Dividend yields and the successful income investor
Many are chasing dividend yields to make up past losses, but this U.S. expert has a better way, and it includes three Canadian investments.
A dividend yield may not be all it’s cracked up to be.
It’s true that a healthy dividend yield — say 3 to 7 per cent — means you’re getting more income for your investment buck.
On the other hand, a very high yield often means your stock is riding too low — and may not be able to support that dividend much longer.
And a lower dividend yield doesn’t mean the stock’s not doing its job. In many cases, strong growth stocks do just fine with lower yields.
In fact, one American expert has firm advice on the subject. Don’t chase dividend yields.
Says Mr. Roger Conrad in Personal Finance: “Many investors have decided they can make back the losses of the past couple years by buying anything with a super-high dividend, regardless of the underlying business paying it.”
But that is what hurt so many investors in 2008 — high yielding stocks that couldn’t sustain their payments.
“If you’re going to shop for yield,” he says, “you’d better pay attention to who’s writing the checks.”
What you want, he adds, is “income plus.” The analyst tells us just what this means, and illustrates with six examples, half of which are Canadian. No surprise there, since Mr. Conrad is one of America’s foremost experts in the field of Canadian investments.
Healthy and growing
The “plus” in income plus is the strength of the business paying the income. “Every high-yield investment we buy is backed by a healthy and growing business,” Mr. Conrad states. “Investing for income means holding onto positions long enough to collect interest and dividends.”
Some practice what is called the dividend-capture strategy. This means buying a security before the “ex-dividend date” (the date new buyers are not eligible to receive upcoming dividends), holding the security until the dividend is “captured” and then selling it.
This is one of those strategies that may be worthwhile for those moving billions of dollars, says the analyst, but with fees, commissions and taxes, it’s a costly one for most of us — especially if the share price falls.
Forget fancy tricks like that, says Mr. Conrad. Look at two basic risks.
“Credit risk concerns the underlying business’ ability to keep paying distributions. Inflation, meanwhile, erodes purchasing power of income and principal. The higher it is, the worse the damage.”
Risk has receded
The good news is that credit risk has receded dramatically. Studying the yield spread on 10-year Treasury notes, this analyst is able to conclude that the liquidity crisis is over.
Turning to the Consumer Price Index and 30-year Treasuries, he also sees dropping inflation and a positive climate for interest rates.
Taken together, these three benchmarks reveal “a relatively benign environment for income investments. And they point to further gains across the board as long as these conditions persist.”
If the U.S. is unable to keep inflation reigned in after its massive stimulus package that could change, of course.
Keeping pace
Adopting an “income plus” strategy won’t keep your portfolio free from all volatility, says Mr. Conrad. But it remains the best approach.
“If the economy remains weak — or worse, moves into a second leg of a “Big W” recession — only growing and healthy companies will continue to pay the distributions,” he says. “If we see more inflation, growth is our best chance of keeping pace.”
He repeats — high dividend yields that are not supported by growing businesses face devastating dividend cuts as long as recession is a threat. And they’re guaranteed losers if inflation emerges.
When we get down to specifics, we find Mr. Conrad guarding carefully against the weakening U.S. dollar. That means some Canadian content.
A double play
A weakening dollar means higher energy prices, the analyst says. That would benefit the oil and gas producers in the portfolio. Two are “super oils — America’s Chevron (NYSE-CVX) and Italy’s Eni SPA (NYSE-E).
The third is Mr. Conrad’s favourite Canadian oil patch trust, Vermilion Energy Trust (TSX-VET.UN; OTC-VETMF). “Vermilion pays dividends in Canadian dollars, a currency whose multi-year fortunes closely mirror oil prices because of the country’s hefty exports,” he tells his U.S. readers. Consequently, it offers investors a double play of rising income and rising exchange value.”
Vermilion yields a robust 7.7 per cent on a distribution of $2.20. It’s trading today at $29.96.
Chevron yields 3.5 per cent on a dividend of $2.72 and trades at $78.13, while Eni yields 5.9 per cent on a dividend of $2.93 and stands at $49.63 on the New York exchange.
U.S. investors can also get greenback protection from two more Canadian trusts, says the analyst. These are Canadian Apartment Properties REIT (TSX-CAR.UN; OTC-CDPYF) and Yellow Pages Income Fund (TSX-YLO.UN; OTC-YLWPF). Neither, of course, benefit from energy prices. But both reward investors in Canadian dollars.
CAP REIT yields 8.2 per cent on a distribution of $1.08, while the units stand at $13.03. Still under-appreciated by the market in general (but not by Mr. Conrad), Yellow Pages sports a high yield of 15 per cent on its distribution of $0.80, and trades at $5.23.
The analyst has one other holding that hooks up to commodity prices. Dominion Resources (NYSE-D) has holdings in shale gas and a big role in the New England power generation market. Its most important inflation protection comes from its ability to keep pushing the dividend up. It yields 4.8 per cent on a dividend of $1.75 and trades at $36.20.
Mr. Conrad admits that Yellow Pages is the one investment in this group that might feel the pressure of a second recession. But it did cover its payout comfortably in the last quarter.
The rest of these investments have their dividends well covered and have been able to do so through tough times.
Dividend yield is all well and good, he concludes. Just be sure you invest in companies that won’t be forced to yield their dividends.
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