Treat High Dividend Yields As A Danger Sign If It Seems Too Good To Be True, It Probably Is

The Oxford English Dictionary cites the phrase “too good to be true” as first being used in 1580. Apparently, even during the Elizabethan Era, there must have been gullible retirees who invested in high-yield stocks, only to discover the dividends were not sustainable. “The company's dividend wast gen'rous yet the company doth goest bankrupt, so I hath fewer shillings than wenst I started,” wrote one disgruntled investor in 1580.

All right, I made that up. But you get the point.

Since there is no such thing as an investment without risk, the closest an investor can get to a “risk-free” rate of return today is via high-interest savings accounts and Government of Canada treasury bills, where one-year rates sit at about 1%. For conservative investors seeking relatively high yields from common shares, the upper limit is about 5%. Companies that pay in that range include BCE Inc, Power Financial Corp., Power Corp. of Canada, IGM Financial, CI Financial and Emera Inc. Once you reach for yields that are higher than that, however, you’re taking on added risk, whether you realize it.

Extremely high-yielding investments often have a high dividend payout ratio, which means they’re paying shareholders more than what they’re generating in cash flow or earnings. Some companies maintain their dividends by issuing debt or new shares. Others have what looks like a generous yield thanks to a plunge in their share price and may be selling off assets to maintain the dividend.

As Warren Buffett famously said, “Don’t worry about the income, worry about the outcome.”

Here are some income-generating investments with relatively high yields. All have a long track record of consistent payouts and sustainable dividends in relation to cash flow. As far as growth prospects go, income-seeking investors should be more concerned about share price volatility than growth. This is by no means a complete list, and the descriptions are merely starting points for further research, not buy recommendations.

Disclosure: Both my wife and I hold positions in Pembina Pipeline in our Locked-in Retirement Accounts (LIRAs).

Enbridge Income Fund Holdings Inc. (ENF/TSX)

Enbridge Income Fund Holdings Inc., sponsored by Enbridge Inc., gets most of its earnings from Canadian pipelines and “green power” projects such as solar and wind farms, and waste heat recovery.

Revenue, earnings and Earnings per Share have all climbed steadily every year. Most importantly, ENF has steadily increased its dividend, to 17.1c per month.

Like Enbridge itself, the shares of ENF and other energy transporters have been in a slump thanks to the oil price dip and opposition from anti-pipeline groups, and both energy prices and environmental concerns are perennial risk factors for pipeline companies. In this case, however, ENF’s affiliation with Enbridge helps mitigate the risk.

Enbridge Income Fund’s stock traded in the $35 range in early 2017, but has recently slipped to about $30, which means the annual dividend of $2.05 yields about 7.3%. ENF offers a Dividend Reinvestment Plan (DRIP) at a 2% discount to the current share price.

Pembina Pipeline Corp. (PPL/TSX)

Pembina, first set up in Alberta in 1954 to transport crude oil from the Pembina field near Drayton Valley to Edmonton, became an income trust in 1997 and converted to a corporation in 2010. Today Pembina’s midstream pipelines transport oil and gas produced in western Canada and ethane produced in North Dakota, mostly under relatively safe long-term contracts. The company also owns and operates gas gathering and processing facilities and an oil and NGL infrastructure and logistics business. Last year Pembina paid $9.4-billion for Veresen Corp., creating a giant with an enterprise value of $33-billion.

Although revenue slipped in 2016, Pembina’s cash flow and profits have grown steadily every year. Like many high-yielding stocks, Pembina’s dividend payout looks excessive when compared to earnings and free cash flow (operating cash flow less capital expenditures) but modest in relation to operating cash flow.

Pembina’s shares fell below $30 in late 2015 and early 2016 but have since recovered and have managed to stay above $38 for the last couple of years. Pembina raised its monthly dividend to 18c from 17c last fall, and at a current price of about $40, the stock is not cheap. The dividend yields 5.4%.

Pembina suspended its DRIP indefinitely last year but said shareholders in the DRIP would automatically be re-enrolled when it resumes.

First National Financial Corp.

First National originates, underwrites and services mostly prime residential and commercial mortgages, with more than $100-billion in mortgages under administration.

