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Invest Well. Live Well: The dividend advantage

Recently, the Canadian stock market has been a bumpy ride. Even dividend stocks have suffered. Rising interest rates and trade tensions with our neighbours south of the border have put pressure on Canadian stocks.
Davis and Davis

Recently, the Canadian stock market has been a bumpy ride.

Even dividend stocks have suffered. Rising interest rates and trade tensions with our neighbours south of the border have put pressure on Canadian stocks. Some common dividend payers are down 10 per cemt this year.

This raises the question: Are dividend stocks out of favour?

As a quick recap, a dividend is the portion of corporate earnings that a company distributes to its shareholders. We’d like to highlight some of the key potential benefits of dividend investing:

1) Dividend payers can provide higher returns: Dividend paying stocks can provide a steady income stream which helps reduce the volatility of a portfolio when markets decline. In fact, as stock prices decline, the yield increases, making these shares potentially more attractive to prospective investors.

This may provide stability as people buying the stocks provide support to the share price. As noted earlier, some of these stocks are down more than 10 per cent, so their dividend yield is quite compelling. For example, Enbridge Inc.'s price dropped roughly 15 per cent and now pays a dividend over 6.5 per cent (Thompson Reuters, March 16, 2018).

2) Dividends can account for almost 40 per cent of total returns: Many investors are aware that the Big Five Canadian Banks have historically been considered a good investment. TD records show that in 1995, they paid only $0.22 per year in dividends and as of Mar 15, 2018, paid $2.68 a year and has a share price at the time of writing near $76.15, for an annual yield of 3.5 per cent.

Through all the good and bad years, this results in dividend growth in excess of 12 per cent. Assuming eight per cent growth rate over the next 10 years, shareholders could receive a dividend near $5.79 generating a yield of 7.6 per cent based on todays’ share price of $76.15.

3) Dividends outpace inflation: The silent killer or forgotten risk is inflation, which erodes purchasing power. Using the Bank of Canada website inflation calculator, inflation averaged 2.14 per cent over the past 30 years (1988-2018). More importantly, a $100 basket of goods in 1988 would now cost $188. It is a challenge to find Canadian dividend data; however, using the identical frame for the S&P 500 Index, it grew its dividends from $18.05 to $44.43, or in excess of three per cent, thereby keeping ahead of inflation.

4) Dividends are tax-efficient: Investments can generate interest, dividends or capital gains, which are all taxed differently. Because eligible Canadian public companies have already paid corporate taxes, dividends are taxed favourably for investors to avoid double taxation. Assuming no other income, British Columbians can earn $45,916 in dividends and pay no tax.

Another way of comparing dividends to interest is calculating the interest equivalent factor. A common guideline is to gross up the dividend by 1.3 times to arrive at an approximate interest equivalent factor. For example, a four per cent dividend is similar to receiving a 5.2 per cent GIC. While interest rates have come up, we have yet to see these types of GIC rates.

We believe dividend investing continues to be compelling and can be a key contributor to one’s portfolio. As always, please consult with a professional to ensure any investment strategies make sense for your personal circumstance.

Until next time, Invest Well. Live Well.

This document was prepared by Eric Davis, vice-president, portfolio manager and investment advisor, and Keith Davis, investment advisor, for informational purposes only and is subject to change. The contents of this document are not endorsed by TD Wealth Private Investment Advice, a division of TD Waterhouse Canada Inc.-Member of the Canadian Investor Protection Fund. All insurance products and services are offered by life licensed advisors of TD Waterhouse Insurance Services Inc., a member of TD Bank Group. For more information, call 250-314-5124 or email Keith.davis@td.com.