It’s generally not a good idea to buy dividend stocks that offer yields much higher than their peers. An inflated dividend yield is a sign of danger that cautious investors look for when making a buy decision.
High yields that look quite attractive for income generation are an indication that there is something wrong with the company’s financial health. With their high yields, investors seek a discount to own the share of the company.
But, sometimes, companies share prices get weakened due to temporary setbacks. That’s the time when smart investors take advantage of the attractive valuations and they lock-in their juicy dividend yields. Here is a dividend stock that I think going through a similar situation:
Inter Pipeline Ltd.– a growth stock but loaded with debt
It’s hard to find anything wrong with the business model of Inter Pipeline Ltd. (TSX:IPL), a Calgary-based firm that runs a diversified business in the energy infrastructure space. It operates a large pipeline network, 16 strategically located petroleum and petrochemical storage terminals in Europe. Its NGL business is one of the largest in Canada.
With their diversified operations, IPL is also expanding fast. In Canada, IPL is in the middle of building a $3.5-billion petrochemical complex near Edmonton to convert propane into polypropylene plastic. In late October, IPL announced a $354-million deal to buy European storage terminals from Texas-based NuStar Energy.
But that impressive profile isn’t enough to impress some investors who believe that the company won’t be able to sustain its high payout ratio. The company pays $1.71 annual dividend, which translates into 7.78% dividend yield on today’s price.
This is a huge return if you compare it with the government bonds, one of the safest security. Canada’s 10-year government bond is currently yielding 1.53%. But the company’s 110% payout ratio terrifies some investors. It shows that IPL is paying more in dividends than its earnings, which is generally a bad sign for a company in the energy space, where cash flows are very volatile.
There’s no doubt that IPL stock isn’t for conservative investors. The company has shown volatility in its earnings with a lot of debt on its balance sheet. But I think the company has a right mix of assets and a diversified revenue stream. In addition to this, IPL is in a strong growth mode that separates it from other risky dividend payers.
Other financial indicators, such profit margin (23%), operating margin (38%) and return on equity (16%), all point to a strong underlying business.
If your risk appetite is higher and you can tolerate the energy market’s volatility, then IPL is a good bet to earn a higher yield. That said, it’s not a stock for conservative investors who want to preserve their capital and earn only modest income.
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Fool contributor Haris Anwar has no position in the stocks mentioned in this article.