Nokia's big dividend and low price is a value trap

BOSTON (MarketWatch) — Like a lot of investors, Ray in Marion, Ind. is looking for yield in the form of stock dividends. And Ray is thinking big.

“I know that it’s a bad sign when a stock has a yield above 10%, because the company can be in trouble and paying that much because they’re desperate,” he said in an email. “I saw a lot of financial companies and REITs and energy and tanker stocks, and that didn’t feel so safe to me, so I searched for the first stock with a yield under 10% that I felt was in a business that would be around and safe and recession-proof.”

Barron's Tiernan Ray explores the 2012 Consumer Electronics Show in Las Vegas, perusing the array of lifestyle gadgets, including electronic devices that use connectivity and real-world measurement to try and amplify your everyday life.

That search led Ray to Nokia Corp. NOK -2.26% The world’s largest manufacturer of mobile devices sports a yield approaching 10%, but the stock itself is unattractive enough to be the Stupid Investment of the Week.

Stupid Investment of the Week highlights the concerns and conditions that make a security less than ideal for average investors in the hope that showcasing troubling situations will make danger easier to recognize elsewhere. While obviously not a purchase recommendation, the column is not intended as an automatic sell signal.

Anyone invested in Nokia for yield is likely sticking around until the company cuts its dividend. While management gives no indication that such a move is planned, that would certainly send yield-hungry folks like Ray to the exits. That’s part of the problem.

NOK 5.63, -0.13, -2.26%
SPX 1,311.11, -3.39, -0.26%

But first, let’s look at Nokia’s positives.

In spite of recent issues, Nokia is the world’s leading mobile device manufacturer and dominant in the mobile network equipment and software businesses. Those are growth businesses, and while Nokia has struggled to retain market share, demand for its products isn’t going to suffer because of global economic issues. Moreover, Nokia’s enormous scale gives it some advantages and power that competitors don’t enjoy, which could be exploited to make its products more attractive.

The balance sheet isn’t awe-inspiring — there are a lot of restructuring ideas that are hard even for sophisticated investors to comprehend — but it’s not horrible. There’s a promising partnership with Microsoft to develop handsets for Microsoft’s Windows Phone 7 platform, which could help Nokia recapture some of its lost share of the smartphone business.

Then there’s that yield and the stock’s valuation. Trading for less than $6 per share, most fair-value estimates for the stock are between $6.50 and $13 per share, meaning there should be some upside to go along with the fat dividend. That’s a big part of why Nokia gets a top, five-star rating from Morningstar Inc., and is priced below the point where the Chicago-based research firm labels it as worth buying.

That’s why investors like Ray can get their head around the idea; sure, there’s market risk but the big payout and the company’s giant size make the investment feel less risky.

It’s also where the buying case falls apart. Aside from the obvious, snarky argument against Nokia — When’s the last time a friend bragged about their new Nokia phone? — the fastest way for a stock to see its yield rise is for the stock price to get hammered, and that has certainly happened here.

A year ago, the yield on Nokia would have been 5%; the number has gone up and attracted the Rays of the world, but the good-looking yield happened for bad-looking reasons. Nokia will post net losses for 2011, and the current dividend payout represents more than 200% of the company’s forecasted forward earnings. In an industry where staying atop the technology curve is paramount, you’d have to think the company will eventually decide to cut the dividend to put the money back into the business.

“Your risk is very great that Nokia will have to cut back its dividend, if only because they have to reinvest,” said Brent Wilsey of Wilsey Asset Management in San Diego. “How do you fix a company that’s lagging? You don’t do it by paying a high dividend, you do it by putting more into research and development. … The yield would still be attractive if the dividend payout was cut in half, but the stock will take a big hit if that happens.

“There’s no doubt you’re getting a great dividend yield,” he added, “but it still comes down to whether you are getting a good company.”

And while the current valuation is attractive in some eyes, that assumes the company isn’t going to keep losing money, or that the Microsoft deal will prove to be a lifesaver. Those are big assumptions for a company whose market share is more a product of the past than a promise for the future. In the mobile-device business, public sentiment changes every time someone needs a new product, and having the third- or fourth-best products on the market will not hold on to a leading position for long.

“Dividend yield is an easy place to begin the selection process, but an investor should only buy quality dividend yields … high, growing and sustainable,” said Jun Wang, research analyst for The Applied Finance Group in Chicago. “Investors need to feel comfortable about a company’s fundamentals, which should be healthy, though [those] could be misunderstood or underappreciated. … It is up for debate whether [Nokia’s] business is doomed or underappreciated.”

For someone like Ray, who is looking for big, safe yield, Nokia is not the right fit; it’s beaten down, but there’s no clear bottom. While yield can ease market pain, it can’t take it away completely, and Nokia investors will likely feel more hurt before things get better.