Though Canadian interest is on the rise, the fact that retail investors love dividend-paying stocks will likely not change anytime soon. Even though Canadian tax law largely favours capital gains over dividends or income, Canucks just can’t seem to stay away from those juicy yields.
This said, savvy dividend investors tend to pay attention to the consistency of dividends, rather than the size, which can change quickly. A dividend investor’s worst nightmare is when a dividend gets cut because (1) the investor gets fewer dividends in their pocket and (2) sentiment around the stock likely drops which typically causes a selloff in the stock, to the investor’s chagrin.
Ultimately, the decision on whether to cut a dividend is up to the company management’s discretion. However, there are a couple of ways to tell if a dividend is teetering toward being cut.
(1) The stock’s own history. Canada is home to a handful of companies that have not cut their dividends in 20 years. Here they are:
Over a full economic cycle, the company’s management must make conscious decisions to manage its cash flow such that it can support ongoing operations, research and development, new capital projects, and of course pay shareholder dividends. There’s nothing like a solid track record to boost investor confidence. On the other side of this coin, investors might also have a look at the dividend track records of those whose dividends are quite variable. Particular attention might be paid to those that started and stopped paying dividends frequently, which might not be appropriate for a dividend investor.
Investors should also keep abreast of any larger projects or capital expenditures that might lead to the company requiring cash flow (or debt) to finance, to the detriment of paying dividends.
(2) The company’s most recent financial statements might also provide hints on the capacity to pay dividends. Here, investors might look to the dividend payout ratio. This measures the proportion of a company’s earnings cash flow that is being paid out as dividends. If this ratio exceeds 100%, it means that the company is paying out more than it is making, which it can’t keep doing forever unless it continues to issue debt which generally has negative implications for an existing investor. Though there is no hard/fast rule, generally investors should look for lower (more conservative) payout ratios. In certain sectors (like energy and utilities), operating cash flow might make more sense in the calculation. For these sectors look for an even more conservative (lower) payout ratio on cashflows.
Using information from Morningstar CPMS, I screened for Canadian-listed companies with higher-than-usual payout ratios. Here are the results.
This screen used both trailing and estimated cashflows and earnings. In the case of estimated figures, investors are looking at a projection of the payout ratios, should street analyst estimates come true. It’s also noted that in the case of REITs, we are using funds from operations as a measure for cash flow. Investors should be mindful that there’s no guarantee that these companies will cut dividends in the future, only that they might look a bit stretched to continue to do so in the current manner.
It’s also worthwhile noting that a stock that cuts dividends isn’t necessarily bad for all investors. It might be the case that the company is keeping its earnings and cashflows in-house to finance projects that generate revenue in the future. For a dividend investor, not great. However, a growth investor with a longer investment time horizon might find the company quite attractive.
As always, investors are encouraged to conduct their own independent research before buying or selling any of the securities listed here.
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