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Risky Dividend-Paying Stocks to Avoid

Investors have had to endure a lot of turbulence and volatility this year, but it's been a very good year for those who invest in dividend-paying stocks.

In the third quarter, dividend increases by U.S. companies amounted to $8.8 billion, according to S&P Dow Jones Indices.

During the quarter, there were nearly 440 dividend increases, up more than 25% from the third quarter of 2011.

Companies that aren't in the S&P 500 also are among those sharing the wealth. The percentage of non-S&P 500 common issues paying a dividend again increased, to 43.4% in the third quarter from 42.7% in the second quarter, 41.7% in the first quarter and 41.4% at the end of the fourth quarter of 2011.

Even with all the positive news for dividend-paying stocks, there are some that are best avoided. Here are a few to keep out of your portfolio.

Stay Away from these Dividend-Paying Stocks

Two dividend stocks investors should avoid are Hewlett-Packard Co. (NYSE: HPQ) and Xerox Corp. (NYSE: XRX).

HP was once one of the most innovative companies in Silicon Valley, and Xerox was a steady, dependable stock.

But over the past five years, HP has lost 72% of its value while Xerox has lost more than 58% in the same period.

Xerox pays a dividend of 4.3 cents per share per quarter – down from 20 cents a share per quarter in 2000. And the company has a long-term debt-to-equity ratio of 0.59.

HP has a yield of 3.9% and has raised its dividend the past two years, but it's a yield trap.

Before 2011, the company went 12 years without a dividend increase. And HP's recent $8.8 billion write-down of its Autonomy acquisition is equal to more than six years' worth of the company's dividends.

READ: For some of the best dividend stocks to buy, .

Avoid this Yield Trap

Another yield trap is electronics retailer Best Buy Co. Inc. (NYSE: BBY), whose 5.6% yield makes it hard to ignore. Best Buy's payout has more than doubled since 2005 and the company raised the dividend this year.

But Best Buy was cash-flow negative in the third quarter and will generate a maximum of $1.05 billion in free cash this year – well below a previous forecast of as much as $1.5 billion.

Best Buy needs to conserve cash after management missteps, declining earnings and margins and other red flags. The retailer that put Circuit City out of business has been savaged by competition from Inc. (Nasdaq: AMZN), Costco Wholesale Corp. (Nasdaq: COST) and Wal-Mart Stores Inc. (NYSE: WMT).

Costco and Wal-Mart pay dividends, both of which are far safer than Best Buy's.

Another dividend-paying stock, real estate investment trust Annaly Capital Management Inc. (NYSE: NLY), has been a favorite of income investors in recent years and it's easy to see why: The shares currently yield almost 14%.

But a flatter yield curve is hurting Annaly's spreads – the firm's ability to profit from the difference in medium- and short-term interest rates.

The REIT has pared its payout four times in the past five quarters and another dividend cut is likely. Annaly also buys mortgage bonds, as does the Federal Reserve, making the Fed a competitor of sorts.

Investors would do well to look for other dividend-paying stocks.

For a 2013 dividend-paying stock forecast, check out this special report from Money Morning Global Investing Strategist Martin Hutchinson.

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