# If you're seeking high yield stocks and bonds



## james4beach (Nov 15, 2012)

andrewf has been good at hammering this point: "The distribution yield is mostly irrelevant. What matters is total return." (in this Income portfolio thread)

A lot of us get drawn to high dividend yields and high yields on bond funds, because it _feels_ like the investment is going to generate a lot of cash. But in reality that comes at the expense of performance/capital gains. This reasoning is difficult to wrap your head around, I admit, especially in a strong market where it feels like nothing can go down. Also the zero interest rate environment tends to make us into yield-chasers. You have to fight this psychological tendency!

Here's an example: Just Energy (JE). Like most high-payout stocks, its price had gone way up as yield-chasers piled into it. But what good is a 13% dividend yield when the stock can drop 22% in one week, as is happening now? It's dropping due to the consequence of an unsustainable payout. A great illustration of andrewf's point!

I expect the same thing will eventually happen with most high yield stocks and high yield bonds (junk bonds)


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## gibor365 (Apr 1, 2011)

What do you mean by high yield stocks ? 5% or 10+%?

As per this quote.... yield you know right away, but total return is absolutely unknown , you can only speculate. The yield is very important , but more important yield sustainabilty ... long history of dividend increases, reasonable payout ratio and P/E.
Can you list stocks that were increasing dividends for more than 25 years and cut/suspended it?


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## james4beach (Nov 15, 2012)

You've got a point there gibor and this is hard to evaluate. I agree that we can only speculate on long-term price fluctuations. I also agree that you can take yield seriously (it's an important investment return) if it's sustainable.

However I'd automatically be wary of a company that pays out more in dividends than it earns (e.g. JE) because that's fundamentally not sustainable. There are certainly other high yielding stocks that share this feature, so you can't consider those guys sustainable and thus can't take their yield seriously.

On the bond side, it's harder to evaluate because you have to consider the debt the company has and their overall creditworthiness... "sustainable" in the bond sense means, could the company default before the bond matures? You only get the bond yield-to-maturity if it actually matures 

In the current rate environment I think anything exhibiting more than 5% yield is rather suspect (either payout ratio or default risk), where you should also consider whether some of that is return of capital


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## Sherlock (Apr 18, 2010)

I don't think you can say that anything with a yield higher than x is suspect, eg look at something like RPI.un the yield is high but the payout ratio is reasonable, there is no reason to suspect a dividend cut or a share price drop.


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## fatcat (Nov 11, 2009)

not only andrew but cc who started this forum (and many others) make this argument and it is a good one, total returns determine the best investment choices

i suspect that people like stephen jarislowsky and tom connolly who both recommend high-quality dividend stocks exclusively would answer that companies who have a solid record of dividend distribution tend to be stellar companies and thus will outperform based on their superior management/products

there are a lot of people who espouse this philosophy, i.e. the ability to pay a consistent dividend is the mark of a great company

we are in environment where we could see low returns and a sideways market for a long time and in this world you want to get paid for holding equities

i do agree that very high dividends (above 6-7% maybe) should be looked at carefully though


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## Squash500 (May 16, 2009)

It also depends on how much money in investable assets you have. I watched John DeGoey on BNN recently and he said any investor with less than 1 Million in investable assets should forget about individual stocks and just buy ETFS.

Also if you're in accumulation phase....then total return is OK. However if you're in semi-retirement or retirement then the yield of the individual stock or ETF is very important as chances are you're using some of that income produced by the individual stock or ETF to live on.


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## fatcat (Nov 11, 2009)

Squash500 said:


> However if you're in semi-retirement or retirement then the yield of the individual stock or ETF is very important as chances are you're using some of that income produced by the individual stock or ETF to live on.


exactly, i am 64, if we go sideways for say 10 years and i am in growth stocks paying .75% or something, i am not a happy investor

many boomers basically are basically drawing some kind of line between income/capital and life expectancy and hoping that the income/capital line doesn't cross the life expectancy line too early

the concept of "growth" loses more meaning each time you cross age 60-70-80 and so on ...


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## Eder (Feb 16, 2011)

I wonder how many people didn't buy BMO when it was yielding 8-10%?


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## doctrine (Sep 30, 2011)

To be fair, BMO was only in the crazy range of below $35 (which was a 8% yield) for a few months. However, it did exist at higher 6-6.5% yields for a significant period of time. Then again, most people were calling for the end of the world and such, so you needed some conviction to invest.


