Last week I received a couple of great questions, and I felt they were important enough to share with readers. So with permission, I’ve posted one of the questions today, and I will post the other next week. I also invite your discussion, since ultimately we are all here to learn!
Is a 16.8% Dividend Sustainable?
Question:
Given the low payout ratio of 58% and a P/E of 3.29 would now be a good time to stock up on Chorus Aviation (CHR.B-T)? Do you think the 16.8% dividend is sustainable? What might be the problem in the future? Seems too good to be true!!
Answer:
If I’ve been trying to point out anything to my readers, it is the following: high dividend yield = high risk.
This isn’t some academic hyperbole, it’s advice you can take to the bank. Have you by any chance noticed what happened to Yellow Media (YLO-T) recently? I have three questions for you: (1) Do you think a 16.8% yield is really sustainable? (2) Is this a company you could see yourself buying and holding forever, and sleeping comfortably at night knowing you own it? and (3) Do you think airline stocks are good investments?
The correct answer to all these questions is “probably not”, therefore it is indeed too good to be true! I generally get nervous with any company that has a dividend yield of 6% or higher, and when it gets close to 10%, I am outright in night sweats. A high yield is also a warning sign of other problems – likely high debt, and low earnings, a dropping share price, or possibly a business model that isn’t working. Also Chorus Aviation likely uses Distributable Cash Flow to measure their payout ratio, and not Earnings per Share, hence the PE Ratio and EPS are meaningless. This is something I cover in my upcoming November Canadian MoneySaver article.
Food for Thought:
I’ve spent a lot of time writing about the perils of high yield stocks, especially in light of the recent stock market rise from the Spring of 2009 through to May 2011. When times are good on the market, small-cap companies perform extremely well, often outpacing their blue-chip counterparts. Many of the Income Trusts for example, have been exceptional performers. But it’s when the market turns, that these higher-yield and smaller-cap companies can get into trouble, often being the first with plummeting share prices. We have seen that recently with some of the previous income trusts, especially in the oil & gas sector.
The reality is if you’re getting a very high yield, then you are also taking significant risk, whether that is in a volatile share price or company fundamentals. I’ve generally considered that if a company is paying a yield over 5.5% to 6% or higher, then it’s a risk investment – plain and simple. Once the yield is over 10% I become very wary, and apply “the do not invest” rule!
Readers what’s your take? Do you agree or disagree, or have anything you want to add?
A high yield like this is not sustainable over the long haul. While companies may try as hard as possible to continue to offer this high yield to their investors, it will be one of the first things to go if the company runs into financial trouble down the road. You can’t bank on it.
Nice post, and yes, almost 16% is certainly not sustainable!
Most of my holdings, operate in the 3-5% range. Anything over 6% definitely runs the risk of a dividend cut. 8%, almost guaranteed cut coming within 2-3 years. Over 10%, a given, probably within a year.
“The reality is if you’re getting a very high yield, then you are also taking significant risk, whether that is in a volatile share price or company fundamentals.”
Well said and totally agree Ninja.
Hank and MOA thanx for posting guys! Yes people still assume a high-yield is worth the risk – when in fact it rarely is 😉
I like this post. It’s very no-nonsense and to the point (not that your other posts are not to the point!).
It’s true, a high dividend yield may be super seductive, but it’s not sustainable.
I suppose I would liken it to dating a SUPER HOT out of a guy’s league girl who seems like she gives you a lot back, but fizzles out soon after because she can’t sustain her hotness.
LOL.
Y&T, glad you liked the post! This is the best comment I’ve ever had on this blog! LMAO 🙂
If I was single, I’d be willing to allocate 10% of my dating budget to SUPER HOT, becuase a 1/10 chance is plausible. But lets face it, spending money on a SUPER HOT date, often translates into a direct capital loss (out of my wallet). That means the risk versus reward ratio is high. Therefore I’ll just stick with HOT instead of SUPER HOT, and improve my odds! (Not that I really know what that has to do with dividends).
Cheers!
Personally, I take a very long look at any stock over the normal dividend paying 2-4% range.
Another thing about this stock, Chorus Aviation (CHR.B-T), is that it is an airline company. I do not invest in any airline companies as I think that the chances of an airline company surviving over the long term is minimal. If I do not think that a company will survive over the long term, it is not an investment for me. Airline companies have a bad habit of going bankrupt.
Susan, thanx for dropping by! You are absolutely right, airline stocks are terrible investments. A yield of 3% to 5% is my sweet-spot. 🙂
An interesting point to note is Susan and I mention a minimum yield on a stock. In other words if a stock doesn’t even pay a minimum yield, why bother investing in the first place?
Cheers
The Dividend Ninja
I appreciate your clarity in this article D. Ninja. As Y&T pointed out, these yields are very seductive and it’s important that investors don’t surrender to these understandable temptations.
