Why Retirees Need to Be Wary of High-Yield Stocks

Who doesn’t want to retire with more income? People retire with a nest egg to enjoy. A portion of the nest egg might be invested in high-yield stocks to boost retirees’ income. That’s where retirees got to be careful, because they may be taking on more risk than they think for that high yield. You simply don’t want any dividend-cut surprises.

Know well what risks you are taking when you invest in high-yield stocks. Here are some examples for illustration.

Is there price appreciation potential?

It’s fine for retirees to invest in real estate investment trusts (REITs), such as NorthWest Health Prop Real Est Inv Trust (TSX:NWH.UN), for stable monthly cash distributions. Yet many REITs, especially the high-yield ones, don’t grow very fast, particularly in a rising interest rate environment.

Other than the growth of REITs that should make the underlying stocks appreciate over time, retirees should aim to buy at good valuations to increase their price appreciation potential.

It’s wonderful if you’d bought Northwest Healthcare REIT about three years ago when the healthcare REIT was cheap. However, since then, the run-up of the stock has made it fully valued at best.

Northwest Healthcare REIT’s occupancy is sustainably high, and its payout ratio is reasonable. Therefore, its cash distribution is safe. However, it would be wise to buy on dips at good valuations, so you boost your initial yield, get your income, and increase your price appreciation potential.

Is the business stable? Is the dividend safe?

Alaris Royalty (TSX:AD) stock offers a mesmerizing dividend yield of 8.7%. However, it has been in a downtrend for five years. Investors who’d bought the stock at a high point would be sitting on some substantial paper losses, despite getting an above-average yield.

Fortunately, Alaris Royalty has been sustaining its dividend, but, then again, its run-rate payout ratio has been pushed up to about 98% since it had some problematic revenue streams. Even for Alaris Royalty, which tends to have a high payout ratio, a ratio of 98% is cutting it really close, and it’d be more reassuring to see the ratio closer to 90%.

Thankfully, the company has about $230 million available for deployment into new or existing partners to increase its revenue stream and reduce its payout ratio. For every $50 million that is deployed at 15% (which is the typical yield that Alaris gets from its cash distributions), it’d be an impact of $0.10 per share.

Investor takeaway

When exploring high-yield stocks, ensure the underlying businesses are stable and the dividend is sustainable. Be cognizant of the valuation you’re paying for the stocks. In general, businesses that have some growth are better than those that are merely stagnating.

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Fool contributor Kay Ng owns shares of Alaris and Northwest Healthcare. Alaris is a recommendation of Dividend Investor Canada. Northwest Healthcare is a recommendation of Stock Advisor Canada.

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