High-yield Canadian stocks are sought after by savvy investors, but sometimes the anticipation of a dividend cut is what gives some of them their above-average yields

In this country, high-yield Canadian stocks are often a key part of an investor’s portfolio, but at the same time, they can provide a false sense of security. That’s because some investors tend to think that all high-yield Canadian stocks are safe. However, dividend payments are not nearly as predictable or as safe as, say, bank interest. In fact, investment income like dividends can dry up in a heartbeat. Companies are sometimes unable to honour their commitments, and they sometimes spring the bad news on you with no warning.

At TSI Network, although we think very highly of dividend-paying stocks, sometimes high-yielding Canadian stocks are giving you a warning sign—and that requires you to take a very close look at the sustainability of the company’s dividend.

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Here’s the biggest risk with high-yield Canadian stocks

When looking for stocks with high yields, you should avoid the temptation of seeking out stocks with the highest yield—simply because they have above-average yields.

That’s because a high yield may signal danger rather than a bargain if it reflects widespread investor skepticism that a company can keep paying its current dividend.

Dividend cuts will always undermine investor confidence, and can quickly push down a company’s stock price.

Above all, for a true measure of stability, focus on stocks that have maintained or raised their dividends during economic or stock-market downturns. Generally, these firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they also provide an attractive mix of safety, income and growth.

In short, a track record of dividend payments is a strong sign of reliability and an indication that investing in the stock will most likely be profitable for you in the future.

When a high dividend yield means danger

To reiterate: a high dividend yield may be a danger sign. It may mean insiders are selling and pushing the price down. A falling share price makes a stock’s yield go up (because you still use the latest dividend payment as the numerator to calculate yield—but the denominator, the price, has dropped). But when a stock does cut or halt its dividend, its yield collapses.

A classic case is the now-defunct Yellow Pages Income Fund. When it first issued units in 2003, it was widely trumpeted by brokers and 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 yield—consistently above 10%—was a big warning sign. We never recommended the shares of Yellow Pages Income fund, instead advising investors to stay away from them.

In August 2011, the company’s credit rating was downgraded to junk status; in September 2011, it cut its dividend altogether. By then the yield was above 30%. The company has since restructured to cut its massive debt and re-emerged as Yellow Pages Ltd.—but the original shareholders of Yellow Pages Income Fund got nothing in the reorganization.

High-yield Canadian stocks of blue chip companies are a sound investment in any market

A company with a long-term record of paying dividends is generally one that is most deserving of the “blue chip” label in its traditional sense. Dividends, after all, are much more stable than earnings projections. More important, dividends are impossible to fake—either the company has the cash to pay them or it doesn’t.

That’s not to say there won’t be surprises that affect every company in a particular industry. But regardless of whether investors opt for stocks with high dividend yields, picking well-established, dividend-paying stocks benefits most investors. They have the asset size and financial clout (including solid balance sheets and strong cash flow) to weather market downturns or changing industry conditions.

Top Canadian dividend stocks offer both capital-gains growth potential and regular income. In fact, their dividends are likely to still be paid regardless of how quickly the price of the underlying stock rises (or falls for that matter).

Dividends from Canadian companies also come with a tax credit. This cuts your tax rate.

All in all, it’s realistic to assume dividends from blue chip companies will continue to contribute up to a third of your total return.

Find high-yield Canadian stocks that pay dividends with our Successful Investor philosophy

1. Invest mainly in well-established companies;
2. Avoid or downplay stocks in the broker/media limelight;
3. Spread your money out across most if not all of the five main economic sectors (Manufacturing & Industry; Resources & Commodities; Consumer; Finance; and Utilities).

 What types of stocks have you found to have sustainable high yields?

What is your experience with stocks that have cut their dividends?