Summer is the season for gardens and growing things. We enjoyed our first crop of yellow beans this week with the promise of cucumbers to come.
In the markets, investors look for growth from Canadian dividend stocks. They can find good candidates in the S&P/TSX Canadian Dividend Aristocrats Index (the aristocrats index herein), which seeks companies that have increased their dividends in each of the past five years.
The aristocrats index enjoyed a compound annual growth rate of 10.3 per cent over the 14½ years from the end of 2011 through to the end of June.
It’s an unusual index because its holdings are weighted by dividend yield rather than by size (i.e. market capitalization). That is, more of its money is put into stocks with high dividend yields and less goes to stocks with low yields. Mind you, there’s an 8-per-cent cap on any individual holding in the index, which is refreshed annually.
But weighting by dividend yield might not have been optimal because a size-weighted portfolio of stocks in the aristocrats index climbed at an 11.8-per-cent annual rate over the 14½-year period. Similarly, an equally weighted portfolio, where an equal-dollar amount of each stock was purchased, gained an average of 11.4 per cent annually. Mind you, the portfolios likely benefited from being rebalanced monthly rather than annually.
(The portfolio returns herein are based on backtests using monthly data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are rebalanced monthly.)
Perhaps more critically, a focused high-yield portfolio that starts with the stocks in the aristocrats index (96 currently) and then buys an equal-dollar amount of the 10 per cent of them with the highest dividend yields would have gained an average of 9.0 per cent annually over the 14½-year period. It lagged both the aristocrats index and the Canadian market index, as represented by the S&P/TSX Composite Index, which advanced at a 10.9-per-cent annual rate over the same period.
Stocks with dividend yields north of 10 per cent often have troubles. For instance, the recent history of one the largest telecommunication companies in the land comes to mind and another appears to be following a similar path.
The iShares S&P/TSX Canadian Dividend Aristocrats Index exchange traded fund (CDZ) follows its namesake’s index and offers a convenient package for an annual fee (MER) of 0.66 per cent. It gained an average of 10.7 per cent annually over the 10 years to the end of June.
Mind you, investors would have been better off in the more diversified iShares Core S&P/TSX Capped Composite Index ETF (XIC) with a lower annual fee of 0.06 per cent and average annual returns of 12.8 per cent over the same 10 year period. (ETF returns from Morningstar.)
But many Canadian dividend investors like to build their own portfolios, and they can use the aristocrats index as a starting point for further research.
For instance, it’s an easy matter to start a portfolio with, say, the 20 largest stocks in the aristocrats index. This week the top 20 includes the six big Canadian banks along with Alimentation Couche-Tard (ATD), Brookfield (BN), Brookfield Asset Management (BAM), Canadian Natural Resources (CNQ), Cenovus Energy (CVE), CN Railway (CNR), Enbridge (ENB), Great-West Lifeco (GWO), Imperial Oil (IMO), Loblaw (L), Manulife Financial (MFC), Sun Life Financial (SLF), TC Energy (TRP), and Wheaton Precious Metals (WPM).
Alternately, investors who prefer low-volatility companies might start with the aristocrats index’s stocks and pick the 20 with the lowest volatilities over the prior 260 days. The 20-stock low-volatility portfolio gained an average of 12.5 per cent annually over the 14½ years to the end of June. It currently holds the six big banks along with AltaGas (ALA), Canadian Utilities (CU), Emera (EMA), Enbridge (ENB), Fortis (FTS), Great-West Lifeco (GWO), Hydro One (H), Manulife Financial (MFC), Metro (MRU), Power (POW), Pembina Pipeline (PPL), Sun Life Financial (SLF), Telus (T), and TC Energy (TRP).
More active souls might opt instead for a momentum twist on dividend growth stocks. If they started with the stocks in the aristocrats index and picked the 10 with the highest returns over the prior year, they’d have enjoyed average annual gains of 13.5 per cent over the 14½-year period. Mind you, momentum-oriented portfolios should be updated frequently, which goes against the grain – and boosts costs – for many dividend investors.
The stocks in the momentum portfolio are: Aecon Group (ARE), Altius Minerals (ALS), Badger Infrastructure (BDGI), Cenovus Energy (CVE), CES Energy Solutions (CEU), Exchange Income (EIF), Great-West Lifeco (GWO), Hammond Power, (HPS.A), Power (POW), and Toromont Industries (TIH).
As a fan of dividend payers, it should come as no surprise that I own shares of many of the companies mentioned above.
While I hope the dividend portfolios will continue to post reasonable returns over the long term, there are no guarantees when it comes to the market. Investors should also look beyond dividend growth stocks to build more diversified portfolios.
Details on a broader selection of dividend, and value, stocks can be found via this link.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.