Canadian dividend stocks can produce as much as a third of your total return over your investing lifetime.
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.
Canadian taxpayers who hold Canadian dividend stocks get a special bonus. Their dividends are 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.
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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—investors in the higher tax bracket pay tax on capital gains at a rate of 25%.)
Now this may seem trivial to some investors because a yearly 2% or 3% or 5% dividend barely seems worth mentioning alongside possible yearly capital gains of 10%, 20% or 30% or more.
But dividends are far more reliable that capital gains. A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02). As well, some investors forget about the wonderful effects compounding interest can have on your portfolio. As quick refresher, compound interest is earning interest on interest which can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio. Dividend payments act in a similar fashion.
All in all, we think that dividends can contribute up to a third of your long-term investment returns, even without the tax-cutting effects of the dividend tax credit.
What are dividends?
Dividends are typically cash payouts that serve as a way companies share the wealth they’ve accumulated through operating the company. These payouts are drawn from earnings and cash flow paid to the shareholders of the company. Typically, these dividends are paid quarterly, although they may be paid annually or monthly as well.
Dividends help keep you out of the market’s worst stocks
You should also keep these five important points in mind:
1. Dividends are a sign of investment quality. Some good companies reinvest profit instead of paying dividends. But fraudulent and failing companies hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst stocks.
2. Canadian dividends can grow. Stock prices rise and fall, so capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But companies like to ratchet their dividends upward—hold them steady in a bad year, raise them in a good one. That gives you a hedge against inflation.
For a true measure of stability, focus on companies that have maintained or raised their dividends during economic and stock market downturns. These firms leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth.
3. Look for Canadian dividend stocks with consistency. One of the best ways of picking a quality Canadian dividend stock is to look for companies that have been paying dividends for at least 5 to 10 years. Companies can trump up quarterly earnings, issue press releases to appear to be making strong progress, but they cannot fake dividends. Dividends are cash outlays that an unsuccessful company could never produce. A history of dividend payments is one commonality that all the best dividend stocks have.
4. Canadian dividend stocks can have hidden assets. The best place to look is on a company’s balance sheet. Can you spot any hidden assets? For instance, when a company buys real estate, the purchase price goes on its balance sheet as the historical value of the asset. Over a period of years or decades, the market value of that real estate may climb substantially. But the historical purchase price remains unchanged on the balance sheet. You have to look closely to spot this hidden value. At times, the hidden assets in a company’s real estate can even come to exceed the market value of its stock.
5. The best Canadian dividend stocks dominate an industry. We look for Canadian dividend stocks that have industry prominence, if not dominance. Our reasoning, besides brand recognition, is that major companies can influence legislation, industry trends, etc. to suit themselves. Minor firms can’t do that.
Canadian dividend stocks are an important contributor to your long-term gains, and dividend-paying stocks tend to expose you to less risk than non-dividend-payers. That’s why the majority of your stocks should be dividend-payers at all times. As you get older and closer to retirement, you should raise the proportion of dividend-paying stocks in your portfolio, to cut risk and improve the stability of your investment results.
Are you a new investor? Have you invested in Canadian dividend stocks? Which ones? Share your experience with us in the comments.