When Dividend Investing, the Payout Ratio Does Not Tell the Whole Story

For the most part, I am a dividend investor. Oh, I hold some ETFs for diversity but mainly I hold dividend-paying Canadian stocks. I've written about dividend paying stocks in the past. I have always told my readers to pay attention to the Payout Ratio when buying a stock for the dividend. Too high a payout ratio indicates the dividend may not be secure.

I have come to think this "rule" is not a rule at all. Lots of good, secure dividends are paid by company's with payout ratios above 100%. If the payout ratio is the percentage of a company's earnings going to meet its dividend demands, how is it possible to pay out more than 100%? I will try and give you an answer but if you'd like an explanation from a more knowledgeable source try Morningstar. (Click the link.)

Take Enbridge Inc. (ENB). It has a payout ratio of 123.64%. Yet, ENB has consistently paid its dividend, without missing a payment or reducing it, for the past 29 years. What is going on? I turned to Perplexity for an answer.

"Pipeline companies like Enbridge often base their dividend payout ratios on Distributable Cash Flow (DCF) due to the financial characteristics of their operations. Here’s a detailed explanation:

 

Capital Expenditure Demands

1. High Capital Expenditures: Pipeline companies typically face significant capital expenditure (capex) requirements to maintain and expand their infrastructure. These expenditures can include costs for building new pipelines, upgrading existing ones, and ensuring regulatory compliance.
2. Impact on Earnings: High capex leads to substantial depreciation charges, which can reduce reported earnings. Since these accounting entries do not reflect actual cash flow, relying solely on net income can present a misleading picture of a company's financial health.

Cash Flow Characteristics

1. Stable Cash Flow Generation: Pipeline companies benefit from relatively stable cash flows due to long-term contracts and regulated rates, which provide predictable revenue streams regardless of fluctuations in commodity prices.
2. Distributable Cash Flow as a Metric: DCF represents the cash available for distribution to shareholders after accounting for necessary capital expenditures. By focusing on DCF, companies can provide a more accurate reflection of their ability to sustain and grow dividends.

Enbridge's Payout Ratio Strategy

1. Target Payout Ratio: Enbridge has established a target payout ratio of 60% to 70% of DCF. This range allows the company to balance returning cash to shareholders while retaining sufficient funds for ongoing capital projects and operational needs. (I calculated the ENB DCF at 70.4% today by multiplying the annual dividend by 100 and dividing this by the Cash Flow. Using WebBroker, both figures are found under Fundamentals)
2. Financial Stability: By maintaining this payout ratio, Enbridge aims to ensure that its dividend payments do not jeopardize its financial stability, allowing it to continue investing in growth opportunities while rewarding shareholders consistently."

This brings me to company like Telus (T). When I tried to check the Telus earnings, cash flow, and payout ratio, I discovered that all fields were blank. No earnings, no cash flow and therefore no ratios. Yet, Telus pays a 7.33% dividend -- $1.61 annually. Again, I ask, what is going on? This time I used Google Gemini to get the answer:

"Telus (T) is able to pay a dividend while reporting neither cash flow nor earnings thanks to to several factors:

1. Cash Flow Generation: While specific cash flow numbers may not be publicly disclosed, Telus is a mature telecommunications company with a stable cash flow generation. This cash flow can come from various sources, including subscription fees, equipment sales, and network infrastructure investments.

2. Dividend Policy: Telus has a well-established dividend policy, with a focus on maintaining and growing its dividend over time. This commitment to shareholders is a key consideration for the company.

3. Financial Planning: Telus likely has a robust financial planning process that takes into account future cash flow expectations and dividend obligations. This allows them to assess their ability to maintain the dividend even in the absence of immediate earnings or cash flow reports.

4. Debt Management: The company's debt levels and interest expenses play a significant role in its ability to pay dividends. A strong balance sheet and disciplined debt management practices can help ensure sufficient funds for dividend payments.

5. Regulatory Environment: The regulatory environment in Canada, particularly for telecommunications companies, can provide stability and predictability in revenue streams. This can contribute to a consistent cash flow and support dividend payments.

