The Motley Fool

Beware the Dangers of High Yields

Alaris Royalty Corp. (TSX:AD) isn’t the typical financial services stock, such as Royal Bank of Canada (TSX:RY)(NYSE:RY) or Sun Life Financial Inc. (TSX:SLF)(NYSE:SLF). That’s why Alaris Royalty offers a yield of nearly 9.8%, which more than doubles Royal Bank’s yield of ~3.9% and Sun Life’s yield of ~3.5%. Alaris Royalty’s much bigger yield should automatically signal that the company is a higher-risk stock.

What does Alaris Royalty do?

Alaris Royalty offers capital to private businesses that want to maintain the ownership in their companies but can’t get the capital they need from traditional means. In return, Alaris gets big cash distributions from them monthly. Alaris Royalty gets a different yield from each of its partners, but for most it gets yields of ~15%.

Although Alaris Royalty looks for partners that generate strong cash flow, there’s obviously high risk involved given the big yields that it receives. Indeed, the risk has played out at two of its 16 revenue streams, which are giving Alaris Royalty fewer distributions than they’re supposed to. That’s why the stock has fallen ~25% in the last 12 months.

caution

Is Alaris Royalty’s dividend safe?

One of the contributing factors of a safe dividend is a sustainable payout ratio. Management estimates that Alaris Royalty’s payout ratio will be ~93% based on its projections for its net cash from operation.

Alaris Royalty’s payout ratio has been above 90% in the past and has been above 80% in the last five years. So, a high payout ratio is pretty normal for the company. That said, it also means there’s little room for error. Shareholders just have to hope that none of Alaris Royalty’s other partners run into trouble.

The takeaway for investors

For the time being, Alaris Royalty’s dividend is safe, but if you’re looking for safer yields in the financial space, you should consider Royal Bank or Sun Life. Royal Bank’s and Sun Life’s payout ratios are estimated to be ~45% and ~40%, respectively, this year. So, their dividends have a much bigger margin of safety.

What about the margin of safety of the shares? Based on the 12-month mean target price from Thomson Reuters, Alaris Royalty is discounted by ~25% at the recent quotation of ~$16.60 per share, Royal Bank is discounted by ~13% at the recent quotation of $97.60, and Sun Life is discounted by ~11% at the recent quotation of $52.20.

Some of Alaris Royalty’s risks have played out, and the stock has traded much lower as a result. If its revenue streams improve, the stock could have a strong turnaround and deliver the highest returns out of the three stocks in the next one to three years.

Royal Bank and Sun Life are trading within their fair valuations. An investment in either stock will likely be a more stable ride than an investment in Alaris Royalty stock.

Just Released! 5 Stocks Under $49 (FREE REPORT)

Motley Fool Canada's market-beating team has just released a brand-new FREE report revealing 5 "dirt cheap" stocks that you can buy today for under $49 a share.
Our team thinks these 5 stocks are critically undervalued, but more importantly, could potentially make Canadian investors who act quickly a fortune.
Don't miss out! Simply click the link below to grab your free copy and discover all 5 of these stocks now.

Claim your FREE 5-stock report now!

Fool contributor Kay Ng owns shares of Alaris. Alaris is a recommendation of Dividend Investor Canada.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss an important event.

Iain Butler and the Stock Advisor Canada team only publish their new “buy alerts” twice a month, and only to an exclusively small group.

This is your chance to get in early on what could prove to be very special investment advice.

Enter your email address below to get started now, and join the other thousands of Canadians who have already signed up for their chance to get the market-beating advice from Stock Advisor Canada.

I consent to receiving information from The Motley Fool via email, direct mail, and occasional special offer phone calls. I understand I can unsubscribe from these updates at any time. Please read the Privacy Statement and Terms of Service for more information.