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## james4beach (Nov 15, 2012)

Squash500 said:


> Also if you're in accumulation phase....then total return is OK. However if you're in semi-retirement or retirement then the yield of the individual stock or ETF is very important as chances are you're using some of that income produced by the individual stock or ETF to live on.


Sure, but you could equally well sell some of your shares and live off that. Think of an income fund: this is exactly what they're doing inside the fund. The cashflow you get comes from:

a) capital gains (if there are any)
b) dividends & interest
c) return of capital

They wrap it all up, so you don't see what's happening behind the scenes. But there's liquidation of shares happening under the hood. For some reason, nobody complains when a big income mutual fund does this (or insurance company, for an annuity), yet people seem to hate the idea of a retail investor selling off their own shares in their account.

Fundamentally speaking, there's not much difference between you receiving cash dividends and you selling shares for value. The dividends paid out to shareholders are value coming out of the company. The only real differences are the fees typically incurred for selling stocks/ETFs, versus no-fee dividends flowing to you. So if you are in retirement and need to live off cashflow, don't get caught up on the need for high distributions. Focus instead on avoiding trading fees, maybe something like index mutual funds with no fees involved in selling.

A perfectly valid structure, which I mention in the income portfolio thread, is one where you simply hold 50/50 a stock index and a bond index. Then you obtain your cashflow through their dividends & interest, plus selling off shares (index mutual funds perhaps). It's exactly what an income fund, or even an annuity, does!

Check out this article, The income illusion. By the way this article points out that XDV does this internally too... 1/6 the distribution is ROC. So again, nobody complains about XDV and its "awesome yield" ... why all the hesitation to do the same liquidation within your own portfolio?


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## james4beach (Nov 15, 2012)

fatcat said:


> exactly, i am 64, if we go sideways for say 10 years and i am in growth stocks paying .75% or something, i am not a happy investor


I would say you're making a mistake if you just sit on your stocks. I think you should be regularly liquidating them at some rate, to live off. For example XTR is liquidating 2% of its assets yearly. There's no reason why you can't do the same.

And again XDV (which many yield investors here love). Last year, 10% of its distribution was return of capital! The funds are just fooling you... they are selling off assets. But I think many investors hold XDV and think to themselves, it's much better to hold XDV and "live off its income". It's just a psychological hangup. Apply the same thing to your own portfolio, live off a mix of its dividends PLUS liquidation


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## james4beach (Nov 15, 2012)

doctrine said:


> To be fair, BMO was only in the crazy range of below $35 (which was a 8% yield) for a few months. However, it did exist at higher 6-6.5% yields for a significant period of time. Then again, most people were calling for the end of the world and such, so you needed some conviction to invest.


But it could have gone the other way too, you know. Canada may have had to nationalize the banks, the equity could have dropped to $0, you would have been wiped out. A bailout does not necessarily mean the equity stays intact. You got lucky.

That could have happened ... the stealth bailout gave the perception that the banks would have "inevitably" bounced back. Not true, they were heavily supported by the Federal Reserve, Bank of Canada, and CMHC. Please read this report from CCPA


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## Eclectic12 (Oct 20, 2010)

doctrine said:


> ... However, it did exist at higher 6-6.5% yields for a significant period of time. Then again, most people were calling for the end of the world and such, so you needed some conviction to invest.


Or you needed to realise that the US financial institutions and Canadian were operating under different rules.

Then too, I recall several articles in Mar 2009 plus investment newsletters pointing out the panic in the streets and that it would be a good time to buy.

Of course, having seen several other cycles of this, it helped to suggest that the concern was oversold.

Cheers


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## Eclectic12 (Oct 20, 2010)

james4beach said:


> ... Fundamentally speaking, there's not much difference between you receiving cash dividends and you selling shares for value ... The only real differences are the fees typically incurred for selling stocks/ETFs, versus no-fee dividends flowing to you.


Hmmm ... is this really true for a retired person?

Retiree A gets paid with capital gains (or RoC) which does not increase income and does not trigger an OAS clawback.

Retiree B gets paid with dividends that are grossed up, which increases income and has the potential to trigger an OAS clawback.

Are they really going to agree that the fees are the only difference?




james4beach said:


> So again, nobody complains about XDV and its "awesome yield" ... why all the hesitation to do the same liquidation within your own portfolio?


Agreed.


Cheers


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## james4beach (Nov 15, 2012)

Eclectic12 said:


> Of course, having seen several other cycles of this, it helped to suggest that the concern was oversold.