It's important to note that while Telus may not have explicitly reported cash flow or earnings numbers, they likely have internal financial metrics and projections that guide their dividend decisions. "

Lastly, I checked the Telus Dividend Investment page on the company website to see if I could find some published numbers. I discovered that Telus has an expressed goal of making semi-annual dividend increases ranging from 7% to 10% annually through to the end of 2025. The declared payout ratio is 60% to 75% of free cash flow based on prospective basis. But, read the small print: "There can be no assurance that we will maintain a dividend growth program through 2025."

Did you notice that the free cash flow is based on "prospective basis". This is a key point. It indicates  the company is looking forward and making an estimate of its future cash flow. Actual free cash flow is a more accurate measure of a company's ability to pay its dividends.

 

TD Cowen is maintaining its BUY rating. Morningstar has Telus on both its Canadian Core Pick List and its Canadian Income Pick List. Plus, Morningstar rates Telus as a five star stock; it is severely undervalued in the eyes of the Morningstar analysts.

Is the Telus dividend secure? It appears to be at the moment but . . .

 

For more information on Dividend Investing go here: https://www.td.com/ca/en/investing/direct-investing/articles/dividend-stocks 

ZPAY vs original Million Dollar Portfolio

• This is an older screen grab of my ZPAY DEMO Portfolio. It was taken Tues. afternoon, June 29th. This is an amazing total value for a demo portfolio opened at the end of Nov. 2020 with an initial value of $1,000,000. For updated values, scroll down to bottom of post.
  

My Million Dollar Retirement Portfolio DEMO has performed very well since Fisher Investments Canada inspired me back in November to "put my money where my mouth is."  Fisher claimed withdrawing a full four percent annually from one's retirement portfolio would likely result in total portfolio depletion at some point. I agreed but many retired seniors, like me, have no choice. We must withdraw at least four percent annually to make ends meet in retirement.

Fisher used million dollar portfolios in their examples. Following their approach, I started a million dollar demo portfolio in Nov. of 2020. Each month I have withdrawn $3,330 to emulate the withdrawals made during retirement.

This is where it gets interesting. The value of my stock holding gained so much in this bull market that my yield expressed as a percentage dropped dramatically. My creative solution? Liquidate the Million Dollar Retirement Portfolio and put all the funds, the original million plus all the gains, into the BMO exchange traded fund ZPAY. My ZPAY Million Dollar Portfolio had a rough first day but it is recovering quite nicely. As you can see, on Tuesday, June 29, 2021 it had a balance of $1,230,293 at market close.

What do I hope to gain from the switch to ZPAY? In a word: yield. With my original portfolio, I'd have felt I was doing well if I removed four percent of the original investment annually ($40,000 on a $1,000,000 investment) and added an annual increase based on inflation. This would not have been good enough for Fisher Investments Canada, I'm sure. Following their withdrawal approach, I'd run out of funds at some point.

With ZPAY I can be more generous. If the portfolio gains value during the year, I will remove a full four percent on the new increased balance on top of my original withdrawal. I will attempt to never remove less than the four percent calculated on the original million or $40,000.

So far, I believe I am on track. Time will tell.

Date                               Original Portfolio                       ZPAY Portfolio             Total Withdrawals

• June 30/2021             $1,229,607.45                       $1,232,308.60                $23,310
  
• July 3/2021                $1,234,006.25                       $1,228,277.65                $26,640 *
  
• July 6/2021                $1,236,530.39                       $1,242,387.15                $26,640
• July 8/2021                $1,234,255.95                       $1,248,837.39                $26,640
• July 16/2021              $1,242,484.29                       $1,260,125.31                $26,640
• July 19/2021              $1,227,570.05                       $1,266,172.41                $26,640
• July 20/2021              $1,235,784.70                       $1,265,769.27                $26,640
• July 24/2021              $1,238,918.44                       $1,258,109.61                $26,640
• July 31/2021              $1,237,770.71                       $1,252,360.77                $29,970 *

It's too early to say a lot about these figures but note how well ZPAY performed on bad market days.

A screen grab from the close Thursday, July 8, 2021.