Like real estate investment trusts, First National’s share price fluctuates with the outlook for interest rates and real estate in general. While its single-family residential mortgages have slipped, its commercial originations increased last year, along with revenue and net income.

In December the company paid out a special one-time dividend of $1.25 after First National said it had “generated excess capital in the past several years and that the capital needed for near-term growth can be generated from current operations.”

Early last year First National raised its monthly dividend to 15.4c from 14.2c, and at a current share price of about $28, the dividend yields about 6.7%. The company does not have a dividend reinvestment plan (DRIP).

Brookfield Real Estate Services

(BRE/TSX)

BRE provides services to a network of about 18,000 residential real estate brokers and agents operating under 294 franchise agreements from 662 locations, representing about 20% of the Canadian residential market. The company’s brands include Royal LePage, Johnston & Daniel and Via Capitale Real Estate Network. Although the real estate industry is cyclical, BRE gets most of its revenue from royalties, fixed fees and long-term franchise agreements. The company was an income trust until the end of 2010.

As BRE’s network has grown, its annual revenue has been climbing over the past three years. While the company’s net income and earnings per share have fluctuated widely, its share price and dividend have been relatively steady.

BRE raised its monthly dividend four times over the past five years. The payout climbed to 10¢ from 0.92¢ at the end of 2014, to 10.4¢ in mid-2015 and to 10.8¢ at the end of that year, and finally to 11.25¢ last year. At a price of about $17, the current monthly payout of $1.35 per year yields 8%, and if past practice is any indication, the dividend could rise again.

Despite the steady share price and dividend increases, with a market capitalization of just $160-million, investors considering BRE must view it as only a small component of a diversified portfolio.

Northland Power Inc. (NPI/TSX)

Northland Power, established in 1987, went public as an income trust in 1997 and converted to a corporation in 2011. Northland has 25 operating solar, wind and thermal power facilities in Canada, mainly in rural Ontario that generate about 2,000 megawatts of electricity. Its major installations include the Thorold Cogeneration Station in Thorold, Ont., a 260MW natural gas-fired generating station in North Battleford, Sask. and the Jardin d’Eole Wind Farm in the Gaspesie region of Quebec, together with dozen 10MW solar energy facilities in Ontario.

Northland also has an 85% interest in the giant 1.2-billion Euro, 332MW Nordsee One offshore wind farm nearing completion in Germany.

Late last year the company increased its monthly dividend to 10¢ a share, up from 9¢ a share, where it had been since 2008.

A long-term chart of Northland’s share price shows slow, steady growth. The price rose 50% between mid-2015 and mid-2016; since then Northland’s shares have held steady between $23 and $24. At a current share price of about $22, the company has a substantial market capitalization of more than $4-billion, while its dividend yields 5.5%. The company offers a dividend reinvestment plan (DRIP).

Extendicare Inc. (EXE/TSX)

The aging of Canadian Baby Boomers bodes well for the future growth of nursing home chains Extendicare and Sienna Senior Living, although both are subject to regulatory risk.

Founded in 1968, Extendicare has a network of 101 owned or managed long-term care centres, 15 retirement living centres and 36 home health care branches, with most facilities located in Ontario. The company sold its U.S. business in 2015. Extendicare is trying to shift its revenue stream to include more private-pay versus government-funded facilities. Retirement communities under its Esprit Lifestyle Communities brand.

Revenue has grown every year. However, earnings have fluctuated. The company reported $132-million in cash and $539-million in total long-term debt as of September 2017.

Extendicare’s dividend was cut to 4¢ from 7¢ in 2013 and has held at that level ever since. The dividends paid to represent about 75% of the company’s Adjusted Funds from Operations (AFFO).

Extendicare’s shares have been in a slump, falling from a high of more than $10 in the first half of 2017. At a current price of $8.40, the 48¢ annual dividend yields about 5.7%.

Whether they’re looking for long-term growth or income conservative investors can always hold blue-chip stocks. Growth seekers can subscribe to DRIPs, while income seekers can take the dividends as tax-favoured income. If you are interested in a company whose shares yield more than 5%, look to its dividend and share price history, along with its balance sheet, but always remember that if the yield seems unsustainably high, it probably is.

Richard Morrison, CIM, is a former editor and investment columnist at the Financial Post. richarddmorrison@yahoo.ca