Beginner investors often look to dividends when making their first stock purchases. A high dividend yield can be a tangible way of being rewarded for investing – by beating skinny savings account rates. It will also often seem more appealing to new investors than the benefits of compound growth over time.
However, just picking a stock that your brokerage account says pays a high dividend can be a risky and illusory reward. That is because a company's 'trailing' dividend is usually the yield that's mentioned, and the trailing dividend is the dividend for the last 12 months. This does not necessarily correlate to what the company will pay in the next 12 months.
For example, Woodside Petroleum Limited (ASX: WPL) was, until mid-February, trading on a hefty dividend yield of 7% or greater. Unfortunately, due to declines in commodity markets, the company had to cut its dividend to a much more ordinary 4.1%. Even this dividend could be under threat, as a result of recent average realised prices being below what Woodside received for its oil last year.
However, the company does have great free cash flow (the cash leftover after all business expenses) and limited debt, which will act to make dividends more steady over the long term.
Another company trading on a huge trailing yield is Monadelphous Group Limited (ASX: MND), which yields 10% fully franked, according to data from retail broker Nabtrade. 10% sounds very enticing, but investors who look a little closer will note that the high yield refers to the final dividend from the previous financial year, with this year's interim dividend likely to be some 40% lower again.
Monadelphous has limited debt and should actually be able to sustain this level of payout. However, with just $42 million cash generated from $800 million in revenue, investors are risking a lot in an operational sense. A couple of relatively small mistakes or delays could wipe out the year's cash flow. So while this dividend seems sustainable, I would not feel comfortable funding my retirement with it.
A final business with a very high yield is Thorn Group Ltd (ASX: TGA), which yields around 8%. Unlike Woodside and Monadelphous, Thorn has quite high levels of debt as a result of its asset leasing business. However, its business is less cyclical and appears to be more defensive, with 70% of customers in a recent survey agreeing that flagship brand Radio Rentals was the only way for them to access affordable everyday goods. The debt is also secured by a low level of delinquencies and cash flows of 21x the company's annual interest repayments.
While debt is rising in order to fund business growth, Thorn's high operating cash flows underpin today's high dividend and this should be sustainable going forwards.
