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Adib Motiwala
Adib Motiwala
Articles  | Author's Website |

Cherokee (CHKE) - An example of the risks of unsustainably high dividend yield stock.

February 02, 2011 | About:

This article does not discuss the valuation or attractiveness of the stock of Cherokee. It only focusses on one aspect - which is the dividend yield of the stock.

Cherokee Inc is a company that markets and licenses brand names and trademarks for apparel, footwear, and accessories primarily in the United States, Canada, Mexico, the United Kingdom, Europe, and South Africa. It owns various trademarks, including Cherokee, Sideout, Sideout Sport, Carole Little, CLII, Saint Tropez-West, Chorus Line, All That Jazz, and Molly Malloy.

Cherokee filed a 8-K on Jan 31,2011 in which it informed that Robert Margolis resigned from his positions as Executive Chairman and director. In this file, there were various details of payments to be made to him under prior agreements.

An interesting part of the 8-K was the fact that the dividend would be cut to $0.20 per share from $0.38 per share. So, the dividend payment was almost cut in half!!!. The trailing dividend yield as of 30th Jan 2011 was 8.4%. Today, it stands at 5%. The stock was punished by 11%. Some may consider it as an over-reaction. However, in my eyes the appeal of this stock was the high dividend yield.

In the 10Q from Dec 2010, I found a line “Our dividend payments in certain past quarters have exceeded our cash flow from operations, and our dividends may not continue at current levels in future periods unless cash flow from operations increases.”

So, if investors were surprised today at the cut, they should not be. The company did warn you about this. However, since the company had been paying dividends well in excess of cash flow for the last few years, investors could have assumed that this could go on for some more time.

So, let us look at the EPS and Dividend per Share for the last few years.

FY 2010 FY 2009 FY 2008 FY 2007 FY 2006
Diluted EPS $1.43 $1.61 $1.84 $3.93 $2.07
Dividends / share $2 $2.5 $3.0 $2.55 $2.15

Similarly, let us look at Cash from Operations v/s Dividend payout.

FY 2010 FY 2009 FY 2008
Cash From Operations $13.74 million $15.96 million $4.9 million
Dividends $17.63 million $23.84 million $26.7 million

As can be seen from both tables, CHKE was paying out more in dividends than its GAAP earnings as well as the cash earnings as represented by cash from operations.

Yahoo Finance shows the dividend payout (ratio of dividend paid / net income) at 133%.

This shows the perils of investing for dividend based solely on a high dividend yield. In my view, it is better to look at the sustainability of the dividend payout and the room for dividend growth.

1) Check dividend payout ratios. Is it too high? Certainly, anything over 80% seems like a concern to me.

2) Is the business growing or able to sustain the high dividend payout?

3) Is there room to grow the dividend per share and possibly the dividend payout ratio as well?

4) Check the history of dividends for the company and dividend increases / cuts.

Here is a good article posted by Dividend Growth Investor on this website that talking about selecting dividend stocks

Disclosure: No position

About the author:

Adib Motiwala
Adib Motiwala is a Portfolio Manager at Motiwala Capital LLC, an investment management firm that manages separate accounts for its clients.

Visit Adib Motiwala's Website

Rating: 4.7/5 (6 votes)


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GuruFocus has detected 5 Warning Signs with Cherokee Inc $CHKE.
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