If you’re looking to yourself a raise with passive-income stocks, you’ve probably thought of owning super-high-yielding securities with dividend yields that double or even triple what’s recommended by the “4% rule.”
As you may know, there’s no free lunch in the world of investing (unless, of course, you speak of portfolio diversification!), so a much higher yield comes at the cost of long-term growth, and you could be taking on a lot more risk than you’d initially expect.
For deep-value investors who are willing to take on more risk, there is an opportunity to “lock in” a massive dividend yield should shares move higher as the yield reverts towards its mean levels.
Consider Vermilion Energy (TSX:VET)(NYSE:VET), a Calgary-based energy company that sports a massive 14.1% dividend yield. The 2014 collapse in oil prices has scarred many Canadian energy companies, and Vermilion was not spared, with its shares now down over 75% from its pre-2014 all-time high.
The international oil and gas producer undoubtedly has its fair share of issues (like a majority of its peers). Still, unlike many other sinking fossil fuel players, the company has kept its dividend intact.
For now, the dividend is alive and well. But since nobody can predict oil prices, it’s tough to say whether the dividend will remain static or be reduced substantially to increase the firm’s limited financial flexibility.
The payout ratio has been stretched over the years (at 111%). Although projected 2020 free cash flows could be enough to cover the gigantic dividend payout, investors should be aware that there’s barely any wiggle room. So, any operational hiccups or a further pullback in oil prices could leave the company no other choice but to reduce its dividend accordingly.
Vermilion has already defied the odds by keeping its dividend intact thus far. And should oil surge in 2020, investors could have an opportunity not only to lock in a 14% yield, but also the potential for substantial capital gains.
If you’re in the belief that things could get no worse for the company, you could profit big time from the name. But be warned, Vermilion hasn’t shown any signs of bottoming out yet, and the ridiculously cheap stock could quickly become much cheaper should the unfavourable environment continue dragging along into the 2020s.
At the time of writing, Vermilion trades at 1.2 times book and 3.9 times cash flow. It’s pretty cheap, but the name is cheap for a reason after the company’s negative 2019 guidance revisions and a similar magnitude of production expected for 2020. Assuming WTI prices stay above US$55, Vermilion expects to have no issues funding capital expenditures and its dividend.
Whether WTI remains above US$55 in 2020 is anybody’s guess, but if you’re bullish on oil, Vermilion could be a play that could make you very rich. At the time of writing, WTI trades at $57 and change, leaving very little room for error going into the new year. As such, I’d only recommend the name to aggressive deep-value investors who aren’t reliant on the income from their investments.
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Fool contributor Joey Frenette has no position in any of the stocks mentioned.