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Is Labrador Iron Ore Royalty Corp.’s (LIF) 17-per-cent dividend yield sustainable?

If you think you can earn 17 per cent without any risk, I have some oceanfront property in Saskatchewan to sell you.

The first thing you need to know is that Labrador Iron Ore Royalty’s quarterly dividend has been exceptionally volatile over the years. It has been as low as 25 cents in some quarters and as high as $2.10, which was the value of the most recent dividend paid on Oct. 26.

There’s a good reason for this variation: The company’s cash flow and dividends are closely tied to iron ore prices through its 15.1-per-cent equity interest in Iron Ore Company of Canada, from which Labrador Iron Ore Royalty also earns a royalty and commissions on iron ore sales.

Commodity prices are notoriously unpredictable, and iron ore is no exception.

Last spring, the price of iron ore – which is used primarily in steelmaking – hit record highs, and Labrador Iron Ore Royalty subsequently announced some big dividend increases. Since then, however, the price of iron ore has plunged amid slowing demand in China – the world’s biggest iron ore consumer – which suggests the royalty company’s cash flow and dividends will also fall.

Another indication came this week when Iron Ore Company of Canada, the operating company, declared its own dividend, which is payable on Dec. 23. Labrador Iron Ore Royalty’s share of that dividend is about $47.9-million, down from about $85.7-million in the previous quarter.

Labrador Iron Ore Royalty’s stock price is also down sharply from its highs, which has pushed the yield well into the double digits.

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Yield can be measured in different ways. The 17-per-cent figure you quoted is a “trailing yield,” calculated by adding up the four quarterly dividends paid over the previous 12 months and then dividing by the current share price. (As of Friday afternoon, the trailing yield had risen to about 17.8 per cent.)

The “indicated yield” is calculated by multiplying the latest quarterly dividend by four to determine a projected annual dividend, then dividing this number by the share price. Iron Ore Royalty’s indicated yield is currently about 22 per cent.

Such projections are fine for stable dividend payers, such as utilities and banks, but not for companies whose fortunes are tied to volatile commodity prices. I’m not saying the stock is necessarily a bad investment at current levels, just that you shouldn’t count on such a rich dividend continuing. The market is skeptical, too, which is why the yield is so high.

For my model Yield Hog Dividend Growth Portfolio (tgam.ca/dividendportfolio), I generally avoid commodity stocks because their dividends are so variable. However, I recommend that dividend investors supplement their holdings with broad index exchange-traded funds that provide exposure to commodity producers, technology stocks and other sectors that don’t typically pay large or stable dividends, but can nonetheless enhance portfolio diversification and returns.

Is there an easy way to look up the sector weightings of the S&P/TSX Composite Index? I like to compare the performance of my self-directed portfolio against the S&P/TSX. This year, I am slightly trailing the index, and I would like to determine if this has to do with my preference for avoiding certain sectors.

One method is to use an exchange-traded fund such as the iShares Core S&P/TSX Capped Composite Index ETF (XIC) as a proxy for the index. If you navigate to XIC’s page on the iShares Canada website (do an internet search for “XIC ETF”) and scroll down to “Exposure Breakdowns,” you’ll find up-to-date sector weightings for the fund. As of Nov. 25, the top five weightings were financials (31.9 per cent), energy (13.2 per cent), information technology (11.9 per cent), industrials (11.6 per cent) and materials (11.4 per cent).

You’ll also find a list of individual stock weightings on the XIC page. Note that Shopify Inc. (SHOP) is the highest-weighted stock in the fund – and on the index – at about 7.5 per cent. If you don’t have a position in Shopify, which has a year-to-date return of about 44 per cent, that could also explain your portfolio’s underperformance compared to the index.

I’m not suggesting you should buy Shopify shares. But if your goal is to keep up with the S&P/TSX, you could simply buy the index through XIC or a similar fund such as the BMO S&P/TSX Capped Composite Index ETF (ZCN). Thanks to their very low management expense ratios of 0.06 per cent, both ETFs do an excellent job of tracking the index.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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