Globally, stock markets are off from between 20 per cent and 25 per cent from their highs in February.
This decline has been the fastest market drop of 20 per cent in history. Consequently, many investors are questioning their strategy. Fear and economic uncertainty because of the COVID-19 pandemic has hit markets hard — including quality dividend-paying companies. As a quick recap, a dividend is the portion of corporate earnings that a company distributes to its shareholders. We feel this is a great time to focus on dividend stocks as they can provide four key benefits:
1) Dividends are tax-friendly: Investments can generate interest, dividends or capital gains, all of which are taxed differently. Because Canadian public companies have already paid corporate taxes, dividends are taxed favourably. Currently, British Columbians can earn up to $53,230 in dividends and pay no tax (assuming no other income).
2) Dividend companies provide higher returns: Dividend-paying stocks provide a steady income stream that helps reduce the volatility of a portfolio when markets decline. In fact, as stock prices decline, their effective yield increases, making shares potentially more attractive to prospective investors. This feature can provide stability as buyers step in providing share price support. Some notable examples from January 1, 2020 to April 2, 2020:
According to RBC research, we shouldn’t lose faith. The following chart shows companies that pay and grow their dividends have best overall returns:
3) Dividends can account for 40 per cent of total returns: Many investors are aware that Canadian banks have historically been a good investment. In 1995, TD Bank paid dividends of $0.22 a year and, as of April 2020, paid $3.16 a year. At the time of this writing, TD Bank has a share price near $57.35, for an annual yield of 5.5 per cent. Through all the good and bad years, dividends grew in excess of 12 per cent. Assuming a more conservative eight per cent dividend growth rate over the next 10 years, shareholders could receive a dividend near $6.82, generating a yield of 12 per cent based on todays’ share price.
4) Dividends outpace inflation: The “silent killer” or forgotten risk is inflation, which erodes purchasing power. Using the Bank of Canada inflation calculator, inflation averaged 1.9 per cent over the past 30 years (1990 to 2020). A $100 basket of goods in 1990 would now cost $178. It is a challenge to find Canadian dividend data; however, using the same time frame for the S&P 500 Index, it grew its dividends by an average of six per cent, thereby keeping well ahead of inflation.
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. Interest rates have dropped sharply recently as governments try to ease the recent burden on Canadians, which means GIC rates will also be lower for longer.
We believe dividend investing continues to be compelling and can be a key contributor to one’s portfolio. As always, please consult with an investment professional before investing.
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.firstname.lastname@example.org.