In a world of low interest rates, many investors have become fed-up with next to nothing yields on bonds. These investors have turned to dividend stocks to find their income. While dividend stocks have a place, one must be certain to look beyond yield. It’s only by doing this that one can analyze the true safety of a dividend payment.

In this edition of Dividend Trap, we’re going to examine Mattel (MAT), maker of Barbie, Hot Wheels, and Fisher-Price products. Mattel has paid a dividend for 27-years. Yet, the company most recently cut its dividend in 2011 due to the aftermath of the housing crisis. After immediately returning to dividend growth the company ceased raising in 2014. This makes 2017 the potential third year of no increase.

Beyond the dividend, Mattel’s stock performance has been abysmal this year. While the major indices have charged to new highs, the company’s stock is down nearly 20% for the year. Compare this to their main competitor, Hasbro (HAS), up 30% this year. The performance is worrisome as much of it is attributed to Mattel’s weak holiday season and slower than expected turnaround in key brands. This recent underperformance has sent the company’s dividend yield soaring far above the market average to nearly 7%. Given an S&P 500 yield around 2% and ten-year treasury’s little better at 2.4%, a yield like Mattel’s will get many income investors salivating.

Yield is only surface deep.

The question income investors should be asking is not whether a 7% yield here is attractive, stocks don’t care what you think. Rather, whether it is both as sustainable and more advantageous than alternatives. For instance, a lower risk yield of treasuries. Or, greater diversification found in an ETF such as Vanguard’s High Dividend Yield (VYM) yielding 3%.

Before even considering the dividend investors should focus on the company’s basic fundamentals. In the case of Mattel, we find that growth rates across revenue, operating income, and net income are all negative. This results in earnings per share growth rate of nearly -5%, per year, over the past decade. Unfortunately, there’s little to show management has significant strategies in the pipeline to turn the tide, barring any new license deals or acquisitions.

While a company can go through weak business cycles it doesn’t always mean their dividend is in trouble. In fact, companies who manage their dividend payouts relative to earnings and cash flows in good times are able to leave themselves a margin for when business slows. So, how does Mattel stack up in this area?

With earnings having declined to $0.92 per share as of the end of 2016 Mattel is still attempting to pay an outsized dividend of $1.52 per share. This means the company is paying out 165% of their earnings.

However, earnings can often be deceiving as companies include or exclude one-time items. So, one of the best ways to review dividend sustainability is in comparison to free cash flow. This is the cash left for a period after a company operates its business.

For Mattel, free cash flow for 2016 stood at $1.06 per share compared to the dividend of $1.52. This means management had to finance the dividend by using its cash stockpile or issuing debt. Investors should be concerned. The point of a dividend is to realize part of a company’s profits while leaving a portion for future growth. In its current state, Mattel is not only paying out all its earnings but extra cash as well.  This to appease investors while risking future growth.
There is no guarantee of what happens next. Yet, it would appear that without significant changes Mattel cannot sustain its dividend at these levels. This fact should give those looking at it pause. Those who own it should measure it against other opportunities in the market to see if their capital is better allocated elsewhere.