High Yield Stocks - Buyer Beware!

This is NOT a personal finance blog but rather it's a blog about me spouting my opinion on stock picking. I like to pick and shop for dividend stocks that pay a dividend anywhere between at least 3-5%.

This historically has been the sweet spot to buy a very stable company with the potential to grow anywhere between 8-10% a year.

So, 5% + 8%+ =13% return per year on that particular investment.

A high yield is usually a sign that the stock has severely declined in price and it is paying out a lot of it's earnings just to keep the business growing.

Don't be fooled into thinking that the stock is cheap and therefore a good buy.

What to Look For

I search for stocks with a decent yield and a payout ratio of less than 100%.

'Payout ratio is the proportion of earnings paid out as dividends to shareholders, typically expressed as a percentage. The payout ratio can also be expressed as dividends paid out as a proportion of cash flow."

If a stocks payout ratio is too high, then the dividend is in danger of being cut. A low payout ratio allows the company room to increase it's dividend.

As a retiree I always hunt for quality stocks with the ability to raise it's dividend. That's like getting a raise from your boss when you have a job.

Here's an Example

Alaris Royalty AD.TO

Dividend Yield - 8.5%

Payout Ratio = 2.7X

That works out to paying out over 200% of their earnings back to investors. Does that sound like a sustainable business model to you?

"There are no simple rules of thumb with payout ratios. But if you stick with strong companies that have manageable payout ratios – and which also have growing revenues and earnings – you're more likely to be rewarded with dividend increases and less likely to suffer a dividend cut." - John Heinzl

Alaris Royalty can't go on forever like this. They will have to borrow money to keep paying shareholders or make some more acquisitions to grow it's asset base. I don't own AD.TO but have in the past but see no reason to waste my retirement money here.

You will find this throughout the high yield world so do your homework and be careful what you buy. It makes no sense to just buy a stock for a high dividend only to watch the share price crater on you. In that case you really are better off just holding cash. The dividend payments you collect will never keep up with the price plop.

It's a real piss off to see that happen in your portfolio. Happened to me many times before I became an income investor.

More High Yielders

Diversified Royalty DIV.TO

Dividend Yield: 6.2%
Payout Ratio: 2.3X

DIV has a payout ratio over 200% 

Corus Entertainment CJR-B.TO

Dividend Yield: 14.3%

Payout Ratio: 1.18X

Corus pays out 110% of it's earnings. I would run from this stock and the dividend cut is coming within months. There is no way it can keep this up.

Would you risk your retirement money in an entertainment industry stock? No thanks! 

Altagas ALA.TO

Dividend Yield: 7.5%

Payout Ratio: 4.4X

Altagas is paying out over 440% of it's earnings. The dividend is in danger and this is a risky stock. The price keeps moving lower. Troubling times ahead for you if your money is invested here.

If you stick to bank, utility, telecomm and low yielding stocks (3%) you will eventually get a raise and not a paycut.

Most of the blue chip companies payout less than 75% and have yields in the 4-5% range.

Try not to get seduced by the siren song of high dividend yields. As they say in Lost in Space when that happens, "Danger Will Robinson"

Related Post: How I Built My Own Dividend Stock Portfolio

Recommended Reading: You Can Retire Sooner Than You Think