Is it safe to build a high-yield, passive-income portfolio? There are different facets of safety, including the safety of your principal and the safety of the income. As well, know what to expect for your capital growth and income growth. Generally, high-yield portfolios have slower growth than diversified portfolios that also include stocks that are lower yield but expected to have higher growth.
Big dividend stock examples
Enbridge (TSX: ENB) is a large energy infrastructure company with a market capitalization of roughly $98 billion and an enterprise value of about $161 billion. As its earnings-per-share growth has slowed, its stock price has traded in a sideways range. In fact, the stock is trading at similar levels as in 2015.
Investors have noticed the slower growth in the company and essentially refuse to pay more for the stock. Still, Enbridge management has been diligent in maintaining a growing dividend. So, the stock now offers a high yield of almost 7.7%. In a higher interest rate environment, ENB stock is unlikely to experience a big run-up. Enbridge’s dividend increases through 2025 will likely be approximately 3% per year.
At $46.23 per share at writing, the stock is fairly valued and could deliver total returns of about 7-10% per year over the next few years. Whenever interest rates start coming down, it should be a positive for the stock.
Similarly, Bank of Nova Scotia (TSX: BNS) also offers a high dividend yield but has been underperforming. Its international strategy has not worked out well in the past few years. Therefore, the bank exited certain geographies with write-downs. In fact, in the past 10 years, its diluted earnings per share only increased at a compound annual growth rate of about 4.4%.
The fairly new chief executive officer, Scott Thomson, who started leading the company in February, has yet to prove himself. At $60.99 per share at writing, BNS stock trades at about 8.7 times earnings, which is a discount of about 22% from its long-term, normal price-to-earnings ratio.
Canadian REITs
Canadian real estate investment trusts (REITs) have been a good source of monthly income. In a higher interest rate environment, Canadian REIT valuations have also come down, driving their cash distribution yields higher.
For example, in late 2021, Automotive Properties REIT (TSX: APR.UN) traded at about $13 per unit with a cash distribution yield that was north of 5%. At $10.18 per unit at writing, it offers a high yield of close to 7.9%.
Notably, in the past five years, its funds from operations per unit actually declined a few percentage points. However, its payout ratio appears to be sustainable, with an estimated payout ratio of about 83% of funds from operations this year. At the recent quotation, the 12-month analyst consensus price target represents a discount of about 14%.
Investors should also note that Canadian REIT cash distributions are taxed differently than dividends. In non-registered accounts, the return of capital portion of the distribution reduces the cost base. The return of capital is tax deferred until unitholders sell or their adjusted cost base turns negative.
REIT distributions can also contain other income, capital gains, and foreign non-business income. Other income and foreign non-business income are taxed at your marginal tax rate, while half of your capital gains are taxed at your marginal tax rate.
Automotive Properties REIT’s cash distributions last year consisted of other income, return of capital, and capital gain.
Can you make a passive-income portfolio with just big dividends?
Some retirees realize they don’t have enough savings to make the passive income they need for their retirement. So, they end up holding a large portion of high-yield dividend stocks, including preferred stocks.
If your focus is on income, you can choose to build a passive-income portfolio with just big dividends. Just be careful to choose dividend stocks that have sustainable payouts and be ready for below-average growth of your capital.
Coincidence or not, as shown in the graph below, all three big dividend stocks introduced above have apparently underperformed the Canadian stock market over the long run as well as over the last one, three, and five years.
ENB, BNS, APR.UN, and XIU Total Return Level data by YCharts
