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When Corus Entertainment Inc. (CJR.B) slashed its dividend this week, nobody should have been surprised.

Yet, judging by the stock’s hefty drop over the next couple of days, some investors were still clinging to the hope that the dividend – which had been yielding a clearly unsustainable 18 per cent – might somehow survive.

To some degree, the market’s ugly reaction might also have reflected the fact that Corus’s third-quarter results were worse than expected and that the nearly 80-per-cent dividend reduction was at the high end of analyst estimates. But anyone who had been paying attention knew a deep cut was coming.

To succeed as a dividend investor, it’s essential to know when a high yield is sustainable and when it’s an accident waiting to happen. Today, I’ll offer a few tips.

Use your common sense

With high-yielding stocks, it never hurts to remember the phrase: “If it seems too good to be true, it probably is.” When a yield soars into the high single-digits or even double digits – usually because the share price is tanking – the market is telling you that something isn’t right. We’ve seen the pattern before with companies such as AGF Management Inc., Yellow Pages Income Fund and Mattel Inc. that cut or eliminated their payouts. Not every high-yielding stock is a ticking time bomb, but with dividends it often pays to be skeptical.

Read between the lines

When a company is preparing to cut its dividend, it will often try to give the market advance warning so as not to take everyone by surprise. The clues can be subtle. On Corus’ first-quarter conference call in January, for instance, both the chief financial officer and chief executive officer said the company remained committed to the dividend “for fiscal 2018.” That should have signalled to investors that, after fiscal 2018, all bets were off. Sure enough, Corus’ dividend cut is effective as of the first quarter of fiscal 2019, which begins on Sept. 1.

Study the dividend history

Companies don’t usually cut their dividends out of the blue. They typically stop raising them first, which is your first sign that trouble could be brewing. Toy maker Mattel, for instance, raised its dividend annually for years but then left its dividend unchanged for 13 consecutive quarters before cutting its payment in June, 2017. It eliminated the dividend entirely a few months later.

Watch the financials

Dividends aren’t paid out of thin air. For a dividend to be sustainable, the company must have the cash flow to pay it. Sure, it can support the dividend in the short run with debt, asset sales or a share issue, but that can’t go on forever. If you stick with companies whose revenues, earnings and cash flows are growing – and whose dividends are rising as well – you’ll greatly reduce the odds of a nasty dividend surprise.

Pay attention to the payout ratio

What constitutes an acceptable dividend payout ratio varies by industry and the growth stage of the company. For example, cyclical companies with volatile earnings, or fast-growing companies that need to reinvest most of their cash, typically have low payout ratios – if they pay a dividend at all. More mature companies with relatively predictable earnings – such as utilities and power producers – generally have higher payout ratios. The best companies set a target for their payout ratio and publish the actual number with their quarterly results so investors can gauge how the company is doing.

A payout ratio that is elevated temporarily is usually no cause for alarm, but when it shoots well above 100 per cent for a sustained period that can be a bad sign. Cominar Real Estate Investment Trust, for instance, had a payout ratio of 122 per cent through the first six months of 2017 before cutting its distribution by 22 per cent last August and chopping it by another 37 per cent in March.

Stay in the loop

Companies know that dividends are important to investors, which is why they will often comment on their dividend policy, payout ratio and dividend growth outlook in quarterly statements, conference calls and investor presentations. You can often find conference call transcripts and investor presentations on the company’s website or elsewhere on the internet. By reading these materials – and paying attention to a company’s dividend history, financial statements and payout ratio – you’ll be in a better position to judge whether a dividend is secure or could be heading for the chopping block. For examples of dividends I consider relatively safe, see my model Yield Hog Model Dividend Growth Portfolio at tgam.ca/dividendportfolio.

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