Like MOA, most of my holdings are currently in the 3-5% range. I consider this the “sweet spot”. Maybe a bit lower or higher but NOT too much. I think stocks like JNJ, ABT, PEP, PG, TD, EXC and others fit this well.
BUT, to be a bit of a contrarian, I am wondering what your thoughts are on putting a small percentage of your portfolio in some higher (>6%) yielding dividend stocks that might be the exceptions. Emphasize small here. Let me be specific.
A&T and Telus are my big Telecomm holdings (yielding currently 6 and 4% respectively). But, I do hold a smaller position in TEF (yielding about 10% now). I bought some recently because I thought it was undervalued due to its location (Spain). But they have good growth opportunities in Latin American. However, their high debt is a legit concern. D. Mantra and I have exchanged some thoughts on this one since both of us have it and we both have expressed concern over the debt but seem to think it’s a good value w/ growth prospects. I intend to keep it as a small percentage of my portfolio, however, due to the greater risk. Hey, did I just give in to temptation? 🙂
Anyhow, thanx for bearing w/ the details. Any thoughts would be appreciated (as always).
Cheers.
Rock the Casbah well we all stray from our ideals from time to time don’t we?
Right now I have Rogers Sugar (RSI-T) which is a high yield stock at 6.6% dividend yield. But its also a company that is well positioned here in Western Canada for example – it’s on the shelves everywhere from big to small stores! Yes the yield is high but it’s not a company I worry about at night – though they could cut the dividend with that higher yield. And I have a couple of others like PGF-T and LIQ-T that I would definitely like to offload sooner than later!
On the other hand TEF-N is not a company I would feel comfortable holding at all. The yield of 9.4% with the high debt is signalling trouble sooner than later. If you have already made profit then certainly sell it. But if you have already bought it, and you are below what you paid for it, well it’s a tough choice isn’t it.
Cheers
The Dividend Ninja
Hi
For DIVIDEND SUSTANABILITY,
I am wondering what RATIO is more important.
You have said DIV. PAYOUT RATIO is very important.
What about CASH FLOW RATIO?
Should this RATIO be less than 60% for DIV. SUSTAINABILITY?
What about CURRENT RATIO? Is that RATIO imporatant?
Thanks
Nirmal Good question! Most companies use EPS to measure the dividend payout ratio. Almost all of the previous Income Trusts and REITs however, measure their payout ratios from a Cash Flow measure (AFFO for REITS) and not EPS. I cover this in my November Canadian MoneySaver article (be posted here after November 15th):
Payout Ratio = Annual Dividend / Distributable Cash Flow * 100
REITs use AFFO (Adjusted Funds from Operations instead of DCF)
Distributable Cash Flow = Net Income + Depreciation – Capital Expenditures
Unfortunately,these aren’t the easiest numbers in the world to find in the balance sheet – and I doubt the average investor (including myself) knows how to dig these up or calculate them. If you do then let me know 🙂
Cheers!
Hi
Thnaks for the Info. and I will look forward to your Nov. article.
Just curious, YLO.To has gone up from 12c to 38c today.
YLO has NO div. pay out.
Any commnet on this stocks big rise?
Thanks
Nirmal Thanx! I hope you enjoy the November article. I don’t gamble on penny stocks, and already discussed YLO-T extensively. There is nothing more to add here, I never liked it’s business model, and it’s not even a consideration 😉
Cheers
I am a new investor starting January 2011. I bought a position in this stock in June when it was trading around the $5 mark. The dividend payout ratio is below 60%, however, even at the $5 price, the dividend yield is still beyond 10%.
I am anxiously awaiting for the stock to return to the levels when I purchased it, in which I would sell it. Looking at current quarter earnings indicates it isn’t making enough net income to cover its dividends, resulting in a negative impact to their retained earnings.
The situation here slightly resembles Yellow Pages, which does indicate a risky investment. Playing the waiting game in order to determine my next move.
Hey Matthew,
Consider this part of the learning curve we all go through, since everyone has made mistakes along the way. Now you know if seems to good to be true – then it is 😉 But hanging onto a loser seldom pays off.
One solution might be to initiate a stop-loss maybe at $3.25 or $3.50 per share, so if it really starts to tank at least you get out before there is more. That way if it goes up you still hang on, but protect yourself on the downside. For more info on stop loss orders:
http://www.dividendninja.com/stop-loss-and-limit-orders
If the stock price goes up, then you can also raise the stop-loss price. Just be sure to give yourself enough spread on the stop loss price so you don’t sell early 🙂 Just keep in mind I’m not offering you financial advice, its your own decision.
Hope that helps!
Cheers
The Dividend Ninja
Hi Matthew
What is the name of the stock that is you discused above.
Cheers
Hi Nirmal,
I was referring to Chorus Aviation (CHR.B-T) on the Toronto stock exchange.