Stingy Investor Contact - Subscribe - Login
  Home | Articles | Links | SNW
 
Be wary of extreme yields

The urge to reach for yield can be hard to resist. But income investors should be wary of securities with extraordinarily high yields because they're often accompanied by similarly large risks.

I like Canadian dividend stocks with reasonable yields, which is why I'm a fan of Scott Barlow's list of dividend-paying stocks in the S&P/TSX Composite Index. It's easy to start at the top of the list and imagine enjoying yields north of 7 per cent for many years to come.

Before exploring whether high yields lead to happy returns, it's useful to look at how the S&P/TSX Composite, a fair proxy for the Canadian market, has fared over the years. The index enjoyed average annual returns of 7.4 per cent over the 21 years from the end of 2001 through to the end of 2022.

Similarly, an equally-weighted portfolio of all the businesses in the index climbed by an average of 7.2 per cent annually over the same period when rebalanced each year. (All of the portfolios herein are equally weighted and rebalanced annually. Their returns are based on data from Bloomberg and include dividend reinvestment, but not fund fees, commissions or other trading frictions.)

Income investors love their dividends and a portfolio containing only the dividend-paying stocks (and trusts) in the index climbed by an average of 9.1 per cent annually from the end of 2001 to the end of 2022. The dividend payers, as a group, enjoyed above-average returns over the period.

I sorted the index's dividend payers into percentiles by indicated yield. Think of percentiles as grades that go from 0 for the stock (or trust) with the lowest yield to 100 for the one with the highest yield.

The dividend payers are then put into five portfolios based on yield. The portfolios each contain as close to an equal number of constituents as possible. The portfolio of dividend payers with the second-highest yields (those from the 60th to 80th percentiles) fared the best, with average annual gains of 10.2 per cent from the end of 2001 to the end of 2022.

Reaching for yield in the S&P/TSX Composite Index

The first four portfolios (below the 80th yield percentile) outperformed the index over the period as shown in the accompanying chart. The worst performer was the portfolio containing the fifth of businesses with the highest yields, which isn't shown in the chart. It gained 7.2 per cent annually over the period and slightly lagged the returns of the index.

Intrigued, I cut the highest-yield portfolio (above the 80th percentile) in half by yield. The highest-yielding half (more than the 90th percentile) gained an average of 4.4 per cent annually from the end of 2001 to the end of 2022. The lower-yielding half (80th to 90th percentile) fared much better, with average annual gains of 9.8 per cent.

I repeated the process by splitting the highest yield half in half yet again. The portfolio with the 5 per cent of businesses with the very highest yields gained an average of just 0.4 per cent annually. Gulp! (To make it into the extremely high yield group, a stock currently has to pay a dividend yield north of about 7 per cent.)

On the other hand, the group with the next-highest 5 per cent of yields gained an average of 7.4 per cent annually, which happens to also be the return generated by the S&P/TSX Composite Index as a whole.

Overall, returns tend to fall dramatically when yields reach extremely high levels.

It's fairly easy to explain why stocks with giant yields might perform poorly. Just think about how a stock gets a high yield. In happy cases, yields are boosted by dividend growth. But extremely high yields often occur when a business falters and its share price falls dramatically. In such cases, the low price and high yield reflect the risk of an impending dividend cut - or worse.

However, very high yields do not always lead to poor returns. Sometimes the market becomes overly pessimistic, and the stock proves to be a bargain over the long term. When seeking dividend stocks, I tend to favour those with the generous yields from the 60th to 90th percentiles, which currently corresponds to yields between roughly 3.8 per cent and 6.1 per cent.

After all, history shows that investors should think twice before reaching for stocks with extremely high yields.

First published in the Globe and Mail, January 15 2023.

 
Globe & Mail Articles
 Portfolios

 250 Megastars for 2024
 Extreme yields
 The easy way
 Smaller stable dividend
 250 Megastars for 2023
 Champagne portfolio
 Screaming Value
 Blended momentum
 Dividend monster
 Frugal dividend
 Stable dividend
 Speads and recessions
 TSX 60 for value investors
 Looking at 10-year returns
 Watching for a bottom
 Oh, bother!
 Low P/E DJIA
 Indexing advice
 Media-shy stocks
 Curse of size
 Market uncertainty
 Be even lazier
 Scary beats safe
 Small, illiquid, value
 Use the numbers
 What value is good value?
 Sculpt for value
 Value vs CAPE
 Graham Rules
 CAPE vs PeakE
 Top value ratio
 Low Beta
 Value and dividends
 Walter Schloss
 Try unloved AIG
 Why I'm a value investor
 New world of ETFs
 Low P/Es possible
 10 yielders
 Be happier
 Long-Short
 Dividend Downside
 Shiller's P/E
 Copycat investing
 Cashing in on class
 Index roulette
 Theory collides
 Diving too deep
 3 retirement villains
 Scourge of inflation
 Economic omens
 Analyst Expectations
 Value stock scarcity
 It's all in the index
 How to pick good funds
 Low Beta Wins
 Hunt for dividend stocks
 Think garage sale

