Learning to avoid the pitfalls of high-yielding stocks
If the yield is in the high single digits or double digits, you need to ask serious questions
There’s no free lunch in the investing world. No one gives you something for nothing.
Investors were reminded of that once again in late June when Toronto-based Corus Entertainment announced it is slashing its dividend by 79 per cent to $0.24 per year, from the current $1.14.
The market was shocked. The share price lost a quarter of its value in the next two trading sessions as people dumped the stock in what almost amounted to a panic sell-off. More than 10 million shares changed hands over two days — this for a stock that rarely trades more than 900,000 shares a day.
What’s puzzling is that investors appeared to be caught by surprise. Prior to the June 27 announcement, Corus B shares were trading at $6.25, giving them a dividend yield of 18.2 per cent. That should have alerted even neophytes to the fact something was seriously wrong. Nobody hands out money at that rate.
When you see dividend yields in the stratosphere, it’s a clear signal that something is seriously wrong with the company, and it’s time to bail out before it’s too late. In the case of Corus, we found out how bad things were when the quarterly results were released the same day as the cut was announced.
PAPE continued on B16
The loss attributable to shareholders for the three months to May 31 was a gut-wrenching $935.9 million, or $4.49 per share. With numbers like that, it’s a wonder the company will continue to pay any dividend at all.
All of this suggests you should take a close look at any highyielding dividend stocks in your portfolio. If the yield is in the high single digits or even double digits, you need to ask some serious questions about the company’s financial status.
For example, let’s look at Alaris Royalty Corp., which trades in Toronto under the symbol AD. At the time of writing, the shares were yielding 10.2 per cent based on a monthly dividend of $0.135 ($1.62 per year). That high return is a tip-off that investors are nervous about the company.
The latest quarterly results fuelled those worries. Alaris reported a loss of $3.1 million for the three months ending March 31 compared to a profit of $11.8 million in the same period the year before. That may be a one-off, but the market doesn’t seem to think so. The stock has been on a downward trend for most of the past year, dropping from $23.45 at this time in 2017 to below $16 now.
Income-oriented investors naturally gravitate to stocks with high yields, especially when interest rates remain relatively low.
But when those returns reach unreasonably high levels, it’s prudent to look carefully at the company. There’s something amiss, even if it is not immedi- ately apparent.
Here are my four basic rules for investing in dividend stocks: Look at the dividend history. Companies with a long track record of dividend payments aren’t likely to alienate their investors by cutting or eliminating the payment unless they are in dire economic straits.
If that should happen, the market will give you advance warning by driving down the share price. Invest in companies with stable earnings. Predictable revenues and profits usually translate into dependable dividends. Utilities and telecoms are classic examples. Avoid companies in cyclical industries. Their dividends aren’t dependable; in good times they pay well, but when conditions change, they may slash their payout dramatically. One example is Norbord Inc., which makes a product used in home construction. Right now the stock is paying $2.40 a year to yield 4.4 per cent. But two years ago the annual payout was only $0.40, and it could go back to that level in another recession. Put special emphasis on regular increases. Some companies have a long track record of regular annual increases. For example, Fortis and Canadian Utilities have both raised their dividend annually for more than 40 consecutive years. Their yields aren’t especially high — 4.1 per cent for Fortis and 4.7 per cent for Canadian Utilities — but you can depend on them going up every year.
Dividend stocks are interestsensitive, so the share price can be negatively impacted by rising rates.
Frankly, I don’t let that worry me. These tend to be solid, dependable companies that offer decent cash flow. I own a lot of such stocks (including Fortis and CU) and plan to continue to do so. They should be at the core of any conservative portfolio.