There are quite a few financial websites out there dedicated towards investing in dividend-bearing securities.
Some give the impression that it is nearly guaranteed to produce returns superior to the overall market.
In addition, a lot of them convey that the production of income through dividends is somehow “safer” than investing in major index ETFs.
In general, I do not have issues with dividend-bearing equities. In a lot of instances companies do not have proper places to re-allocate capital and giving it to shareholders is the right decision – especially if their stock price is high and the cost of their debt is low.
Where I have issues with dividend investing is in companies that have suspicious cash flow profiles or give cause to believe that their earnings profiles are going to be less than what is implied by their market pricing.
I’ll give an explicit example. Cineplex (TSX: CGX) I have written about in the past. Specifically in a May 2014 article (when the stock was trading at around $41), I was puzzled why the stock was doing so well given the “dinosaur” aspect of their business.
A lot of people though will take a look at their current 5.4% dividend yield (currently trading at $32/share) and blindly buy on the basis of that number alone. What will not be asked is whether this can be sustained or whether the business is fundamentally sound to generate sufficient cash flows in the future. Maybe it will, but there is an awful amount of risk for that 5.4%, much more than I could justify for my own (cowardly) risk profile. The 5.4% doesn’t compensate for the risk of future potential losses.
Another example that I have not written about in the past is Laurentian Bank (TSX: LB). This got on my radar back in June when their CMHC securitization issues hit the headlines. After doing some deep-dive research, while I believe the financial institution in general will continue to generate cash, I determined that better prices in the future could probably be had. Their last quarterly report was a prime example of mediocrity that one would expect from a centuries-old financial institution and their stock got hit 5% on the day after the report. Dividend investors were screaming “buy, buy, buy!”, looking at the juicy 6% yield and apparent value (then trading around 17% under book value). How can you lose? Today, it is down another 5% from the day after they reported earnings. It would take a year of dividends and a flat stock price to “catch up” to even.
The real test of the veracity of dividend investors is what happens when the capital value of their investments go south, and I am not talking 5-10% – when they start seeing 20-30% capital losses across their portfolios, will these dividends be nearly as important?
Just note this is not a prediction on the future outcome of CGX or LB or the market in general. It is simply a commentary that dividend investing is not risk-free magic and it requires just as much financial rigour as other types of investing. For common share investments, I’m agnostic towards companies that either give out or do not give out dividends or distributions. It factors little in my investment decision-making. I’m much more concerned about what management does with the capital they have.
The worst example of dividend obsession I’ve seen is with Income Financial Trust (INC.UN). It’s a CEF that owns financial stocks. The odd thing about it is that they pay 10% per year based on the price of the stock NOT the asset value. So if the stock rises they keep increasing the dividend regardless of the NAV. Earlier this year it got up to about $20 with $12 of NAV! People were investing with no concept that this rich 10% yield was largely return of capital.
@Rod: https://www.quadravest.com/inc-fund-features
Wow. Just wow. I have to commend Quadravest in this fund for perfecting the “pay people with their own money” fund. Maybe they should get into politics since governments do it with tax dollars all the time.
“Pursuant to the terms of the investment management agreement, Quadravest is entitled to a base
management fee payable monthly in arrears at an annual rate of 0.65% of the Trust’s net asset
value, calculated as at each month-end valuation date.
Pursuant to the management agreement, Quadravest is entitled to an administration fee payable
monthly in arrears at an annual rate equal to 0.1% of the net asset value of the Trust, calculated
as at each month-end valuation date and an amount equal to the service fee payable to dealers
at a rate of 0.25% per annum.”
I’m surprised that they’re charging such a low rate for this product. They could probably get away with 2% and nobody would bat an eyelash. MER (which includes other costs) is 1.66% for 2017 though – with $25 million in AUM at the end of 2017 it doesn’t scale well with the other required costs.
Quadravest is a sleazy operation. I was actually surprised that it could all be legal. Surely there were securities laws against some of this stuff. I broke my rule of not shorting and opened a small short position for 200 shares of INC.UN at $17 a few months ago when the NAV was around $10 or $11. I figured that given it’s a fund it’s a safer short and the dividends running at $1.70 plus the fees would knock that NAV down pretty fast. On some of their other funds that trade at large premiums, they do overnight stock offerings (Ponzi anyone?). They haven’t done one with INC yet, probably because it’s too small to be worth it and maybe, just maybe, they realize they created a monster!
As always, dividends is just one of many factors to look at, but many investors always want to go for shortcuts, ‘magic formula’, and look at only one factor in isolation.