I would say you made your decision with imperfect information, and got lucky. You were not aware of how much assistance was actually needed by the big Canadian banks (none of us were, because nobody disclosed it to us). CIBC received total lending from 3 government institutions that surpassed the company's equity value (totally underwater) for more than 3 months. BMO was totally underwater for about 1 month.

I know this sounds obnoxious of me, and I apologize somewhat, but you did buy an insolvent bank and you were not aware that it was completely bailed out by the government and central banks. You got lucky, because they could have easily let the equity collapse completely. Your perception that the Canadian situation was vastly stronger than the US situation is unfounded, in my opinion. Check out the report I linked.


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## james4beach (Nov 15, 2012)

Eclectic12 said:


> Hmmm ... is this really true for a retired person?
> 
> Retiree A gets paid with capital gains (or RoC) which does not increase income and does not trigger an OAS clawback.
> 
> ...


I acknowledge the tax and other government implications of one versus the other... I'm just saying that from a fundamental viewpoint, I don't think there's any difference.


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## james4beach (Nov 15, 2012)

To clarify what I mean when I say that CIBC and BMO were totally underwater: I mean that the total assistance the banks received (a combination of emergency loans from Bank of Canada/Federal Reserve, plus a straight gift from the CMHC who purchased mortgages for *cash*) exceeded the market value of the bank.

This notion that the Canadian banks were self sufficient is totally untrue. It wasn't just a small amount of assistance, it was worth their ENTIRE market value. The Government could have simply purchased CIBC and BMO outright, easily. You equity and preferred share investors out there are very, very, very, very lucky that didn't happen, but it was a very close call.


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## doctrine (Sep 30, 2011)

Risk/reward - they were risky, those who took it were rewarded. Now, it doesn't look as risky, but you won't get a 10% starting yield either.


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## Eclectic12 (Oct 20, 2010)

james4beach said:


> I acknowledge the tax and other government implications of one versus the other... I'm just saying that from a fundamental viewpoint, I don't think there's any difference.


Fair enough ....




james4beach said:


> ... plus a straight gift from the CMHC who purchased mortgages for *cash*) exceeded the market value of the bank ...


I will look through the article in more detail when I have time but I'm confused by the "gift" by CMHC. If CMHC paid cash, how is it a gift? The banks sold assets did they not? 

Or did CMHC pay $2 for each $1 of mortgage? Or did more than the usual rate of mortgages fail after CMHC bought them?


Cheers


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## Squash500 (May 16, 2009)

james4beach said:


> Sure, but you could equally well sell some of your shares and live off that. Think of an income fund: this is exactly what they're doing inside the fund. The cashflow you get comes from:
> 
> a) capital gains (if there are any)
> b) dividends & interest
> ...


Excellent post James. Thanks for posting that income illusion article.


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## gibor365 (Apr 1, 2011)

imho, another bogus assets -> covered calls ETF like ZWB, HEX, HEE and so on...
They started about 1 - 1.5 year ago and first several months paid very nice yield , this way they lured a lot of invcome investors and after this they started every month reduce distributions by double digits %, and now , for example, ZWB distribute about the same that ZEB (and always underperform ZEB).
So, I think, the best way is to have list of high-quality blue chip stocks that increasing dividends for many years and have reasonable payout , and for certain sectors/industries in order to increase divdersification add some straight forward ETF with low MER


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## fatcat (Nov 11, 2009)

james4beach said:


> Check out this article, The income illusion.


james, i missed this earlier ... excellent article ... this should be pinned as a must read for all beginning investors ... my only disagreement is this: it is true that a company is a $1000 "poorer" when it pays out $1000 worth of dividends .. but only in a technical sense .. the ability of a company to manage cash flow and generate profits in a consistent and stable fashion is the mark of a well-managed company, a well run company ... in the end this is what we all want to own, whether we receive benefit by virtue of dividends or growth ... the advantage that stable dividend companies offer is a degree more predictability and reliability ... growth is somewhat more tricky to navigate with more pitfalls ... though, once again, i do agree that it is total return at the end of the day that matters .. or as andrew and others have said, after your meeting with the tax man, how much do you have in the pocket ? ... great article though especially on the illusion of income funds and the risks of covered calls

ps. i am beginning to believe that the way to make money is look for all the newly emerging hot investments in all the financial sites and just ride them for about a year and then get the hell out .. i remember well the _covered-call mania_ that swept over every financial rag on the net a while back ... though i know that pie has done well with them and the theory makes sense ...


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## james4beach (Nov 15, 2012)

Hi all, thanks for the replies. Yes I like that Income Illusion article too, it really got me thinking.

