What to think about high dividend stocks?

Dividend-paying stocks have suffered from the recent rise in bond yields. Is it time to adopt them?

After losing nearly 20% of its value, BCE stock currently offers a dividend yield of 7.5% per year. That’s way more than inflation.

The dividend is the part of the net profit that the company redistributes to its shareholders. It is generally quarterly, but it can be paid every month or once a half, depending on the case. It can be fixed or vary from one period to another. In fact, companies increase the dividend when their financial situation allows it, but they are more reluctant to reduce it when things get tough. When they finally resign themselves to doing it, usually, they really can’t do anything else.

A yield of 7.5% means that the investor will receive 7.5% of the price at which he purchased the stock each year as a dividend. More if the dividend is increased, less if it decreases. The return therefore varies daily due to the volatility of the share price.

So is a dividend yield of 7.5% tempting or not?

The question arises because dividend enthusiasts have suffered in recent months. They watched helplessly as their portfolios continued to decline. It’s all well and good to receive a dividend of 5% or more, but if the price of the underlying stock falls 15% in the meantime, you don’t come away any richer.

Consider the iShares Canada Select Dividend Index (XDV, Toronto) exchange-traded fund, based on the Dow Jones index of the same name. Since the start of the year, the total return obtained, including dividends, has reached 0.54%. This is a lower return than the total return of 4.25% obtained by the S&P/TSX index of the Toronto Stock Exchange during the same period.

Dividend-paying securities are suffering from the rise in rates on long-term bonds with which they compete to attract investor capital. When bond yields rise, they can become more attractive than dividend-paying stocks. Bond rates have increased due to inflation, but not only that, according to explanations from National Bank Financial (FNB).

“ [La récente montée des taux obligataires] also reflects growing concerns about the fiscal trajectory of several advanced economies. The median deficit could be the largest recorded since the 1940s, excluding recession,” reads the latest issue of the Economic monthly.

These days, the 5-year rate on Canadian government bonds gives a current yield of 4.3%. As recently as the beginning of May 2023, the same rate stood at 2.87%.

According to FNB’s preferred scenario, the 5-year Canada rate would peak at 4.90% on 4^e quarter of this year. No one knows with certainty the trajectory of bond yields in the future. The chances are good, however, that the bulk of the rate hike is behind us.

It is in this context that we question the relevance of investing in high dividend stocks at this time.

Over time, dividends represent a considerable portion of an investor’s total return, recently recalled Hugo Ste-Marie, director of portfolio strategy and quantitative analysis at Scotiabank World Markets.

“Thus, $100 invested in 1956 in the TSX index would be worth approximately $3,600 today compared to $29,000 taking into account dividends received,” he wrote in a note to his clients on September 27.

In Canada, high dividend stocks are concentrated in telecommunications, energy, utilities and financial stocks.

Which titles to choose?

In his suggestions, expert Hugo Ste-Marie focuses on securities which offer a current yield of at least 3% per year and which have a strong chance of increasing their dividends in 2024. This hoped-for increase must be based on growth in profits or free cash flow (free cash flow).

In telecoms, his choice is Telus. According to him, the company is expected to experience the largest change in freed cash flows in the sector, due to a drop in investments and an expected increase in operating profit resulting from spending cuts announced in 2023. The company’s policy is to increase its dividend by 7 to 10% annually.

Mr. Ste-Marie does not comment on BCE, Bell’s parent company. The stock has suffered recently, to the point that its dividend now yields 7.5%, which is historically high. BCE has a long track record of dividend growth. The late financial columnist Claude Chiasson made his career advocating the purchase of securities paying increasing dividends when prices were low.

“Since its IPO in 1983, BCE has never reduced its dividends,” said Éliane Légaré, BCE spokesperson, in an email. In general, dividends have always increased, with the exception of the second and third quarters of 2008, when they were suspended and not paid. Since the first quarter of 2009, dividends have been increasing and the dividend growth objective is still maintained. 2023 is the 15th^e consecutive year in which BCE recorded dividend growth of 5% or more. »

Daniel Ouellet, of Groupe Ouellet Bolduc, affiliated with Desjardins Wealth Management, recently reinvested his excess cash in securities like BCE, Telus and TC Energy. “We think that the rise in long-term rates is pretty much over and that the readjustment of the price of these shares is pretty well done,” he explains in an interview. We have a very good window opening to return to Canada. The exchange rate is 1.37 and the Canadian stock market has underperformed the American stock market for several years. From a valuation point of view, we are starting to find that the Canadian stock market is becoming attractive again. »

On the issue of the high debt of these three companies, a situation that worries investors, Mr. Ouellet says he has done his homework. In the case of BCE, only 28% of its debt will be renewed within three years. According to his calculations, we are talking about 150 million additional interests to be absorbed annually. “It’s manageable,” he says.

As defensive securities that are less vulnerable in the event of a recession, telecoms benefit from the vigorous growth of the Canadian population, underlines the portfolio manager.

In return, BCE distributes a higher amount in dividends than its free cash flow. Such a high payout ratio poses a risk to future dividend growth, recognizes Mr. Ouellet. “But I am not worried about the continuation of the dividend,” he maintains.

TC Energy is Scotia Strategist’s Pick in Utilities. The return is high, but Mr. Ste-Marie is reassured that it is sustainable due to progress in the construction of the Coastal GasLink pipeline and the sale of certain assets.

In the financial sector, Mr. Ste-Marie prefers life insurers to banks. His favorite choice is Manulife, whose dividend estimated at $1.58 in 2024 is supposed to represent 44% of distributable profit, a ratio which reassures him about the sustainability of the distribution.

As for Canadian banks, CIBC delivers a current yield of 6.7%, the most generous of the major Canadian banks apart from Scotia. In recent years, investors have never regretted buying bank stocks. This time, however, the high outstanding mortgage loans combined with the high level of interest rates are causing many to have doubts. CIBC has paid dividends without interruption since 1868. Canadian Confederation was one year old.

Risks

Chasing high dividend stocks can be risky. Examples are legion where a high rate of return has heralded a drastic reduction in the dividend. The case of Cominar is eloquent. From 2016 to 2021, this real estate investment trust reduced its dividend every year. The company was finally privatized in 2022.

“Companies that pay high dividends,” continues Mr. Clérouin, “in the telecommunications sector, the energy sector, banks, these are companies that have reached maturity and are not finding new growth opportunities to reinvest capital at high returns. At Medici, we favor companies that have the ability to reinvest their profits at high rates of return. »