This is a recipe that will cost many dearly.
I have oftentimes seen companies with payouts of 100%+ and rising share counts.. as a Dutch saying goes, “receiving a cigar out of one’s own box”.. but the Quadravest sounds like a true ponzi scheme. Well, if you don’t know what you’re investing in, you had it coming I guess.
Agree with all comments, but I always have some “Casino Money” that I like to throw at some of the very risky split share funds, after they have gotten crushed. I did quite well with DGS buying in at 5.65 in 2016, then selling a year later at 8.00 picking up a high teens monthly dividend along the way. Its been falling rapidly the last week, and I will surely roll the dice again when and if it hits 6.00. EIT.UN is a less riskier fund that I like to keep a little position in.
Hi Marc
If I were you, I would be think twice about investing in DGS. The NAV is now at 5.19 and if it is 5, they will not be allowed to pay dividends anymore on the capital portion of the split shares and then you can expect a sell out of these shares. It is surprising that it still closed at 6.65$ last Friday. A year ago the NAV was close to 7$ and the pricecloser to 8. The smart money is moving out of this one as nobody wants to be the last one holding the bag.
The split shares are an interesting case where the incentives of the mangers are opposite to the ones of the investors. This was not the case when the structure was first put in place as it had a finite time span. Nowadays all the managers were able to obtain from the unit holders that these can be extended from 5 years to 5 years. Now at renewal time (in Dec. 2019 for FFN as an example), the objective of Quadravest is to maintain the revenue stream but to achieve that they have to limit redemption to the minimum. They will therefore be tempted to pay an above market rate to the Prefs, but obviously this is contrary to the objectives of the capital holders who will see their holdings lose value quicker.
I would not say that it is a sleazy operation as there is value in the split share structure. Brookfield for one uses split shares to beef up their returns through leverage but they tipically keep the capital shares for themselves such as GRP.pr.a.
I agree with your assessment that buying a stock primarily for the dividend is silly, and also that dividends are only one part a prudent capital allocation strategy. I liked CI Financial’s recent decision to cut the dividend and use the cash to buy back undervalued shares so much I bought the stock.
I also know a guy who bought Laurentian Bank simply because of its 5%+ dividend a few weeks ago. That hasn’t worked out so well for him. At the time I asked him what he thought about the mortgage problems and he had no idea what I was talking about. So that was a bit of an eye-opener for me.
You would think focusing on the dividends would allow an investor to tune out more of the market noise, but we both know it won’t be the case for many people during the next bear market. I’d argue those people would be selling at the bottom anyway, whether they’re dividend, index, value or whatever type of investor.
I have finally clicked the button to include “Replies” in comments!
I looked at CI Financial. I was tempted, but inevitably their balance sheet threw me away although they do generate an impressive amount of cash. There is a price they could get low enough where I would be tempted.
My other residual concern is one of “How much longer can they suck up AUM where clients will pay 2%/year?” and if the answer is “A long time to come since there will always be people willing to invest at very expensive costs”, then CIX would be a pretty good meal ticket.
LB’s big issue isn’t the CMHC matter (which was not good, but not a gigantic issue for the bank) but rather their mediocre business that isn’t generating higher amounts of profit. Since they’re trying to get rid of branches and people, this also doesn’t bode well for their expired collective bargaining agreements. They do have a bit of residential exposure as well, they’d be one of the entities that’d fall quite hard if there was a swift increase in unemployment, especially in Quebec.
The flip side of dividend obsession is avoiding good stocks that DON’T pay dividends. There are certain types of stocks where investors expect and demand dividends. A good example is real estate. Very few investors are interested in owning a real estate stock that pays no dividend thanks to the prevalence of high yielding REITs. So a non-dividend payer like Dream Unlimited (DRM) can sit there at a very cheap price. People think a real estate company with no dividend has no value!
This is also right, I do notice non-dividend bearing companies are less noticed and tend to be cheaper trading, probably because there are a lot of funds out there that exclude non-dividend bearing entities, especially those not on major indexes.
DRM at current prices, people can do a lot worse, I’ll agree with that.
Thanks for the heads up Chessman….Ive been watching the NAV…kind of hoping it drops below 5, causing a stampede of selling. I can only recall them cancelling the DIV in 2009 for a few months, even with the NAV dipping below 5 several times. Have you ever run across a site listing their holdings?
Hi Marc
You will find the info with this link: http://bromptongroup.com/funds/fund/dgs/overview
Thanks again Chessman….been to that site so many times and missed it….front and center….duh, always looking at the menu to the left.