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High-yield dividend stocks can be very enticing. This is particularly true since interest rates remain very low.
But stocks with extremely high dividend yields should be approached with caution. Sometimes, an abnormally high yield can be a sign of danger. When a stock price declines, its dividend yield increases.
If the share price decline is accompanied by falling sales and profits, a rising dividend yield could be a precursor to a dividend cut. This is what investors should seek to avoid.
Video game retailer GameStop (NYSE: GME) sports a 6% dividend yield, as its share price has declined 22% over the past one year.
It is struggling with a difficult environment for retail more broadly, and increasing competition. At the same time, it has a turnaround plan that might just work.
Game Over for Video Games?
The reason for GameStop’s crashing share price is because sales of video games and related hardware are dropping at a disturbing rate.
For example, net sales fell 2.8% last quarter, and have declined 4.7% over the first nine months of the year. GameStop’s comparable-store sales, a crucial figure for retailers that shows sales performance at stores open at least one year, dropped 6.5% last quarter.
The main reason for the sales decline is because new hardware sales declined 20.6% and new software sales declined by 8.6%.
This looks very bad for GameStop, and raises difficult questions about its future. In an era of digital video game downloads and fierce online retail competition, some analysts have raised the possibility that GameStop is the next Blockbuster.
As bad as it looks for GameStop, management insists its turnaround plan is working.
GameStop’s Shifting Focus
It seems GameStop envisions a future in which digital downloads could replace physical video games. In preparation, it is transitioning its business into new categories. One is the company’s emerging Technology Brands segment, which includes its Simply Mac and Spring Mobile stores.
GameStop operates 70 Simply Mac stores, where it sells a full line of Apple (NASDAQ: AAPL) products. It also offers repair services.
Meanwhile, Spring Mobile sells AT&T (NYSE: T) products and services, including DIRECTV, through its 1,429 AT&T branded stores. It also operates 70 Cricket branded stores.
Thanks to its impressive growth, this business is rapidly becoming a major piece of GameStop’s overall earnings. Technology Brands sales increased 54% last quarter. Operating profit soared 262% from the same quarter last year. This segment now represents 24% of GameStop’s operating earnings.
GameStop also has a growing collectibles business. Collectibles sales rose 37% last quarter, to $109.4 million. GameStop added 22 collectibles stores last quarter, and now has 69 stores, including 15 ThinkGeek stores in the U.S.
Over time, the company believes half of its annual operating earnings will come from areas outside physical gaming.
GameStop will also be active in digital gaming. It has its own digital platform which is nearly a $1 billion business by annual revenue. Digital sales increased 12% last quarter.
GameStop Dividend Appears Secure
GameStop’s turnaround appears to be working. The company is struggling with falling sales, but its profit is actually increasing. For example, gross profit rose 8% last quarter. This is because margins for digital games, collectibles, and Technology Brands products exceeds physical games.
The company expects comparable store sales to decline 6.5% to 9.5% this year. However, it still expects to generate earnings per share of $3.65 to $3.80 in 2016.
The GameStop dividend totals $1.48 per year at present. This represents just 40% of expected earnings this year. That is a fairly modest payout ratio which leaves plenty of room for the company to continue paying dividends.
An Opportunity to Buy for Valuation and Income
High-yield dividend stocks typically carry a higher element of risk. GameStop stock has fallen significantly over the past year.
But this decline could represent a buying opportunity. The stock trades for a price-to-earnings ratio of 7 and the GameStop dividend yield is 6%.
Assuming GameStop’s turnaround materializes as expected, GameStop stock could be a good investment on valuation and income.
Disclosure: The author personally owns GameStop and Apple.