The best bank stocks for dividends: knowing the big five

We’ve long recommended that most Canadian investors own two or more of the Big Five Canadian bank stocks—Bank of Nova Scotia, Bank of Montreal, CIBC, TD Bank and Royal Bank — because they are some of the best stocks for dividends

Banks remain key lower-risk investments for a portfolio. As well, the big five Canadian banks are some of the best bank stocks for dividends because they all have long histories of annual dividend increases. That history helps answer the question, which are the best bank stocks for dividends?

We believe each of the Big Five is still well-positioned to weather downturns in the Canadian economy, contrary to the pessimistic forecasts of some in the business media. The big five banks trade at attractive multiples to earnings and continue to raise their dividends.


When to trust your dividends

“One of the best ways to judge whether a company will keep paying its dividend, or even increase it, is the dividend payout ratio. This simply measures what portion of a company’s earnings are allotted to paying dividends. If a company keeps its payout ratio fairly steady, say at 7% of earnings, and its earnings grow…”
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In the wake of the 2008 financial crisis, banking regulators around the world have come up with new regulations that would help avoid another crisis. The new rules forced banks to increase their capital reserves, which have helped them better absorb future loan losses.

However, Canada’s banks were already in much better shape than banks in other countries.

The big five Canadian bank stocks have long histories of annual dividend increases—and their strong profitability should let them keep raising their dividends.

Best bank stocks for dividends: Dividends are a big part of long-term investment gains

We think that Canadian dividend stocks rarely get the respect they deserve from investors. But with today’s low interest rates, savvy investors are paying more attention to dividend yields (a company’s total annual dividends paid per share divided by the current stock price). Dividend-paying companies are responding by doing their best to maintain, or even increase, their payouts.

If you stick with top-quality stocks with high dividends, the income you earn can supply a significant percentage of your total return. As we mentioned above, that can be as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.

To summarize then, when it comes to investment safety, a long history of steady dividends is in some ways more important than a current high dividend yield.

The best bank stocks for dividends will also give you a dividend tax credit

Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends can be eligible for the dividend tax credit in Canada. This dividend tax credit—which is available on dividends paid on Canadian stocks held outside of an RRSP, RRIF or TFSA—will cut your effective tax rate.

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 29% on dividends, compared to 50% on interest income. At the same time, investors in the highest tax bracket pay tax on capital gains at a rate of about 25%.

If dividends are your focus, then don’t limit your investing to only bank stocks

A well-constructed stock portfolio will make your life easier and maximize your gains.

Early in their investing careers, many investors have only a vague idea of the value of a planned portfolio when investing in the stock market.

When you try to pick a handful of stocks that will all beat the market, you’re asking a lot of yourself. No one, not even people that devote their entire lives to it, has ever been able to consistently pick stock market winners over long periods.

On the other hand, it’s relatively easy to acquire a balanced, diversified portfolio of mainly high-quality dividend-paying stocks, spread out across most, if not all, of the five main economic sectors: Resources & Commodities, Finance, Manufacturing & Industry, Utilities and Consumer.

If you diversify, you improve your chances of making money over long periods, no matter what happens in the market.

For example, Manufacturing stocks may suffer if raw material prices rise, but in that case, your Resources stocks will gain. Rising wages can put pressure on manufacturers, but your Consumer stocks should do better as workers spend more.

Spreading your holdings out across the five sectors helps you avoid overloading yourself with stocks that are about to slump because of industry conditions or a change in investor fashion. By diversifying across the sectors, you increase your chances of stumbling upon a market superstar—a stock that does two to three or more times better than the market average.

How many Canadian bank stocks do you hold in your portfolio?

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