One of the worst mistakes income investors can make is chasing yield. Investors who are new to dividend investing can get caught up in the allure of a high yield. It is not surprising. The higher the yield, the more income the investment generates.
The reality however, is that chasing yield is a fools game and can lead to significant losses. Why? A high yield can be hiding several underlying negatives and in the long run, may not be sustainable. This can lead to dividend cuts, or at worst, the elimination of the dividend altogether.
This is not to say that all high-yield stocks are risky. On the contrary, there are plenty of companies who boast a high yield and whose dividend is well covered. How can you determine if the dividend is well covered?
The most popular metric is the dividend payout ratio which is used to compared the dividend in relation to earnings. Although relevant, we like to dig a little deeper and also consider the dividend against free cash flow (FCF) and cash from operations (OCF). Why?
Earnings contain many non-cash items and one-time expenses which have no bearing on the company’s ability to pay a dividend. At the end of the day, dividend is a cash outlay and as such, should also be compared against the company’s cash flows.
Taking that into consideration, here are a couple of high-yield stocks worth chasing.
Don’t be fooled by Fiera Capital’s (TSX:FSZ) negative payout ratio as a percentage of earnings. Over the past twelve months, the dividend accounts for only 27% of OCF and 50% of FCF.
Likewise, the company is expect to grow earnings by 16.80% in 2019 and a further 18.40% in 2020. On a forward basis, the company’s payout as a percentage of earnings is only 67.2% (2019) and 56.7% (2020).
As of writing, the company is trading at a cheap 7.61 times earnings and has a tiny P/E to growth (PEG) ratio of 0.39. It is no wonder its yield has climbed to near record highs of 7.44%. The dividend however, is safe.
Power Corp Financial
Its current yield of 5.96% is near the top end of its historical averages. Reason for concern? Not in the slightest. The insurer has paid out uninterrupted dividends since 1998 and has never cut its dividend, not even during the financial crisis.
Its dividend accounts for only 57% of earnings and 45% of FCF which ensures a safe and reliable dividend. A dividend that has grown at a steady rate of 5% over the past four years.
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