Avoid a yield trap when hunting for beaten down dividend stocks.
That's my advice to investors who want to capitalize on falling share prices to lock in high yields on dividend-paying common shares. Yields have indeed risen in this summer's stock market pullback. In fact, ETFs tracking the broad Canadian market had yields just a hair below 3 per cent as of late July. Just for context, that's double the yield on a 10-year Government of Canada bond.
If you dig down into the highest yielding stocks on the TSX, you find some that have been whacked in the recent market pullback and others that have been more resilient. It's the former group where you find the yield traps. As market conditions got stressful, investors chose to eject these stocks from their portfolios. If market conditions worsen, these stocks would presumably continue to plunge. That's what I mean about yield traps. You buy for the juicy dividend payout, but have to contend with a falling share price. Worse case, the plunge in share price foreshadows a dividend cut or suspension.
Here are some of the highest dividend yields on the S&P/TSX 60 index and their 12-month total return to July 24. First, a couple of stocks you'd have to consider as potential yield traps:
- Crescent Point Energy: The yield was just below 14 per cent and the 12-month total return was a loss of 50 per cent. With energy prices retreating, this stock could be considered a yield trap.
- TransAlta: A yield of almost 8 per cent and a 12-month total return of minus 22.6 per cent. Note: TA cut its dividend in early 2014 to 18 cents per quarter from 29 cents. A utility stock as yield trap? Could be.
And now for a couple that appear not to be yield traps:
- Potash Corp.: A 5.5-per-cent yield and a one-year loss of 3.5 per cent. Considering POT is a commodity stock, it has held up rather well. The dividend was actually increased at the beginning of this year.
- BCE Inc.: A yield of 4.9 per cent and a one-year total return of 12.7 per cent. BCE's had a yield in the 5 per cent range for a while now. It's normal for this stock.
Found a tempting high-yield stock? The question of why and how the yield got so high should be your top research priority.