But I think the article underplays the value of dividends a little too much. A sustainable, reasonably sized dividend is still very important, and I will always want one.

fatcat: you make some good points especially regarding stability and good management. I'll add two more reasons: first, companies could also squander their cashflow e.g. overpay a CEO, waste money on stupid acquisitions (HPQ!), or just lose it outright in the future due to fraud/mismanagement. A dividend is cash in my hand now, not some ethereal promise that if the company manages things right for the next 20 years, that money will be intact. When corporate America can only think 1 year out, I can't trust them to "manage my money" 20 years out. Second reason: we're now probably in a low growth period. Very few companies will be able to efficiently reinvest internally. It makes sense for me to receive some chunk of the earnings in dividends, especially in a low-growth period.

For example, I'm a Berkshire shareholder. Their policy of not paying dividends (so as to internally reinvest all cashflow) makes me nervous. What if Buffett's replacement turns out to be a crook, and loses tons of money? What if the US economy crashes again? If they had paid dividends I could have already taken home 30% return by now. Sure, that return would have come at the detriment of long-term performance (they may get better ROR than I can with the cash). But without the dividend, now I'm totally dependent on that stock price -- and stock prices can do crazy illogical things. Flash crash for instance. I see future stock prices as very ethereal and flaky.


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## fatcat (Nov 11, 2009)

james4beach said:


> Hi all, thanks for the replies. Yes I like that Income Illusion article too, it really got me thinking.
> 
> But I think the article underplays the value of dividends a little too much. A sustainable, reasonably sized dividend is still very important, and I will always want one.
> 
> ...


i think we agree, a long and steady history of good dividends that are regularly increased is the mark of well run forward thinking company, correct ? ... as far as berkshire, you are in a similar boat as apple, the loss of well respected and brilliant ceo presents possible risks ... but it seems like a berkshire shareholder can't claim they haven't been warned, buffets strategy is well known


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## james4beach (Nov 15, 2012)

fatcat said:


> i think we agree, a long and steady history of good dividends that are regularly increased is the mark of well run forward thinking company, correct ?


Yes we agree on that. This makes me curious about one of BMO's newer dividend funds, ZDV. I don't own it, but I've read their methodology document about how they select stocks (from TSX Composite) for the fund: they consider payout ratio and 3 year dividend growth rate. It's an intriguing idea, though I think 3 years is a bit short-sighted when looking at dividend growth history.

What I'd like to do is closely inspect a few of its top holdings, to see if their methodology is leading to sane choices. Either way I'll be waiting, as I won't buy at such an extreme high.


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## liquidfinance (Jan 28, 2011)

The is has really got me thinking. I have done a bit of s searching and found this article in the globe. 

It goes some way to explain the "why" and "where" behind the return of capital although in xtr. Although we know the underlying his holdings of xtr do not produce enough to cover the payout. 

http://www.theglobeandmail.com/glob...ion/the-abcs-of-dividend-etfs/article1373200/


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## james4beach (Nov 15, 2012)

This ROC really is confusing. The article talks about one of the things that happens inside an ETF that's simultaneously growing with new funds sloshing in, and I think that's present in just about any ETF and a relatively small issue. But I think what happens with XTR and the other monthly income funds is a different issue. If they have to make a $0.72 distribution, and only have $X of earnings available, they're clearly doing something under their control to make up the ($0.72 - X) deficiency. Maybe some of the deficiency comes from the ROC variety provided by funds sloshing in, but it can't be the whole story --- because in XDV that only provides a bit extra, but the monthly income funds need A LOT extra. This is why I think they're basically liquidating some of the portfolio. 

But I'm not sure; I still haven't found any clear source on this. I've read a lot on this and there's one thing I've learned; that ROC has many varieties and it's clear as mud where they come from. The fund phone agents sure as hell don't know, and the salespeople don't know either.

In finance I've learned that when you can't find a clear answer it usually means something's up. So I will continue to stay away from monthly income funds and anything with too much ROC, until someone can clearly explain to me where all these numbers come from -- referencing the audited financial statements as a source. iShares or BMO are welcome to convince me, if they wish.


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## james4beach (Nov 15, 2012)

This article differentiates between four varieties of ROC (four!!), including what you just posted about (#2 in their list) and the portfolio liquidation I'm talking about (#4 in their list).

http://howtoinvestonline.blogspot.ca/2010/07/return-of-capital-separating-good-from.html

So obviously there are different forms of ROC, but how to know which is which still seems like a mystery.


