I often receive email from readers asking what I think about a specific stock or an industry. I usually try to analyse these companies in the upcoming month as I think that it could be interesting for most of you to have a deeper look into these stocks.

 

About 2 weeks ago, I received an email from Russ. He asked me why he couldn’t find many stock analyses on 2 high dividend paying utility stocks. I thought his question was quite interesting as they were indeed paying a good dividend yield. I didn’t know either of the companies so I was a bit intrigued (we are all looking to make a good trade on a new stock, right?). So, I ran my program to generate the dividend metrics I usually use to analyse a stock. And this is when I realized why I hadn’t noticed these 2 companies before…

 

More Info on the Utility Sector

 

At first glance, the utility sector seems very appealing for dividend investors. Most companies are offering high dividend yields (4-5% seems to be the average for several sub-sectors) while showing a stable business model. The demand is relatively predictable, the competition is known and the whole industry is moving together in many cases. Water and Electric companies seem to be the most popular dividend payers while there are more oil related utility stocks in Canada. In both countries, the metrics of this sector is perfect for someone who’s looking for a high yield and steady dividend stocks. You obviously can’t seek huge growth but if you can secure the dividend payout, I guess that one can find it very suitable for his portfolio (especially if you are retired!).

 

Why Dividend Yield Should Not Be A Decision Factor

 

When I first read that email, there is one thing that caught my attention; the mention of the dividend yield for both companies. Here’s the email I received:

 

“Just wondering, why aren’t utility stocks like Just Energy (JE with a 8.9%
yield) and Atlantic Power (ATP with a 8.3% yield) aren’t on many lists of
people’s favorite dividend stocks? »

 

I don’t mean to put Russ in the spotlight because I receive this kind of email on a regular basis. In fact, it is a common mistake to start with the dividend yield. The problem that exists when you start your research with this metric is that you are thinking about the payout before trying to know if it’s sustainable or not. If an investor starts thinking about money, he forgets about his rational stock analysis process.

 

You look at a high dividend yield sector and find higher dividend payers. This sounds like the jackpot, doesn’t it? This is why you should never start by looking at the dividend yield. This is how you can prevent yourself from being tempted.

 

Using Several Metrics At The Same Time

 

When I look for the next stock to add to my portfolio, I start by running a bunch of filters at the same time and look at which stocks come out. The dividend yield is only one factor and I use it to filter a minimum payout (usually 3%) and I don’t class the stocks from the highest dividend yield to the lowest. In fact, revenue growth, dividend payout ratio and dividend growth are a lot more important to me. Before buying a stock, I want to make sure that the dividend yield I receive today will be the smallest yield I will ever get from the stock (meaning it will keep increasing over time).

 

Back To My Reader’s Question

 

Russ’s question was regarding ATP and JE. Both are Canadian utility stocks and both pay a very good dividend yield. However, both of them showed losses more than once over the past 5 years and don’t show strong metrics overall. My thoughts? Chances are the dividend yield will continue to increase…because the stock value will probably fall!

 

If a company posts losses, it means that it is financing its dividend. In other words, both companies have borrowed money or have used equity money to pay their dividend. Does this sound viable to you? For this reason, I’m calling a big “NO GO” on these 2 stocks. Here’s the metric for both stocks:

 

Ticker
ATP CN Equity
JE CN Equity
NameAtlantic Power CorpJust Energy Group Inc
Dividend Metrics
Current Dividend Yield8.438.89
5 year Dividend Growth1.284.65
1 year Dividend Growth2.070
Company Metrics
Sales Growth (1 year)45.9128.44
Sales Growth (5 year)27.9412.15
Earnings growth#VALUE!#VALUE!
P/E ratio#VALUE!82
Margins growth-4.045.96
Payout ratio#VALUE!29.45
Return on Equity-5.81#VALUE!
Debt to Capital Ratio1.080.4
Mangement
.

What do you think? Would you go ahead and buy them based on a strong dividend payout?

 

 

Disclaimer: I do not hold positions in either of the stocks mentioned above.

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11 Comments   |  

11 Comments

April 18, 2012, 10:26 am

I know Just Energy and have seen it be a bad investment. It is a stock for traders who perhaps could get a juicy dividend or two and trade it for a profit. It is not for somebody to base a held portfolio on.

I unlike you do look for high yield, but only use it as a start to find better deals. If I find a high yield stock I investigate further and usually find some red flag that eliminates it from consideration. Occasionally though you will find a good stock, maybe the price is down for an unfounded reason, maybe the yield is high but the payout ratio is still lower than 50%. And with those high yields you obviously get great return on your money.

But I can say that JE will not work out well for you.

joey
April 18, 2012, 11:09 am

Searching around a bit, I found SXL. Can you comment on this one as a long term dividend play?

April 18, 2012, 12:55 pm

If the stock falls then the high yield is not worth it. We need the underlying business to grow as well.

Matthew C. Waterman
April 18, 2012, 6:04 pm

Disagreeing with the idea that current yield doesn’t matter, but at the same time agreeing that the other metrics you mentioned are critically important.

It takes a bit of understanding of the industry that you’re shopping in. Over time it becomes easy to tell if something is out of place, but if you spot something in your watch list that is running a higher yield that it’s peers, it could be an opportunity to spot an inefficiently priced stock.

Or, it could be very efficiently priced depending on whether further analysis reveals problems. Rule #1 is that your company has to be earning money, and it has to be predictable that it will continue to earn money. If they don’t meet that test, then right, current yield is meaningless.

Michel
April 19, 2012, 5:36 am

I think dividend growth is more important and consistency of course. try Tim Hortons, Canadian Western Bank and Proctor and Gamble in the US.

April 19, 2012, 8:25 pm

[…] Man, I haven’t watched the movie Wall Street in a loooong time.   Dividend Guy Blog said dividend yield should not matter for dividend investors.  My answer to this is, yes and no.  Dividend yield matters, but you need to be wary of dividend […]

Mike
April 20, 2012, 2:32 pm

@Matthew,

you are right, dividend yield does matter (I would not buy a stock with a 1.5% div yield thinking I’m building a dividend portfolio), but it should not be part of your main criterion.

April 21, 2012, 3:01 pm

Yes companies profit is the key. Dividends comes from companies profit if no profit then no dividends if profit is decreasing don’t expect dividend increase at long term.

April 21, 2012, 10:04 pm

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August 8, 2012, 6:35 am

[…] you have been following this blog for a while, you should have learned that the dividend yield should not be a factor in your investment process. Actually, as long as the dividend yield meets a minimum requirement (mine is set at 3%), you […]

June 23, 2013, 4:33 pm

[…] you have been following this blog for a while, you should have learned that the dividend yield should not be a factor in your investment process. Actually, as long as the dividend yield meets a minimum requirement (mine is set at 3%), you […]

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