Which high-yielding dividend stocks are safe, and which are not? The answer to this simple question is not that simple.
When you see a dividend yield on the rise, it should automatically raise a red flag. A higher dividend yield typically shows that the market is seeking a discount to own that stock.
For example, if a company’s business relies on a narrow customer base, it’ll be very tough for that business to continue generating cash and sustaining its cash flows. Amid this uncertainty, its share price could start to drop, and its yield could swell.
The latest example to explain this phenomenon is Toronto-based Corus Entertainment Inc. (TSX:CJR.B), a media company which operates a network of Canadian radio stations and children’s TV channels, including YTV, Nickelodeon, and Cartoon Network.
The shift to digital media and over-the-top players, such as Netflix, has been hurting the company’s ad revenues and raising questions about the sustainability of its dividend payout.
As its stock price continues to plunge, its dividend yield has soared to ~20%. With a yield of this magnitude, one can say with certainty that the market is expecting an imminent payout cut.
In a situation like this, when a company is facing shrinking revenue, and when there is no guarantee of how long it will take to turn things around, you should avoid catching this falling knife.
What about this 9% yield?
Corus is a straight-forward example of a dangerous yield that dividend investors should avoid. But what about AltaGas Ltd. (TSX:ALA), a Calgary-based power and gas utility whose stock is now yielding 8.7%? In this case, investors are concerned about the company’s rising debt level after it announced a $8.4 billion mega deal to buy U.S.-based WGL Holdings, Inc. last year.
That deal not only clouded the company’s future outlook, but it also raised questions about the viability of its $0.1825-a-share monthly distribution. That amount of the distribution has increased ~50% from the $0.12 a share that was being paid five years ago.
The company plans to hike it payouts by 8% each year through 2019 if its acquisition of WGL goes through after getting all the necessary approvals from U.S. regulators.
The bottom line
These two examples give you some understanding as to why some stocks offer yields that are much higher than the average market. When you look at higher-yielding stocks, you should do your due diligence to find out which opportunity is worth raking the risk.
Between the two stocks we discussed here, I find AltaGas’s 9% yield is a much safer bet, as this power and gas utility has a reliable business with regulated revenue. The potential for reward is great once the company concludes the WGL deal later this year.
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Fool contributor Haris Anwar has no position in any stock mentioned. David Gardner owns shares of Netflix. Tom Gardner owns shares of Netflix. The Motley Fool owns shares of Netflix. AltaGas is a recommendation of Stock Advisor Canada.