buy High, Sell Higher?: We can’t even argue that shares are being overly punished given the terrible fundamentals. They’re actually expensive, not cheap. At current prices, Windstream’s price-to-earnings (P/E) ratio checks-in at 36.1. That’s 51.5% above the company’s five-year average P/E ratio and 51% higher than the industry average. On a forward P/E ratio basis, the stock trades at a 22.7% premium to the S&P 500 Index.

Not Enough Cash to Go Around: Each quarter, Windstream pays out $147 million in dividends. In the last quarter, though, free cash flow checked-in at just $109 million. The result? It has to borrow money or cut back on capital expenditures – thereby giving up growth opportunities – to pay its dividend. That’s not good or sustainable.

Bottom line: If Windstream didn’t pay a dividend, no investor would go near it. Not only are shares overpriced, but the fundamentals stink, too.

Or as AAII Journal editor, Charles Rotblut, says, “You have very negative trends and that high yield is basically telling you that a lot of people in the market are looking at the company and saying ‘Something doesn’t quite smell right, something doesn’t quite seem right.’”

Something? How about nothing seems right, Charles?

It turns out that the same can be also said about the next two highest yielding stocks in the S&P 500 Index – Pitney Bowes (NYSE: PBI) and R.R. Donnelley & Sons (Nasdaq: RRD). Since they don’t pay dividends until early November, though, I’ll wait until the temptation is at its greatest to share why they’re terrible investments, too.

For those of you who have absolutely no self-control, hang tight until [my next article]. I’m going to share the only way I’d even consider trying to boost my income with these three stocks. If you’re looking to speculate with a small portion of your portfolio, it could be the smartest bet.

Safe investing,

Louis Basenese

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Source: Dividends and Income Daily