How to Determine Dividend Safety

A combination of things can improve the safety of your dividends. Here’s an example with three companies, including Peyto Exploration & Development Corp. (TSX:PEY).

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Typically, when a company’s yield exceeds 7%, investors start to question its sustainability. The rationale is that the market commands a higher yield in that stock, which makes it riskier than similar companies that offer lower yields.

That risk could be in the form of slower company growth or that the dividend is outright unsustainable. However, whether or not a company can maintain its yield must be studied on a case-by-case basis and does not have a direct relationship with how big or small its yield is.

Here are several examples from different industries: Toronto-Dominion Bank (TSX:TD)(NYSE:TD), NorthWest Health Prop Real Est Inv Trust (TSX:NWH.UN), and Peyto Exploration & Development Corp. (TSX:PEY).

Toronto-Dominion Bank

The Canadian banks are known for their safe dividends. Even during the Financial Crisis, they were still able to maintain their dividends, including Toronto-Dominion Bank.

In fact, the bank’s annual payout is more than five times its payout in fiscal 2000 and more than two times its payout in fiscal 2007, right before the Financial Crisis.

Recently, we saw interest rate hikes, which allow Toronto-Dominion Bank and other banks to be more profitable with a higher net interest margin. Throwing in a payout ratio of under 45% and estimated earnings-per-share growth of at least 9% in the next three to five years, Toronto-Dominion Bank is capable of growing its dividend at a decent pace. At ~$67.50, investors can get an initial yield of ~3.5%.

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Northwest Healthcare Properties

Northwest Healthcare Properties earns rental income from 144 healthcare properties in the major markets of Canada, Brazil, Germany, Australia, and New Zealand. The asset mix is about 55% medical office buildings and other and 45% hospitals.

Northwest Healthcare Properties’s portfolio has a weighted average lease expiry of about 11 years and an occupancy of ~96%. Moreover, the real estate investment trust (REIT) has a payout ratio of ~83%, and it has some inflation-indexed leases. So, the company can maintain its yield. At ~$11.10, investors can get a starting yield of ~7.2%.

Notably, Northwest Healthcare Properties’s biggest tenant is Rede D’Or, which was founded in 1977 and is one of the largest hospital operators in Brazil. Rede D’Or contributes 18.7% of the REIT’s gross rent.

Peyto

Although the company is an oil and gas producer (primarily gas), the management keeps a close eye on its earnings and how much in dividends it pays out. Since converting from a trust to a corporation at the end of 2010, the company has increased its dividend by 83%.

That said, with the volatility of the underlying commodity prices, there’s no telling for sure that the dividends from oil and gas producers are safe. However, Peyto is one of the few producers with a higher chance of maintaining its dividend. At $20.40, Peyto offers a yield of ~6.5%.

Investor takeaway

Dividend companies with volatile earnings and cash flows have a bigger chance of cutting their dividends in bad times. A company whose payout ratio is in line or below its peers’ has a safer dividend. Consistent growth in a company’s earnings or cash flows improves the company’s dividend safety. Management’s commitment to the dividend also helps.

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 Kay Ng owns shares of NORTHWEST HEALTHCARE PPTYS REIT UNITS and PEYTO EXPLORATION AND DVLPMNT CORP. NorthWest Healthcare Properties is a recommendation of Stock Advisor Canada.

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