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Are these massive dividend yields too good to be true?

There is little doubt that more and more investors are being pushed up the investment risk curve as a result of historically low interest rates.

Most retirees and SMSF investors typically require a certain level of income to sustain their required standard of living and for many people this just isn’t possible with term deposit rates at around 3%.

This has seen more people invest in equities in the search for yield.

This sounds like a reasonable strategy but investors need to remember that yield is only one part of the equation when investing in shares.

For example, what is the point investing in a company offering an 8% yield if the share price falls by 30%?

Or what if the company pays a trailing dividend yield of 8% but then slashes its dividend due to difficult operating conditions? Does BHP Billiton Limited (ASX: BHP) or Woodside Petroleum Limited (ASX: WPL) sound familiar?

And then there is the other situation where the dividend looks so attractive, but it is the result of the share price being hammered for one reason or another. Sometimes the market can get it wrong – for example Retail Food Group Limited (ASX: RFG) when it was recently trading below $4 per share and yielding more than 6.2% – but it can also be because the market thinks the current dividend is unsustainable.

In these situations, investing for yield alone is clearly a recipe for disaster.

With these points in mind, I recently carried out a quick search looking for companies currently yielding more than 7% and looked at whether those above average yields were too good to be true. Here are a few examples of the companies that came up:

  • Prime Media Group Limited (ASX: PRT) – Currently yielding 16.7% – fully franked! The media sector is facing a number of headwinds and Prime Media continues to suffer from declining revenues. The company does expect to post a full year profit of around $24 million, which should allow for the payment of a reasonable dividend for the remainder of the year. With that said, the longer term sustainability of the company’s business model and dividend is more uncertain and this is sufficiently reflected in the current valuation.
  • Finbar Group Limited (ASX: FRI) – Currently yielding 10.5% – The West Australian property developer has suffered from softening conditions recently thanks to the decline in the resources sector. There could be further pain to come for Finbar and I would not be surprised to see the full year dividend cut when the company reports later in the year.
  • Select Harvests Limited (ASX: SHV) – Currently yielding 11.2% – Just like commodity companies, Select Harvests’ profits are highly dependant on the price it can receive for its almonds. The price of almonds has been declining recently so investors should expect a fall in profits and a complimentary fall in the dividend when the company next reports.
  • Australia and New Zealand Banking Group (ASX: ANZ) – Currently yielding 7.5% – There is a lot of ongoing debate as to whether or not ANZ (and the other major banks) will be cutting dividends this year and this uncertainty is weighing on the share price. There is little doubt that profit growth has stalled for ANZ and the current share price reflects the fact that it is the bank at the highest risk of cutting its dividend in the short term.

Foolish takeaway

Investors should always be sceptical when a company is offering a dividend yield well beyond the market average.

There is usually a reason behind this and it is up to the investor to find out why the dividend yield may be too good to be true.

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Motley Fool contributor Christopher Georges has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.