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Why You Should Avoid These Buggy Whip Stocks

Bob is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Buggy-whip technology is an old investing adage that refers to companies whose products or services have become technologically obsolete. This is an unfortunate inevitability of economic growth: technological advancement in certain industries, while a huge boost to society as a whole, means a few individual businesses will be left behind.

In that vein, here are three stocks that have been left behind by the unstoppable force of technological advancement.

Don’t be fooled by dividend yields

Companies such as Pitney Bowes (NYSE: PBI) and R.R. Donnelly & Sons (NASDAQ: RRD) are beloved by their investors for their high dividend yields, which stand well above the roughly 2% yield on the broader market.

Of course, a company can only pay a dividend until it can’t, and investors who rush into stocks with abnormally high dividend yields often feel double the pain when a company slashes its payout—once in the form of less income, and again since a stock that cuts its payout usually sees its stock price fall hard.

That’s exactly what happened to Pitney Bowes, the company behind postage meters, which has seen its share price steadily drop from $34 per share five years ago to its current level of $15 per share.

Along the way, the company’s dividend yield soared into the double digits, since prices and yields are inversely related, which looked great for new investors. After all, who wouldn’t want to receive 13% annually from a stock?

However, in the investing world, something that looks too good to be true usually is just that. Pitney Bowes finally cut its dividend in half when management could no longer avoid the reality of its declining business model.

Fellow Fools, don’t let the same thing happen to you. Let Pitney Bowes serve as a cautionary tale, and avoid both R.R. Donnelly and Frontier Communications (NASDAQ: FTR) for the same reasons.

Don’t ignore the warning signs

Thankfully for investors, we have the information necessary to understand when a business is at risk of permanent damage.

For years, Pitney Bowes has reported declining revenues. Loyal investors consistently pointed to the company’s free cash flow, which had previously covered dividend payments. Unfortunately, like dividends themselves, free cash flow only exists until it doesn’t. Revenue is the lifeblood of any business, and if sales are in decline, free cash flow will eventually follow.

That’s why R.R. Donnelly’s 6.6% yield looks better than it is. R. R. Donnelly, which offers labeling and packaging products and distributes its products to end-users primarily through the postal service, generated $11.5 billion in revenue in 2008. Unfortunately, the company has not been able to match that level at any time in the years since. Last year, the company booked $10.2 billion in revenue.

Making matters worse, R. R. Donnelly’s losses have ballooned at the same time. In 2012, the company’s net loss exploded to $651 million, marking the fourth year in the past five that the company has lost money.

Dividends have not risen since 2008, and how could they? The stock’s yield has risen, but that has everything to do with a falling share price. R. R. Donnelly was a $27 stock five years ago. It now exchanges hands for $15 per share.

Ditto for telecommunications company Frontier: although the company’s 9.3% yield looks tantalizing on the surface, its enormous payout has everything to do with a stock price in free-fall. The company’s profits and dividend payments are going in the wrong direction. That’s because Frontier is still heavily oriented toward traditional wireline telephone service, which is surely going the way of the buggy whip.

Frontier’s recent results bear this out. Frontier’s most recent annual revenue fell 4.4% year over year, and the company has been steadily less and less profitable over the past several years. Frontier booked $0.57 in per-share diluted earnings in 2008. Unfortunately, profits have steadily fallen since then, to the $0.13 in diluted EPS generated last year. At the same time, the company’s long-term debt has exploded, doubling since 2008 to more than $8.3 billion today.

This is why Frontier was forced to cut its dividend twice since 2010. All told, the company’s $0.10 per-share quarterly payout is 60% lower than it was just a few years ago.

High yields can be deceiving

The story behind these three stocks should serve as a cautionary tale for investors to not rush into a stock for yield alone. An investor needs to make sure a company’s high yield is not solely the result of a collapsing stock price due to deteriorating fundamentals.

I love dividends as much as the next income investor. I believe dividends are the best way to build sustainable, long-term wealth. Moreover, dividend changes are one of the best ways to see into a company’s soul, so to speak.

However, investors need to understand that not all dividends are created equal, and yield doesn’t tell the whole story. It’s absolutely necessary to do your homework before buying high-yielding stocks, to ensure you aren’t climbing aboard a sinking ship. Avoid these stocks and the headaches that come with investing in declining businesses.

Robert Ciura has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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