Dividend yield is just one of the elements to look for while selecting stocks for a great dividend stock portfolio
When you’re looking for income from investments such as Canadian dividend stocks, the dividend yield is typically your most important consideration. But in some cases, dividend yield can be misleading.
The yield is certainly one of the most concrete things about an investment. It is the percentage you get when you divide the current yearly dividend payment by the share or unit price of the investment.
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Of course, it’s an indicator we pay especially close attention to when we select stocks to recommend in our investment newsletters and when you’re building a dividend stock portfolio.
But yield, and especially a high dividend yield, can give you a false sense of security. Investors sometimes have a natural tendency to think that all investment income is nearly as safe and predictable as bank interest. However, dividend income can dry up in a heartbeat. Companies are sometimes unable to keep paying a long-standing dividend, and they sometimes spring the bad news on investors with no warning.
In fact, high yield may be a danger sign. It may mean that investors are selling and pushing the price down in anticipation of a dividend cut. A falling share price makes yield go up (because you use the latest income to calculate yield). When an investment does cut or halt its dividend, its yield then collapses.
Regular income from your dividend stock portfolio
Canadian dividend stocks offer both capital-gain growth potential and regular income from dividend payments. In fact, dividends are likely to still be paid regardless of how quickly the price of the underlying stock rises.
Taxpayers who hold Canadian dividend stocks get an additional bonus. Their dividends can be eligible for the dividend tax credit in Canada. This means that dividend income will be taxed at a lower rate than the same amount of interest income (investors in the highest tax bracket pay tax of around 25% on dividends, compared to 50% on interest income). Investors in the higher tax bracket pay tax on capital gains at a rate of 29%.
A couple of decades ago, you could assume that dividends would supply up to about one-third of the stock market’s total return. Some dividend yields are lower than they used to be, of course. But it’s still safe to assume that dividends will supply perhaps a quarter of the market’s total return over the next few decades.
Use the highest-quality stocks in your dividend stock portfolio
We think investors will profit most—and with the least risk—by buying shares of well-established, dividend-paying stocks with strong business prospects.
The best firms also have rising sales and profits and sound balance sheets, as well as a strong hold on a growing market. Additionally, they have strong management that will make the right moves to remain competitive in a changing marketplace.
Some high-growth dividend stocks give their shareholders the opportunity to participate in its new dividend reinvestment plan (DRIP). This lets investors use their dividends to buy new shares, sometimes at a 5% discount to the market price.
DRIPs bypass brokers, so you save on commissions. DRIPs also eliminate the nuisance effect of receiving small cash dividend payments. Generally, investors must first own and register at least one share before they can participate in a DRIP. Registration will generally cost $40 to $50 per company. The investor must then notify the company that they wish to participate in its DRIP.
You can also register for dividend reinvestment plans at no cost through most discount brokers (these are called “synthetic DRIPs”). However, the broker may or may not pass along any reinvestment discount to you. As well, you can only buy whole shares through these DRIPs, so dividends paid must be greater than the share price. For example, say you receive a $35 dividend, and the stock is trading at $30. Assuming the company does not offer a reinvestment discount, you would receive one share and $5 in cash.
DRIPs help high growth dividend stocks attract more investors. They also let them conserve funds by issuing shares instead of paying out cash, which all growth companies like to do.
What do you have in your dividend stock portfolio? Do they fit the mold of the stocks we discussed above? Please share your thoughts with us in the comments.
This post was originally published in 2016 and is regularly updated.
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