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Behind the numbers

Curb your enthusiasm for high-yield stocks Add to ...

If you want to drive today's investors mad with desire, try this magic word: dividends. There's something about the promise of a high yield that makes grey-haired stock buyers turn giddy as 17-year-olds.

It's not entirely clear what gives rise to this intoxicating effect. Stock market historians say dividend-paying stocks have generally done better than their non-dividend-paying peers, perhaps because being forced to disgorge cash on a regular basis pushes executives to focus on their core business rather than lavishing money on the CEO's pet projects. But paying a dividend, by itself, doesn't guarantee a company success.

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Consider Petrobakken Energy Ltd., the Calgary-based oil producer that, at current share prices, is paying a lush 5.3-per-cent yield. By any standard that's a generous payout. It's even more eye-catching considering that the company, which went public in 2009, is not exactly gushing profits. Instead, it's spending big amounts on acquisitions and capital expenditures as it strives to develop resources in the Bakken region of Saskatchewan and the Cardium field of central Alberta.

The company, which is 59-per-cent owned by Petrobank Energy and Resources Ltd., paid out $177-million in dividends last year while earning only $48-million. The gap between dividends and earnings is enormous, especially considering that the company rewarded Petrobank and its other shareholders with those dividends while simultaneously increasing its bank loans (to $825-million) and issuing $750-million (U.S.) of convertible debentures. In other words, it's borrowing large amounts of money with one hand while paying out fat dividends with the other.

Wouldn't it make more sense to cut the dividend and use the money to reduce debt? Perhaps. But in its reports and presentations, the company prefers to dwell on cash flow - or, more specifically, funds flow from operations, a widely used but non-standard measure not recognized under generally accepted accounting principles. By its chosen yardstick, Petrobakken churned out $3.51 (Canadian) a share in funds flow last year, well above the 96 cents a share it paid in dividends.

The problem with focusing on cash flow or funds flow is that these measures don't account for depreciation or depletion of the company's reserves. The exact rate at which the output from Petrobakken's wells will fade is uncertain. But what is certain is that while Petrobakken is spending a whopping amount on capital expenditures ($812-million in 2010) and on acquiring other companies (four in 2010), its production declined 9 per cent in the fourth quarter. This is not the growth trajectory an investor likes to see.

Perhaps Petrobakken's production will jump as it integrates its new acquisitions. For now, its dividend appears to be in no danger. But investors attracted by the lure of big, regular payouts may want to think twice before jumping on board for the long haul. At the very least, they should ponder whether the company's dividend policy makes sense.

A similar question could be asked of many other companies. Yellow Media Inc., to take just one example, was paying a 12.3-per-cent yield earlier this week as analysts fretted about its lacklustre earnings and heavy debt load. On Friday, the publisher of phone directories announced it is selling its Trader Corp. unit, a move that may have been prompted by the company's desire to maintain its investment-grade debt rating.

Does that divestiture make Yellow Media a buy? Only if you're convinced that the directory business, a line of work that peaked at the same time as rotary-dial phones and The Dukes of Hazzard, is on the verge of mounting a comeback. At current levels, the company is still paying out more in dividends than it earns.

The point here is that dividends, by themselves, tell you very little about a company. While dividend investing has achieved cult status in today's market, its record is more mixed than most people realize. A 2006 study by Credit Suisse found that stocks that paid no dividends actually performed better than the S&P 500 index between 1990 and 2006.

The Credit Suisse researchers discovered that many dividend stocks lagged behind the index, especially in cases where the yield was low and the dividends represented a large part of earnings. Companies that have to stretch to deliver dividends usually disappoint.

The best-performing stocks were ones that paid high dividends that amounted to only a modest fraction of even higher earnings. That's not exactly a surprise, but it's a reality that many investors appear to be forgetting in the current lust for yield.

 
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