Is a >10% Dividend Yield a Good Deal in a High Interest Rate Environment?

Dividend stocks are considered relatively safer than growth stocks. But what does >10% dividend yield mean to shareholders?

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This year has been weak for dividend stocks. High interest rates channelled a significant portion of high-debt companies’ cash flow towards debt payments, leaving a lesser amount for dividends. Many small- and medium-sized companies slashed dividends and restructured operations to make high-interest payments. The overall sector weakness pulled down all stocks, even those that sustained their dividend per share, creating a value pick for dividend seekers. While yields of Dividend Aristocrats like Enbridge and BCE went above 7%, yields of some stocks crossed 10%. 

Are stocks with >10% dividend yield good investments in a high-interest rate environment? 

What does >10% dividend yield signify? 

A dividend is a portion of the profit a company shares with its shareholders. Many companies pay dividends from the cash left after reinvesting in the business and regular debt payments. A dividend yield is a dividend amount as a percentage of the share price. 

If a $100 stock gives a $10 dividend annually, its dividend yield is 10%. 

The 2023 bear market momentum occurred as bank savings accounts gave 5% interest. Deposits are protected up to $100,000 by the Canada Deposit Insurance Corporation. Hence, many low-risk investors switched their investments from dividend stocks to bank deposits, pulling down dividend stock prices. When the market moves freely, it automatically balances risk and reward.

Many dividend stocks fell, which inflated their yields. In some cases, the stock price fell as its credit risk increased. A higher yield signifies a higher risk of a dividend cut. It is the premium a company pays to shareholders for sharing the business risk. Remember, dividends are not protected, and the management decides how much dividend to give considering the business requirement. 

A TSX stock with a >10% dividend yield 

One such high-yield stock is short-term mortgage provider Timbercreek Financial (TSX:TF), which enjoyed high profits from rising interest rates. At the end of the third quarter, it had a loan portfolio of $1.07 billion with a weighted average interest rate of 9.9%. These high interest rates increased its profit margins and distributable cash flow, reducing its dividend-payout ratio to 85.6% from 86.2% a year ago. 

Despite rising profits and a falling payout ratio, TF stock price dipped 35% during the interest rate hike from April 2022 to October 2023. The stock price fell because of the rising credit risk of the mortgage provider and the attractive interest of low-risk bank deposits. 

Timbercreek Financial’s credit risk

Timbercreek Financial provides short-duration (one to five years) mortgages to real estate investors or real estate investment trusts to make repairs, buy, or redevelop an income-generating property. Its mortgage bridges the gap to securing a traditional, lower-cost, longer-duration mortgage from a bank. Most companies repay their loans from traditional mortgages or from the proceeds from selling the property. 

High interest rate earns higher interest income for Timbercreek Financial. But it slows commercial activity if the rate reaches a point that discourages more lending. The Bank of Canada’s accelerated rate hike from 0.25% to 5% did just that. Some real estate companies paused development until the debt became affordable. Higher interest rates also slowed property buying and selling, impacting the mortgage turnover. 

Timbercreek Financial’s portfolio turnover decreased to 6.0% in the third quarter compared to 11.6% in the second quarter as mortgage repayments slowed. More loans reached stages two and three as borrowers struggled to repay. In such a scenario, Timbercreek Financial works with the borrower and modifies or extends the term to help recover debt. For this credit risk, the stock has a>10% dividend yield. 

Is this stock a good deal? 

Economists expect rate cuts next year, which could see TF stock recover while sustaining its dividend per share. But if the central bank retains a high interest rate for a longer term, TF’s dividends could feel the pressure. And if the situation demands a 25-33% dividend cut, the stock price could fall equally. So far, things look bright for TF, with hopes of a recovery in stock price next year. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy.

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