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## james4beach (Nov 15, 2012)

Eclectic12 said:


> I will look through the article in more detail when I have time but I'm confused by the "gift" by CMHC. If CMHC paid cash, how is it a gift? The banks sold assets did they not?
> 
> Or did CMHC pay $2 for each $1 of mortgage? Or did more than the usual rate of mortgages fail after CMHC bought them?


Getting off topic, I responded in a new thread. See Federal bailout of banks 2008-2010:
http://canadianmoneyforum.com/showthread.php/14884-Federal-bailout-of-banks-2008-2010


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## dogleg (Feb 5, 2010)

James4 et al: Some excellent points are made above. Some 'investors' don't look beyond their noses when they assess yield. A friend told me recently he was going to buy PFE because he liked its yield. I told him I bought this stock a few years ago at $27. US , watched it go to $40 then drop gradually to $12. I agreed the 'yield' looked pretty good at the bottom but who paid for it? As people on this thread have pointed out so well there is no free lunch with equity stocks -or any others I suppose except if you get in at the bottom- and who is to say where that is?


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## Squash500 (May 16, 2009)

james4beach said:


> This ROC really is confusing. The article talks about one of the things that happens inside an ETF that's simultaneously growing with new funds sloshing in, and I think that's present in just about any ETF and a relatively small issue. But I think what happens with XTR and the other monthly income funds is a different issue. If they have to make a $0.72 distribution, and only have $X of earnings available, they're clearly doing something under their control to make up the ($0.72 - X) deficiency. Maybe some of the deficiency comes from the ROC variety provided by funds sloshing in, but it can't be the whole story --- because in XDV that only provides a bit extra, but the monthly income funds need A LOT extra. This is why I think they're basically liquidating some of the portfolio.
> 
> But I'm not sure; I still haven't found any clear source on this. I've read a lot on this and there's one thing I've learned; that ROC has many varieties and it's clear as mud where they come from. The fund phone agents sure as hell don't know, and the salespeople don't know either.
> 
> In finance I've learned that when you can't find a clear answer it usually means something's up. So I will continue to stay away from monthly income funds and anything with too much ROC, until someone can clearly explain to me where all these numbers come from -- referencing the audited financial statements as a source. iShares or BMO are welcome to convince me, if they wish.


Hi again James...you're IMHO making some excellent comments in these threads. All I know is that ROC article is giving me a headache trying to understand it---LOL. What I perhaps agree with you the most is that these phone reps and fund salespeople are totally useless and unhelpful for the most part---LMAO.

I personally make all my own investment decisions but I have an excellent accountant who does my taxes for me as I find this whole ACB and ROC quite confusing. I have a rudimentary knowledge of what ACB and ROC is but not enough to do my own taxes. I've even called phone reps at Blackrock before...asked them some intricate questions about certain ETFS and they had no clue what I was talking about. The questions I asked them were nowhere as detailed and well thought out as your research on the XTR as an example.


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## james4beach (Nov 15, 2012)

Thanks. Yes the ROC is giving me a headache too and I'm not happy about it.

If you find someone with knowledge on this, could you please show them the part of the annual financial statements. Here is the 2011 PDF:
http://ca.ishares.com/content/en_ca/repository/resource/annual_report/annual_report_2011_en.pdf

The key question is still, where does that other non-earned part of XTR's distribution come from? Page 138 shows the financial statements for XTR. Page 139 breaks down the distribution by type. In there I only see one mention of "return of capital". We need to find out what that return of capital means and whether it's one of these 4 flavours of ROC? And where does the actual portfolio-liquidation-ROC show up in the financials. My suspicion is that "return of capital" on page 139 is actually true return of capital, i.e. selling off assets internally and distributing the capital back to shareholders.


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## Squash500 (May 16, 2009)

james4beach said:


> Thanks. Yes the ROC is giving me a headache too and I'm not happy about it.
> 
> If you find someone with knowledge on this, could you please show them the part of the annual financial statements. Here is the 2011 PDF:
> http://ca.ishares.com/content/en_ca/repository/resource/annual_report/annual_report_2011_en.pdf
> ...


For some reason my adobe reader won't let me read this document. I'll have to go on the ishares website and see if I can find it? I'll also ask my accountant when I drop off my taxes in March or April as right now I have a pretty substantial position in the XTR and I would like to find out these things for myself.

IMHO how many people actually read the prospectus for either ETFS or mutual funds? I'm sure very few investors do....myself included. You almost have to be a lawyer or accountant to understand the intricate parts of these prospectuses' and financial statements.


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