Watch out! Ultra-high dividend yields are high for a reason. What’s the market telling you? These dividend stocks might have low growth. Make sure to triple check dividend safety. Also, target to pay a low valuation, if possible, for the extra risk you’re taking.
Low growth
A high-yield dividend stock having low growth (but safe dividends) isn’t necessarily an indicator that you should skip it. There can be a place in a diversified investment portfolio for ultra-high dividend yield stocks that pay dividend income that is growing at a slow pace, perhaps, even slower than inflation.
For example, although Enbridge (TSX: ENB) stock’s dividend increases were about 3% per year in the last few years, it could still appeal to income-focused investors.
The blue-chip stock targets a sustainable payout ratio that’s 60-70% of its distributable cash flow (DCF). Indeed, its 2022 payout ratio was 67% of DCF.
At under $53 per share, it offers a dividend yield of 6.7%. It means you can approximate annualized returns of about 9.7% assuming it maintains the current valuation and continues growing its DCF per share by roughly 3% through 2025 as management forecasts. Analysts believe the stock is about fairly valued.
No growth is worse
At least Enbridge stock pays an increasing dividend. Here we have NorthWest Healthcare Properties REIT (TSX:NWH.UN), which has paid the same monthly cash distribution since 2011. Because the healthcare real estate investment trust (REIT) hasn’t demonstrated consistent per-unit funds from operations (FFO) growth, the stock fell hard in last year’s rising interest rate environment.
The fact that it has operations globally could also complicate running the business and increase the cost of operation. In other words, the market demands a higher yield on the higher-risk stock. At $9.58 per unit at writing, the REIT yields almost 8.4%. That said, analysts think the stock is undervalued by 23%. So, it could still be a lucrative investment, particularly if you wait until interest rates start coming down again.
Turnaround investment
Turnaround investments are also riskier than average stocks. Take Chartwell Retirement Residences (TSX: CSH.UN) as an example. Its retirement portfolio saw its occupancy falling from 92.6% in 2016 to 77.5% in 2022. For the record, the occupancy in the pandemic year of 2020 was 84.1%.
The company “believes that pandemic related staff and management turnover and the resulting reliance on temporary agency staffing adversely impacted its resident experience in 2022.” Chartwell has made efforts in recruitment, retention, and improving resident experiences. Management currently targets an occupancy rate of 95% in 2025. Even if only 90% were reached, it would still make an awesome comeback.
As a result of the occupancy issue, its FFO payout ratio was approximately 115% in 2022. The substantial sale of its long-term care operations in Ontario will also reduce FFO in the near term. Therefore, it would be smart not to trust Chartwell’s 6.7% yield entirely. However, the stock could deliver outsized returns if it successfully turns around over the next few years.
The Foolish investor takeaway
Generally, higher yield implies higher risk. That is, the dividend may be in danger, or the business may have slow growth. However, don’t be overly alarmed in every high-yield stock you own because higher interest rates have dragged down stock valuations, thereby, pushing up dividend yields across the board. Investigate each high-yield idea thoroughly.
