Chasing dividend yield, especially with your TFSA (Tax-Free Savings Account), can be a recipe for disaster if you’re not careful. Sometimes, the high yield that’s on your radar might be too good to be true, especially if the free cash flow payout ratio is on the high side. And if a firm’s already on the ropes, with earnings expected to be in a tough spot in the next year or so, perhaps that added yield isn’t worth the extra risk that you’ll need to take on.
At the end of the day, higher reward, and remember that includes yield, tends to accompany high risk. And as a value investor, you must analyze the risk/reward trade-off to ensure that you’re getting a good idea.
Indeed, it’s these “getting a dollar for three quarters” kinds of propositions that investors should look for, whether or not you consider yourself a passive income investor, a growth investor, or something in between. In my view, all investors ought to strive to be value investors.
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Value ought to come first
If that means getting a bit more growth than the market prices in for your investment dollar or a bit of extra yield (don’t forget about dividend growth as well!), the goal is to stretch every dollar you put to work in markets as far as it can go.
If you’re looking for bargains when you go shopping for pricey electronics or just about anything else, while putting in the homework to ensure you’re getting the best product for the price, you should be more than willing to do even more analysis when it comes to your investments.
Of course, it’s all too easy to follow the tip of a friend, colleague, or some expert strategist on television. That said, there’s only one person who’s accountable for their moves: it’s the investor. With that, putting in more than a good dose of due diligence, I think, is only shrewd, especially when it comes to your TFSA.
Your TFSA is arguably the ultimate compounding machine, and if you can minimize the losers you add to it, I do think you can get that snowball rolling quite quickly.
So, if you’re not chasing yield, what should you chase when it comes to your TFSA?
Beyond value, I’d say chasing dividend growth and predictability of future earnings growth is the way to go. Share buybacks matter, too!
Of course, if you’ve got a top dividend grower with an earnings roadmap that couldn’t be more predictable, all bets are off if the price of admission is too steep. Indeed, value is the number-one trait that must be passed before all else is considered, whether it’s dividend growth potential, yield, or growth prospects.
Dividend growth could be better than yield over the long run
Instead of a distressed 10%-yielder (sorry, Telus investors!), perhaps a name like CN Rail (TSX: CNR) could be a wise bet. The stock took off 4.4% in Thursday’s session, and with the name coming back in a big way ahead of earnings, I’d argue that the 2.5%-yielder is a great bet while its yield is still historically elevated.
Of course, it’s the dividend growth profile and wide moat that are stars of the show. Either way, the name still looks cheap at 20.6 times trailing price to earnings (P/E), especially considering the potential for a big freight comeback once the economy starts moving faster.
