Dividend earners can’t resist TSX stocks with high yields, if not the highest. However, there’s a danger for unsuspecting investors. You can fall into dividend traps and incur financial losses instead of gains. The TSX is not free of dividend traps. It would help to know or watch for warning signs to avoid them.
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Warning signs
The worst trap is when a company offers a “very high” dividend yield to attract investors. Raising the payout through the roof is a desperate attempt for a company in trouble or under financial stress. Gather as much information as possible before jumping into the tempting offer.
Review the cash flow and check the payout ratio, as the latter indicates if the dividends are sustainable. A payout ratio (proportion of dividends to earnings) of over 100% is a red flag. The total dividend payments to shareholders shouldn’t be more than the company’s earnings. Verify if the cash flow is little or negative.
However, there are exceptions like BCE, whose business is capital intensive. The telco giant’s payout ratio is more than 150%, but it’s a reliable passive-income provider with a dividend track record of more than 100 years.
Stay clear of highly leveraged firms or companies with excessive debt. The chances of a dividend cut or stoppage are high in a harsh or challenging economic environment. Internal disputes or business problems could cause a stock price to drop and sound alarm bells.
Not a dividend trap
The scissors came out during the coronavirus breakout in 2020. Due to unprecedented conditions, many companies had to bite the bullet and reduce or stop dividend payments. Suncor Energy (TSX: SU) slashed dividend by 55% and suspended share buybacks because of weak commodity prices and staggering losses.
Suncor lost its Dividend Aristocrat status, but management said the move was necessary to shield the balance sheet. Still, the case of this oil bellwether three years ago was not an intentional dividend trap. As of this writing, the energy stock is up 11.83% year to date. At $46.33 per share, the $59.99 billion integrated energy company pays an attractive 4.71%. The current yield is the highest in Suncor’s history.
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This stock could be a dividend trap.
Yield-thirsty investors will love Labrador Iron Ore Royalty Corporation (TSX: LIF), or LIORC. At $31.49 per share (+0.18% year to date), the dividend yield is 12.2%. This $2 billion iron ore producer and processor operates through its subsidiary Hollinger-Hanna Limited.
LIORC holds a 15.1% interest equity interest in Iron Core Company of Canada (IOC), collecting a 7% gross overriding royalty and a 10% per ton commission on all iron ore products that IOC produced, sold and shipped. Unfortunately, this basic materials stock is high risk and could be a dividend trap.
Dividends depend on IOC sales; if they fall the dividend payouts follow. LIORC’s quarterly payouts are inconsistent based on its dividend history from December 2012 to September 2023. The amounts are low in some quarters and high in others.
Sound advice
The advice to income investors is not to take every chance to snatch a generous giver. Not all dividend-paying companies are created equal. Dividend stocks paying extremely high yields are for people with high-risk investment appetites.
