The Seven Sins of High-Yield Investing

Sin #5: Owning Securities with High Payout Ratios

All common stocks, income trusts, master limited partnerships, REITS and other pass-through entities have what is called a payout
ratio. It’s a number that essentially says how much of the dividend is paid out from each dollar of net income.

A company like AT&T has a payout ratio of 74%, meaning that the company retains 26 cents of every dollar after dividends
are paid out to put back into the business. This is a decent ratio, but something around 50% to 60% is more ideal.

When screening for high yield, many entities like the Canadian Income Trusts push the envelope of the payout ratio equation
in an attempt to maintain their lofty dividend yields. When the price of crude oil and natural gas plummeted from their 2008 summer
highs, the payout ratios of many of these energy-related income trusts rose from the mid-50% range to over 110% of income received.

Many believers of long-term higher energy prices stayed with the trusts during this period of what was determined to be a short-lived
sell off in oil and gas prices, but the sell off has persisted well into 2009. So, to counter the negative affects on their balance
sheets, most of these income trusts had to slash their dividend payouts and dig into cash to meet fixed stated monthly payouts.

NEXT: Sin #6: Getting Paid in Special Dividends