2 stocks with unsustainable dividend payouts?

Are these two companies set to slash their dividends?

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The reduction in interest rates to 0.25% means that life is now even tougher for income investors. Returns on cash balances and bonds have been squeezed, which makes high-yielding shares more appealing. However, a high yield on its own isn’t enough to justify the purchase of a stock for its dividend potential. Here are two stocks which have high yields, but potentially unsustainable dividends.

Talktalk

Quad-play (mobile, broadband, pay-TV and landline) operator Talktalk (LSE: TALK) currently yields 7.8%. This makes it one of the highest yielding shares in the FTSE 350. Part of the reason for this is Talktalk’s share price decline over the last couple of years. For example, in the last year it’s down by 20%, which has meant its yield has risen even though dividends are no higher in 2016 than they were in 2015.

Of course, Talktalk remains a relatively unpopular stock among many investors after its hacking scandal. Although the company offered redress to customers and its reputation wasn’t particularly damaged in the long run by the incident, investors aren’t willing to value Talktalk highly at the present time. For example, it has a price-to-earnings growth (PEG) ratio of just 0.6. This is also low because its earnings are due to rise by 72% this year and by a further 20% next year, which shows that it continues to perform well as a business.

However, dividends aren’t due to be covered by profit in the current year. This makes them unsustainable at the present time. Yet due to Talktalk’s rapidly growing profitability, dividends are likely to be covered by earnings over the medium term. This increases its income appeal somewhat, but its outlook remains relatively uncertain. Therefore, while it will appeal to growth investors, for income seekers there may be more robust alternatives on offer elsewhere.

Inmarsat

It’s a similar story with mobile satellite communications specialist Inmarsat (LSE: ISAT). On the face of it, the company has huge income appeal. It yields 5.8%, which is 220 basis points more than the FTSE 100. However, as with Talktalk, Inmarsat’s dividends aren’t covered by earnings. This means that they’re unsustainable and shareholder payouts may rise at a slow pace.

Unlike Talktalk though, Inmarsat isn’t expected to grow its bottom line at a rapid rate over the next couple of years. For example, in the current year Inmarsat’s earnings are due to fall by 20%, before rising by 3% next year. This highlights the unaffordability of Inmarsat’s dividend, but also the volatility of its business model.

For many investors, a high yield is desirable, but it’s the reliability and consistency of dividend payments that matters most. Furthermore, Inmarsat’s price-to-earnings (P/E) ratio of 17.4 shows that it offers a narrow margin of safety. Even though Inmarsat has a bright long-term future, its lack of resilience and the unsustainability of its dividend mean that there’s a better option available elsewhere.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares of TalkTalk Telecom Group plc. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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