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?
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!!
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?