In the volatile market of mid-2016, investors are increasingly looking to derive immediate income from the stocks they hold, and for many dividend yield is the most important consideration. But in some cases, dividend yield can be misleading.
The yield is certainly one of the most concrete things about an investment. It is the percentage you get when you divide the current yearly dividend payment by the share or unit price of the investment.
It’s an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters.
But yield, and especially a high dividend yield, can give you a false sense of security. Investors have a natural tendency to think that all investment income is nearly as safe and predictable as bank interest. In fact, investment income can dry up in a heartbeat. Companies are sometimes unable to keep paying a long-standing dividend, and they sometimes spring the bad news on you with no warning.
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In fact, high yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling share price makes yield go up (because you use the latest income to calculate yield). When an investment does cut or halt its income, its yield collapses.
A classic case is that of Yellow Pages Income Fund. When it first issued units in 2003, it was widely trumpeted by brokers and in the media as a well-established company (although we viewed it as the over-the-hill division of a formerly well-established company).
The company stayed in the limelight even though its high dividend yields—consistently above 10%—ought to have been a warning sign.
In August 2011, the company’s credit rating was downgraded to junk status; in September, it cut its dividend altogether. By then the yield was above 30%. We consistently advised investors to stay away from the shares of Yellow Pages Income Fund.
Canadian dividend stocks: 42 consecutive years of dividend increases
If you stick with quality dividend stocks, the income you earn can supply a significant percentage of your total return.
For instance, conservative stocks such as utilities usually offer sustainable dividend yields in addition to prospects of steady growth. Two of the stocks we cover regularly in our flagship advisory, The Successful Investor, are good examples of this dependability.
Emera Inc. (symbol EMA on Toronto; www.emera.com) gets most of its revenues from Nova Scotia Power Inc. and the rest from investments in pipelines, power plants and wind-power projects in the U.S. and the Caribbean.
The company generates steady cash flow. Much of this is invested in new projects to spur its long-term growth. But it also allows Emera to pay an annual dividend of $1.60 a share that yields a solid 4.0%.
Fortis Inc. (symbol FTS on Toronto; www.fortis.ca) is the main electricity supplier in Newfoundland and Prince Edward Island. It also has power plants in other parts of Canada, the U.S. and the Cayman Islands.
Fortis has the cash to grow by pursuing acquisitions. At the same time, its cash flow has enabled it to raise its dividend for 42 years in a row, the longest current streak of dividend increases by any Canadian stock. The $1.36 annual dividend yields 3.8%.
You can improve your investment safety by focusing on stocks with long histories of dividends. Dividends are more dependable than capital gains as a source of investment income.
Note: This article was originally published in 2012 and was last updated on July 13, 2016
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