How Safe Is Your Dividend?

Financial advisor Frank Weiler has developed a tool to assess which dividend stocks are most suitable for income-focused retirees, writes Rob Carrick, reporter and columnist for The Globe and Mail.

Let’s clarify your investing goal if you’re a retiree.

It’s income, in most cases, not growth. You want investments that pay interest or dividends, not those that offer only the potential to rise in value.

In his new book InSync Income, financial advisor Frank Weiler argues that income is money you can actually keep because it’s paid into your investment account. As for capital gains, they come and go. Lately, it’s mostly been go.

"Say someone has $100,000 in investments and they’re getting 5% income, and they get their $5,000," explains Weiler, president of First Reliance Asset Management. "It’s completely different for someone who has $100,000 and is hoping that it goes up 5%. That concept is not well understood by the ordinary investor."

Statistics Canada has estimated that as much as one-quarter of the population will be 65 or older in 20 years, which means retirement investing is a theme of growing importance. Weiler’s contribution to the discussion is a new method of assessing dividend stocks to find those most suitable to income-focused retirees.

It’s called the Dividend Anchor Score, and it compares a dividend stock’s yield against its volatility, or tendency to jump around in price.

Weiler said the underlying thinking here is that investors want as high a yield as possible while keeping risk, as measured by volatility, under control. "The safety of your dividend is the most important consideration—is it going to continue on?"

The Dividend Anchor Score aims directly at dividend safety. It’s by no means definitive, but it’s worth a look as part of your broader research into whether a dividend stock is suitable for your retirement income portfolio.

In his book, Weiler says the theory behind the score is that the dividend paid by a stock can act as an anchor for its price and prevent it from fluctuating wildly. The more reliable the dividend, the better anchor a stock has.

Calculating the anchor score requires you to know a stock’s dividend yield, which is a company’s annualized dividend expressed as a percentage of its share price, and its beta, which measures volatility against the appropriate benchmark stock index, in this case, the S&P/TSX composite index.

The index always has a beta of 1; a stock with a lower number is considered to be less volatile and thus more desirable for someone seeking stable investment income, while a larger number indicates more volatility than the index and less suitability for retirees. Weiler prefers longer-term five-year beta numbers and has used them in creating the chart that accompanies this column.

To calculate the anchor score, divide a stock’s beta into its dividend yield. Higher numbers are better when evaluating what a score means.

Here’s an example supplied by Weiler of how to interpret an anchor score using two high-yielding income trusts (yes, there are still a few trusts that haven’t converted into corporations):

One is A&W Revenue Royalties Income Fund (Toronto: AW.UN), with a dividend yield late this week of 7.2%, and the other is Keg Royalties Income Fund (Toronto: KEG.UN), with a yield of 7.7%. A&W’s anchor score is 34 and Keg’s is 14, reflecting the fact that Keg’s share price been a fair bit more volatile than A&W over the past five years.

Mr. Weiler went beyond the anchor scores by digging into the distribution history of the two trusts. A&W’s payouts have been very steady over the years, with periodic increases and special distributions. Keg also had a good record of steady distributions, but it’s now paying 8 cents a unit, down from 10.65 cents at the end of 2010. Two different distribution histories, two different anchor scores.

The anchor score is best used as a way to do initial research on companies in the same sector, Weiler said. "You’re a long way from buying once you have the score. You’ll also want to drill down to get more information."

An example of why you need to probe further than the anchor score can be found in Yellow Media (Toronto: YLO), which comes in at a lofty 23. That’s a result of this stock’s sky-high dividend yield of 20.6%, a clear sign investors fear a dividend cut.

Watch out for high dividend yields because they may signal risk, even if the anchor score looks favorable.

As you can see on the accompanying chart, telecommunications companies tend to have comparatively high anchor scores, while energy companies tend to be on the low side. Don’t make the mistake of matching up anchor scores for different sectors like these, because it makes for unfair comparisons.

Mr. Weiler suggests investors pick the sectors they want to be in, and then compare anchor scores for applicable stocks. For example, let’s say you were looking at telecom stocks and wanted to compare Telus (Toronto: T), with a yield around 4.3%, and BCE (BCE), with a yield around 5.2%.

Is there extra risk associated with BCE’s higher yield? The anchor score suggests BCE is actually less risky.

Among the big banks, yields range from 3.4% to 4.8%, but the anchor score suggests they’re all comparably good when it comes to dividend security.

The approach used by Weiler in choosing dividend stocks for income investing is to avoid those with yields in the area of 1% or less, and focus mainly those yielding 5% or more.

There are a few blue chips with dividend yields of 5%, but most high-yielding stocks are smaller companies that might not seem like ideal components of a retirement income portfolio. Weiler believes the anchor score offers a way of sorting through these high-yielding stocks to find the most stable dividend payers.

NEXT: How Top Stocks Fare

The Dividend Anchor Score is a way of assessing how safe a company’s dividend is. It’s calculated by dividing the beta for a stock (that’s a measure of volatility) into its dividend yield. Here are the Dividend Anchor scores for the stocks in the S&P/TSX 60 Index.