Is UPS a Good Stock for Passive Income Investors?

Equity income investors have a lot to consider. With the S&P 500's yield hovering near all-time lows, it's understandable that some market participants are prioritizing yield, at least relative to the broader market.

Then there's the element of consistent, dependable payout growth, which is the lifeblood for long-term passive income investors. Of course, it's always nice to command an above-average yield and steady dividend increases under the umbrella of a single stock. Still, investors need to be cautious before being seduced by high yields and long streaks of payout increases.

United Parcel Service (NYSE: UPS) confirms as much. Earlier this year, the company froze its payout. That's one strike against this industrial stock, and there are other reasons passive income investors should tread cautiously.

This dividend may deliver problems

UPS yields 6.3%, or more than 6 times the dividend yield of the S&P 500, so it's easy to understand why yield-hungry investors may be interested in the stock. Additionally, those viewing it through rose-colored glasses may argue that a company freezing its payout is preferable to a cut or elimination of the payout.

That's true, but the dividend freeze is an acknowledgment that UPS was devoting too much of its earnings to the payout. Additionally, what looks like a step in the right direction isn't 100% protection against negative dividend action in the future. UPS hasn't announced plans to trim or eliminate its dividend, but Morningstar recently released a list of 15 potential dividend offenders, and UPS is part of that dubious group.

Part of the cause for concern is a payout ratio the research firm estimates at 106%. That means UPS's dividend obligation exceeds its net income, and it's well above what many experts consider a healthy payout ratio (generally 35% to 55%).

The other source of concern with the UPS dividend is declining free cash flow. The company posted $5.47 billion in free cash flow last year, but that figure is expected to decline to $5.05 billion this year and $5.01 billion in 2027. That's the wrong trajectory for dividend safety.

The balance sheet is decent, but there's a "but"

At the end of the second quarter, UPS had $23.8 billion in long-term debt and finance leases. That's a big number, but experts view the package shipper's balance sheet as mostly healthy, with no strain on the company in servicing debt.

These are good things, but it's worth noting that high-quality dividend payers can and do accomplish the trifecta of buying back stock, boosting dividends, and lowering debt. UPS isn't checking all of those boxes.

Admittedly, hope isn't tangible investing advice, but there is hope that UPS won't subject investors to negative dividend action. The company bought back $1 billion of its shares last year. The more shares it retires, the lower its dividend obligations become, and that's a good thing for investors. Still, this payout could remain stuck in neutral for some time, suggesting income investors should look elsewhere.

Todd Shriber has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends United Parcel Service. The Motley Fool has a disclosure policy.