MoneySaver Articles
 2 Graham Stocks for 2018
 2 Stingy Stocks for 2017
 2 Graham Stocks for 2017
 3 Stingy Stocks for 2016
 5 Graham Stocks for 2016
 3 Stingy Stocks for 2015
 3 Graham Stocks for 2015
 3 Stingy Stocks for 2014
 4 Graham Stocks for 2014
 8 Stingy Stocks for 2013
 6 Graham Stocks for 2013
 9 Stingy Stocks for 2012
 8 Graham Stocks for 2012
 Simple Way 2011
 5 Stingy Stocks for 2011
 7 Graham Stocks for 2011
 Simple Way 2010
 5 Stingy Stocks for 2010
 8 Graham Stocks for 2010
 Simple Way 2009
 Timing Temptation
 19 Stingy Stocks for 2009
 4 Graham Stocks for 2009
 Simple Way 2008
 Active at Passive Prices
 Unbundling ETFs 2008
 5 Stingy Stocks for 2008
 5 Graham Stocks for 2008
 Is your index too active?
 Graham's Simple Way
 Canadian Graham Stocks
 5 Stingy Stocks for 2007
 8 Graham Stocks for 2007
 Top SPPs
 The Simple Way
 A hole in your IPO?
 Monkey Business
 8 Stingy Stocks for 2006
 Graham Stock Gainers
 Blue-Chip Blues
 Are Dividends Safe?
 SPPs for 2005
 Graham's Simplest Way
 Selling Graham Stocks
 RRSP Money Market Funds
 Stingy Stocks for 2005
 High Performance Graham
 Intelligent Indexing
 Unbundling Canadian ETFs
 A history of yield
 A Dynamic Duo
 Canadian Graham Stock
 Dividends at Risk
 Thrifty Value Stocks
 Stocks in Short Supply
 The New Dividend
 Hunting Goodwill
 SPPs for 2003
 RRSP: don't panic
 Desirable Dividends
 Stingy Selections 2003
 10 Graham Picks
 Growth Eh?
 Timing Disaster
 Dangerous Diversification
 The Coffee Can Portfolio
 Down with the dogs
 Stingy Selections
 Frugal Funds
 Graham Revisited
 Just Spend It
 Ticker Temptation
 Stock Mortality
 Focus on Fees
 SPPs for the Long Term
 Seeking Solid Stocks
 Relative Strength
 The VR Approach
 The Irrational Investor
 Value Investing

Old MS Articles
 Cdn Top 200 2018
 Cdn Top 200 2017
 Cdn Top 200 2016
 Cdn Top 200 2015
 Cdn Top 200 2014
 Cdn Top 200 2013
 Cdn Top 200 2012
 Cdn Top 200 2011
 Cdn Top 200 2010
 Cdn Top 200 2009
 Cdn Top 200 2008
 Cdn Top 200 2007
 Cdn Top 200 2006
 Cdn Top 200 2005
 US Top 500 2018
 US Top 500 2017
 US Top 500 2016
 US Top 500 2015
 US Top 500 2014
 US Top 500 2013
 US Top 500 2012
 US Top 500 2011
 US Top 500 2010
 US Top 500 2009
 US Top 500 2008
 US Top 500 2007
 US Top 1000 2006
 Dividends 100 2017
 Dividends 100 2016
 Retirement 100 2015
 Retirement 100 2014
 Retirement 100 2013
 Retirement 100 2012
 Retirement 100 2011
 Retirement 100 2010
 Income 100 2009
 Income 100 2008
 Income 100 2007
 Top Trusts 2006
 Top Trusts 2005
 Hot Potato
 Buffett Buys
 FB IPO
 Stocks that pay
 Value in the S&P500
 Where to invest $100k
 Where to invest $10k
 Summer Simple Way
 A crystal ball for stocks?
 Cheap & safe
 Risky business
 Dividend investing
 Value investing
 Momentum investing
 Low P/E P/B
 Dividends
 Dividend growers
 Graham's prescription
 The case for optimism
 Wicked investments
 Simply spectacular
 Small stocks, big profits
 Value that sizzles
 So simple it works
 No assembly required
 Investing by the book
 Invest like the masters
 A simple way to get rich
 Stocks for cannibals
 Car bites dogs
 So easy, so profitable
 Dogs of the Dow
 Money for nothing
 Yield of dreams
 Return of the master

Advisor's Edge Articles
 Passive Rebundling
 Doing the math

Flip Books



 
About Us | Legal | Contact Us
Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...