Warning: Avoid This Dividend Stock

The quest for stocks that offer both capital gains and income is downright appealing. And the best-performing dividend stock of 2014 has been delivering on both fronts.

I know that most income investors prefer the safety and security of investing in blue-chip dividend stocks. So I focused my search to S&P 500 stocks with a current dividend yield of more than 3%.

The best dividend stock that met the criteria is a company called Exelon (NYSE: EXC).

[ad#Google Adsense 336×280-IA]Its performance in 2014 is a little surprising.

That’s because in 2013 — when the S&P 500 rose more than 30% — Exelon shares were down 8%.

One of the reasons that the stock dropped last year is because Exelon’s business is expected to shrink.

But now that this slowdown is priced into the stock, it seems value investors are jumping on board.

The stock has bounced back this year, with year-to-date gains of 31%.

Those gains exceeded runner-up Garmin (Nasdaq: GRMN) by 7%, and makes Exelon the fourth-best-performing stock in the S&P 500 index.

Utility stocks have performed well in 2014, and that’s helping shares of Exelon. The Vanguard Utilities ETF (NYSE: VPU) is up 11.5% compared with a 1.2% gain for the S&P 500 (NYSE: SPY). That’s a reversal from last year, when the S&P 500 returns beat utilities by 4-to-1.

So what is Exelon? It’s a utility company that operates in 47 states and provides electricity to more than 100,000 business customers and 1 million residential homes. Plus, the company’s natural gas reaches 6.6 million customers. With $23 billion in revenues and 26,000 employees, Exelon is a major player in the utility business.

Income investors will be attracted to the company’s $1.24 dividend. Based on the recent share price of $35, Exelon stock offers a 3.6% dividend yield.

Yield junkies may scoff at the small dividend. But with the average S&P 500 stock paying just 1.9%, Exelon’s dividend seems relatively attractive.

Like most utilities, Exelon isn’t a high-growth business. This year, analysts expect the revenues to decline by 7.6%. And next year, the revenues are expected to increase at a tiny 1.3%.

On the profit front, Exelon is expected to earn $2.37 a share in 2014. Based on those expected earnings, the stock trades at a P/E ratio of 15. That valuation puts Exelon in line with the S&P 500 index.

So should you chase this winner, and buy Exelon stock?

My short answer is no. And the reasons to avoid this top-performing S&P dividend stock are simple.

Exelon’s business is shrinking for a variety of reasons. And the outlook isn’t very bright either. PJM Interconnection operates the regional power grid, and is a major Exelon partner. But their partnership will end in 2016. The reduction of Exelon’s electric capacity is expected to cause a 41% drop in revenues.

That type of drop in business really scares me. I prefer to invest in growing dividend stocks. The simple reason is because a company that’s growing its business can afford to increase the dividend. And I know that dividend growth is a leading contributor to a stock’s total return.

Last year, Exelon cut its dividend by 41%.. With the company’s business expected to shrink considerably in just a few years, Exelon’s dividend isn’t secure. And while the 3.6% dividend yield may seem attractive today, it may be much smaller in a few years.

In 2014, Exelon shares have bounced back. But that jump in price is supported by little more than value investors who stepped up and bought the stock when it was trading in the high $20s at a P/E of 11.

There are many dividend stocks that are far more attractive than Exelon. I like to look for a growing business, healthy yield, consistent history of dividend growth and an attractive valuation.

— Ian Wyatt

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Source: Wyatt Investment Research