Should You Have High Yield Stocks in Your Portfolio?

Investors have different income goals, and sometimes, they’re forced to buy high-yield stocks, such as Alaris Royalty Corp. (TSX:AD), which currently offers a whopping dividend yield of 10.3%.

Investors should ask themselves why a company is paying such a high yield. Heck, even when Alaris was trading at higher levels and offered a +7% yield in 2015, it was still considered a high-yield investment.

yellow caution signs plastered on a page

How High of a Yield is Too High?

Typically, when a stock offers a yield of 6% or higher, investors should be extra careful. In my recent article on Seeking Alpha, I discussed the risks of investing in Alaris. So, I won’t go into the details of that.

Here’s a quick summary, though. Alaris lends money to companies and gets monthly cash distributions in return. Ideally, Alaris would like to partner with these companies for the long haul to get a high income from them.

How high of an income does Alaris get from its partners? Well, mostly 15%. Yes, you read that right. Immediately, that should raise a red flag because normally businesses don’t borrow money for such a high rate. That said, Alaris operates in a niche area, and there seems to be a need for its services.

Alaris did end up having some problematic partners, and that’s why the stock has done poorly in the last few years. In other words, when investing in Alaris, shareholders must assume that some of its partners will become problematic. That’s also why Alaris offers an above-average yield.

What About a High-Yield Stock such as BCE Inc.?

The dividend yield of BCE Inc. (TSX:BCE)(NYSE:BCE) isn’t quite at 6% yet, but it’s getting close at about 5.6%. What’s the risk in investing in BCE?

BCE should be able to maintain its dividend as its payout ratio is estimated to be about 86% this year. However, notably, its payout ratio has expanded from 63% since 2009. This means that BCE has been increasing its dividend at a pace that’s faster than its earnings growth. If this continues, BCE will have to slow down its dividend growth, or worse have to cut its dividend. (Though, I don’t see the latter scenario happening anytime soon.)

BCE’s three-year dividend growth rate is about 5%. Going forward, analysts estimate that the big telecom will increase its earnings per share by about 3% per year. That’s roughly keeping pace with inflation.

Lots of investors hold BCE for its income. If they’re fine with getting a ~5.6% yield, price appreciation of about 3% for an estimated total return of 8-9% a year, and the fact that BCE’s payout ratio is expanding, which makes its dividend less safe year after year, then that’s ok.

At about $54.20 per share, BCE trades at a multiple of about 15.8. So, buyers today are paying that multiple for (let’s give it some wiggle room), say, 3-5% growth. That’s pretty expensive in my books.

Investor Takeaway

Before investing in any high-yield stock, think about what risks you’re taking.

Between Alaris and BCE, BCE offers a safer yield given its lower payout ratio and more stable and predictable business. BCE should be able to raise the prices of its products and services in pace with inflation, while the same can’t be said for Alaris, as its business model is more unpredictable.

There are better dividend-growth stocks, which have safer payout ratios.

If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.

Disclosure: At the time of writing, I’m long TSX:AD.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

Get Exclusive Articles from me on Seeking Alpha

  • Access my portfolio of high-quality U.S. and Canadian dividend stocks.
  • Real-time updates of when I buy or sell from this portfolio.
  • Get best ideas of the top 3 dividend stocks from my watchlist. Updated each month.
Learn More

Leave a Comment

Your email address will not be published. Required fields are marked *