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Can a dividend yield be "too high" (unsustainable)?
What's a good rule of thumb when it comes to looking at high dividend paying stocks?
Answers
237 points
josephconlin answered one year ago …
Remember where the dividends come from - earnings. If the company can't earn enough money to pay the dividend, or if paying the full dividend will leave it without enough working capital for the rest of it's needs, the dividend will get reduced or removed.
If the company stock price is beaten up due to the market and not due to the company itself, it is likely that they will continue to earn enough to pay the dividend.
The yield is simply a function of the dividend divided by the stock price. A high yield often happens because the stock price has dropped.
So, is the company paying a high yield because it is struggling? If so, you might want to stay away. Is it paying a high yield because the price has dropped without anything changing in the company? If so, you might want to look closer at it.
348 points
Sensei answered one year ago …
The short answer is, yes. Unfortunately it isn't as simple as that.
What is a dividend? It is a distribution of after-tax profits from the company to it's shareholders.
Companies that have been around for a while might establish a "dividend policy" whereby they distribute either a fixed amount (usually on a defined basis - quarterly, semi-annually, etc.) or on some percentage basis. They tend to be rather conservative in these determinations because the WORST thing a company can do is reduce its dividend. BUT (big "but") as they say, "S--t happens" and when it does the company has two choices - cut the dividend, or continue the distributions in the hopes that its fortunes will turn and that, in the long haul, the "overpayment" will adjust.
In the majority of cases, the latter course is taken because, as I've already premised, cutting its dividend is a disaster for a public entity in more ways than one. But if the company's problems were to continue, the dividend could become, to use your word, "unsustainable".
There is no "rule of thumb". You have to ask yourself, "Do I think the company's future is such that it can afford this depletion of its cash reserves for the time being (i.e. it's high but something that will not impair the operations to the point of detriment)? Or is this company falling apart and a dividend cut (or elimination) is almost a virtual certainty (along with the inevitable destruction of its share value?")
To help you out a bit though, get a copy of their financial statements and do this bit of simple research ...
Look for their "net income after taxes". Forget about EBITDA. That's crap! Income taxes have to be paid whether you like it or not and it's a true expense in every sense except that it isn't "tax deductible". Moreover, income taxes reduce the amount available for distribution as dividends. And depreciation and amortization is the means by which accounting professionals (like me) take cognizance of the fact that the company will have to replace its capital assets - and they will have to do so sooner or later. One way or the other, depreciation and amortization will, one day, become a real cash drain - and impair the company's ability to pay those dividends to a greater or lesser extent. So look for "net income after taxes".
Now, find out how many shares are outstanding on a fully-diluted basis - that is after all stock option and conversion privileges are exercised. Now you'll know how many "potential" shares are outstanding.
Divide the first number by the second to get the fully-diluted net earnings per share.
Divide that number by the current dividend. You now know how many times that dividend is "covered". Obviously, the bigger the number, the better.
You now know how "safe" the dividend is and whether or not you think it's "too high" and / or "unsustainable". If it's 1 or less ... well, you know what that can mean.
Use your judgment.
356 points
Dusty answered one year ago …
Look at the percentage of earnings being paid to investors as dividends. Look at the kind of business and business plan. Dividends will run in a relatively narrow range for a kind of business. Excessive percentages from a company should be seen as a red flag.
About a year ago a screen for dividend rates would have pulled up several mortgage companies with absolutely eye-popping dividend rates. They needed cash very badly and were trying to suck in new money at any cost. Most of them did not survive the winter. It's called bankruptcy.
Most companies will pay a dividend ranging from a fraction of one percent to a maximum of about 5%, but the 5% seems to be approximately an upper limit. MLP's in the United States and Canadian Royalty Trusts use another kind of business model and are organized under another group of laws. These will pay returns from 6% to 10% in the US and up to 12% in Canada. The Canadian tax for foreign small investors will often be a wash with the Foreign Tax Credit on the Long Form 1040. Apparently European countries are beginning to allow or considering allowing businesses similar to the MLP's and CanRoy's. Some Investment Funds also pay up to 10% dividends.
The reason that MLP's and CanRoy's can pay so much higher dividends is that the taxes are passed through to the investor. Probably this is also the case with the Funds. For a very small investor the tax rate paid on annual income can be minimal, for investors with large incomes the taxes might be the same as corporate rates.
To explain that, think 'Widows & Orphans' with an inheritance of a couple of hundred grand or less invested and no other taxable income. The tax rate will be very low. A person or institution who is already at or near maximum tax rates will pay those rates on these dividends, too.
Currently the dividend rates from a lot of these companies appear to be a lot higher than normal. Look at the percentage of earnings being paid to Investors as dividends; look at the amount of cash per share being paid as dividends; look at the history of the share prices for that security. Percentage of earnings comes from regular filings, of course, and the rest from BigCharts.com Interactive. As share price falls the percentage of dividend will rise because dividends are in cash. Healthy companies whose share prices are falling because the whole market is being beaten down are just great buying opportunities. Extra shares for the same amount of cash are just that much more dividend cash return for as long as the investor holds the position.
379 points
dustbusterz answered one year ago …
You need to look at 2 items when deciding when a dividend is too high. Dividends as explained above,are paid as part of the returns on cash earned.To begin, you need to look at how much cash does the company earn(ex all expenses).Do they earn enough to service the size of dividend they are paying out? The second part is , looking at cash on hand(free cash). Do they have enough free cash to service at least 1.3 times the level of the yearly dividend? They need to have plenty of free cash flow to be able to fund these payments ,other wise,they can be forced to borrow the needed money to make these payments. Not a good thing , cause this raises debt levels , and during these trying times, you want to maintain lower debt levels or get squeezed .
Always be suspect when you see dividend payments that are far above what is typical for the industry they are in , or when dividends are far above what they would normally pay out.
