by Kim Inglis
Dividend stocks have been on a roll for a few years now and the trend is unlikely to abate anytime soon. As economic uncertainty continues, investors are expected to stick with the dividend theme to hedge portfolios against market volatility. According to Canaccord Genuity analysts, there are several reasons why dividend investing will continue to attract investors.
From a tax perspective, dividend investing makes sense. On an after-tax basis, dividends are generally worth 1.31 to 1.45 times more than the earnings on interest income. In other words, a three per cent dividend yield provides approximately the same after-tax income as a four per cent bond yield.
The risk/reward trade-off is more advantageous with dividend investing. The financials, utilities, and telecom sectors, as well as exhibiting lower volatility, have all generated higher total returns versus the S&P/TSX Composite Index over the last 10 years. This phenomenon is not restricted to Canada. According to data compiled by J.P. Morgan Asset Management, 42% of the total annualized returns earned in the S&P 500 Index can be attributed to dividends, making income as important as capital gains.
Changing demographics will be influential. The proportion of baby boomers in the Canadian population will increase from 21% today to 39% over the next 15 years. As boomers age they are less inclined to assume risk, preferring low volatility investments that provide income during retirement. These investments primarily take the form of balanced funds whose equity components are largely comprised of dividend-producing investments.
Underfunded and maturing pension funds are another contributor to the continued success of dividend investing. According to Canaccord Genuity data, most defined benefit pension plans in Canada are severely underfunded and many mature pension funds are facing a shortfall in cash flows. To make up for cash flow shortfalls, pension fund managers are likely to favor the regular and timely payments of dividend investments.
The overall corporate landscape is also favorable for dividend investing. Many corporations are carrying high levels of cash, prompting senior management teams to enact share buybacks, takeovers, and dividend increases. Telus Corp (TSX: T) is one of a number of companies who have regularly raised dividends and have stated a commitment to increasing them. Not only is this a positive for dividend investors, but it is also good from a capital appreciation standpoint as favorable dividend policies tend to result in higher stock prices.
When looking for dividend investments, investors should do their homework and companies should be analyzed to determine the sustainability of the dividend. Payout ratios should be examined to determine whether growth is possible within the existing business model. If companies are able to fund their growth initiatives internally, they are less likely to cut dividends. The strength of the balance sheet is another key ingredient. A company may be unable to deal with a cash shortfall or take advantage of a strategic acquisition if it is already facing high levels of debt.
Given the current market volatility, a continued defensive approach is warranted. When assessing dividend investments look for quality and take advantage of market dips to add to positions.
- Kim Inglis, CIM, PFP, FCSI, AIFP is an Investment Advisor & Portfolio Manager with Canaccord Genuity Wealth Management, a division of Canaccord Genuity Corp., Member – Canadian Investor Protection Fund. www.reynoldsinglis.ca. The views in this column are solely those of the author.