Investors should look to dividends
Published Monday October 6th, 2008
Market activity difficult to predict these days, leaving investors wondering what to do next
TORONTO - In these volatile times in the world's financial markets, it's a tough call for investors on whether to stay in the stock market or bail to bonds and other fixed income securities.
Exiting the stock market is not a pretty prospect with interest rates on Guaranteed Investment Certificates paying only around three per cent, a small gain for those investors seeking larger returns. So perhaps the best thing to do right now is direct a chunk of your equity portfolio towards those mainly big cap stocks that are offering attractive dividends, boosting your investment yield.
"Dividends are definitely one of the top things we look for all the time, good markets or bad," said Colin Montgomery of the U.S.-based Edward Jones brokerage.
"We know that good markets turn bad and the dividend is kind of your cushion, your protection," he said. "I might even say it's as important or more important in a good market because sooner or later, that market is going to come off and the dividend paying companies are going to be more defensive."
In 2006, the federal government cut its tax rate on certain dividends received by individuals from some Canadian companies in a move intended to make the total tax collected from dividends more comparable to the tax paid on distributions from income trusts.
Existing income trusts will begin paying corporate taxes in 2011, and many are expected to convert into dividend-paying corporations.
Before these changes, all dividends received by individuals from Canadian companies were subject to a 25 per cent gross tax rate and a dividend tax credit of 13.3 per cent of the dividend, resulting in an overall tax rate of 19.6 per cent for taxpayers in the top bracket.
One reason dividends are so attractive right now is because the share price of the issuing companies has been hammered over the last year.
This is especially so for the financials.
For example, Bank of Montreal (TSX:BMO) pays an annual dividend of $2.80 per share. But the stock is down 28 per cent from its 52-week high, falling heavily alongside other Canadian bank stocks that caught up in the fear over how much banks around the world were on the hook for toxic securities connected to the American mortgage sector.
That means the dividend yield now stands at almost six per cent.
Canadian Imperial Bank of Commerce is another good example. The dividend is $3.48 a share but the yield is also close to six per cent.
But with volatility so pronouced these days, Montgomery wonders if "you have the patience to wait for capital to recover and do you have the risk tolerance to watch your capital drop maybe 10 per cent."
To get a quick snapshot, log into http://www.djindexes.com/mdsidx/index.cfm?eventshowSelectDiv for a look at the top 20 dividend-paying stocks in the country (you have to register but the information if free).
Not too surprisingly, about three quarters of the companies are banks and insurance companies, which generally have enough stable cash flows to make regular payments to stockholders.
While the Wall Street financial sector has major risks, with many companies already cutting dividends during the credit crunch, Canadian banks and insurers appear more stable.
"They've been the safest, and they've been growing a lot," noted Montgomery.
But there are two telecoms in the top 20, Telus Corp. (TSX:T), Canada's second-biggest phone company, and Manitoba Telecom Services (TSX:MBT).
The latter particularly deserves a look as the dividend is $3.25 a share or a present yield of eight per cent.
However, dividend increases from that company could be in doubt.
"We see that the dividend payout ratio is already upwards of 80 per cent," said Juliette John, lead manager of the Bissett Canadian Dividend Fund.
"And we also understand that they are going to be trying to grow in the wireless area which may utilize some of the free cash flow in terms of capital expenditures, making them less likely to raise the dividend."
Analysts caution that it's not the best idea to go down the list and bulk up on the top 20-dividend paying companies, regardless of other factors.
"When you look at that Top 20 holding, then there could be companies on that list that are at risk of cutting their dividends when they got to a high dividend position the hard way, by way of a significant price decline as opposed to raising their dividend on a regular basis," said John.
"So by focusing on that straight Top 20 list, investors could be chasing yield but could be sacrificing growth in better qualified companies and therefore not necessarily get the total return they could have gotten another way."
Historically, analysts have said that in looking at dividends you want to make sure that a company has a strong record of raising dividends.
But in these rocky times on the market, John thinks it's OK to cut companies some slack in this regard.
"We've seen that in a lot of cases where companies have been more conservative over the past couple of quarters with respect to raising dividends," she said.
"We've seen a few rises, we've seen a few of the banks raise their dividends."
And while it's always nice to be paid for owning a stock, Montgomery doesn't think that investors should only buy dividend paying stocks at the expense of others.
"No, there's a place in your portfolio for growth stocks as well -- maybe 20 to 30 per cent in growth stocks that aren't paying a dividend," he said.
"But we say a good 50 to 70 per cent of your equity money, not including your bonds, should be in those dividend paying companies."
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