Buying stocks based solely on a high yield can be asking for trouble. Anyone who lost money on Yellow Media, AGF or TransAlta can tell you that.
But can a stock offer both a juicy yield and safety?
Leslie Lundquist thinks so. As co-lead manager of the Franklin Bissett Canadian High Dividend Fund, she looks for companies that can support their outsized dividends with sustainable cash flow, a solid capital structure and a strong management team.
"We're looking for companies that have more going for them than just a high dividend yield," she says. "We basically want companies that are fundamentally very healthy and have a growth element available."
In keeping with Bissett's growth at a reasonable price (GARP) methodology, Ms. Lundquist and her team try to buy stocks at attractive valuations. The process involves calculating a stock's intrinsic value by estimating all future cash flows and then working backward to determine what they are worth today. If the market price is lower than the intrinsic value estimate, the stock is considered cheap.
The fund, which has a management expense ratio of 2.47 per cent, has put up some solid numbers. For the five years ended March 31, 2014, it returned about 19.1 per cent annually after fees, according to Morningstar. That's about 0.5 percentage points ahead of the small- and mid-cap S&P/TSX completion index.
The portfolio's gross yield – before fees – is about 7 per cent, which is more than twice the yield of the S&P/TSX composite index, at 2.8 per cent.
Past returns are no guarantee of future performance, of course. And there are risks with all stocks, even when they're picked by a professional manager. Yield Hog asked Ms. Lundquist to discuss some of the fund's current holdings.
Crescent Point Energy
Tuesday close: $40.61
Yield: 6.8 per cent
The oil and gas producer, with properties in Western Canada and the United States, is the fund's largest holding. Sustaining the generous dividend likely won't be a problem, Ms. Lundquist says.
"When we look at what Crescent Point's properties are and the opportunities ahead of it, we do expect that they should be able to support their dividend without much struggle and still be able to grow their business, increase their reserves either organically or through acquisitions, increase their production modestly on a per share basis, fund the dividend and continue to do this for many years," she says.
Twin Butte Energy (TBE-TSX)
Tuesday close: $2.23
Yield: 8.6 per cent
Twin Butte is much smaller than Crescent Point and therefore overlooked by many investors, she says. Yet the oil and gas producer, which is focused on Western Canada, has a higher yield and generates enough cash to cover both its dividend and capital expenditures.
Production growth "isn't huge. I call it moderate production growth. But really, that's all we're looking for," she says. "They've got a decent balance sheet. We think they've got a realistic outlook on what they have, what it can produce and how it can enrich shareholders."
Chemtrade Logistics Income Fund (CHE.UN-TSX)
Tuesday close: $21.11
Yield: 5.7 per cent
Chemtrade supplies chemicals to pulp and paper producers, water treatment facilities and other industries. Ms. Lundquist's team had been considering the stock when, in December, Chemtrade announced the $860-million (U.S.) acquisition of New Jersey-based General Chemical Holding Co., a deal that will significantly bulk up the Canadian company's sales and customer base.
"The yield is a little bit low for us, but we think that is offset by opportunities to have nice capital gains if and as they expand their business through the General Chemicals acquisition," she says.
Artis REIT (AX.UN-TSX)
Tuesday close: $15.70
Yield: 6.9 per cent
Artis Real Estate Investment Trust owns a diversified portfolio of about 250 industrial, retail and office properties in Canada and the United States. Occupancy levels are solid and Artis's investment grade credit rating speaks to its strong balance sheet, she says.
"These generally aren't trophy properties with marquee tenants," she says. "But when you buy them cheaply and manage them effectively they can be very good investments."
Follow me on Twitter: