When building an income-focused share portfolio, logic dictates investors should seek out stocks that have a high and sustainable dividend yield, as well as sufficient financial strength to survive economic downturns. Typically, large-cap stocks – those with a market cap of $10 billion or greater – have sufficient financial resources and mature enough businesses to meet these criteria. Let’s take a closer look at the three highest yielding Canadian large-cap stocks.
Canada’s largest light oil producer takes first place
Large-cap Canadian light oil producer Crescent Point Energy (TSX:CPG)(NYSE:CPG) is a perennial favorite among income-hungry investors. It has consistently paid a monthly dividend of $0.23 per share since August 2008, giving it an annual dividend of $2.76, a yield of 7%. This the highest dividend yield of any Canadian large-cap stock.
But not all impressive dividend yields are created the same. For the nine months ending 30 September 2013, Crescent Point’s dividend payout ratio was 508%, calculated by dividing the dividend paid by net income, clearly indicating the dividend is not sustainable as it substantially exceeds net income.
However, Crescent Point treats its dividend as an operational expense and calculates the payout ratio by dividing the total dividend paid by total operational cash flow. That gives it a payout ratio of 53% for the same period.
The company considers this a more rigorous method, because cit excludes non-cash items including depreciation, amortization and stock-based compensation and gives a more accurate representation of how much cash the company took in over the year and how much it paid out in dividends.
But it also highlights Crescent Points dependence on cash flow and growing that cash flow to meet its expenses, including the dividend payment. And with a range of headwinds emerging that have the potential to significantly reduce cash flow, the dividend could be under threat.
Key among these is headwinds is waning U.S. demand for Canadian light oil, as U.S. light tight shale oil output ramps up. The impact of this phenomenon is already being felt, with the price differential between Canadian light crude (Edmonton Par) and West Texas Intermediate widening by around 9% per barrel in January 2014 alone.
This oil sands heavyweight takes second
Coming in at second place is oil sands heavyweight Canadian Oil Sands (TSX:COS). Canadian Oil Sands is focused on the production and sale of Canadian Syncrude, a form of light synthetic oil that is the end product after bitumen produced from oil sands has passed through an upgrader.
The company currently pays an annual dividend of $1.40 per share, giving it a juicy yield of 6.6%, with a dividend payout ratio of 81%. While this would typically be considered sustainable because it is lower than 100%, it does not leave much fat should Canadian Oil Sands encounter operating difficulties or a declining macro-environment.
During 2013 Canadian Oil Sands benefited from the narrowing price differential between Syncrude and West Texas Intermediate, yet its cash flow and net income for the full year fell in comparison by 15% and 14% respectively. Much of this was blamed on production outages and the company still reported a respectable result.
However, it is expected that during 2014 this price differential will widen to as much as $5 per barrel and with Canadian Oil Sands forecasting little to no production growth, investors may see net income fall again. However, with a payout ratio of 81%, Canadian Oil Sands is comfortably placed to weather any further marginal decline in net income and maintain its dividend.
This large-cap telco takes third
Third place goes to one of Canada’s largest telco companies, BCE (TSX:BCE)(NYSE:BCE). As a result of the company’s solid 2013 performance, which saw net earnings spike 16%, the board approved a 6% increase in the annual dividend to $2.47 per share.
This gives BCE a particularly tasty yield of just over 5%, with a payout ratio of 62%. This is clearly a sustainable dividend paid by a mature business that is expected to produce another strong performance in 2014.
Foolish bottom line
Not all high dividend yields are created equal. The yield is representative of the risk in the underlying business and in some cases, is maintained at an unsustainable level to attract investors and maintain their loyalty.
While Crescent Point has performed strongly over the years, its underlying business is facing a range of headwinds, which may just render its high dividend yield unsustainable. However, Canadian Oil Sands and BCE are certainly worthy of a second look from investors hungry for high dividend yields.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Matt Smith does not own shares of any companies mentioned.