Dividend Investing: I've Seen Better Days

October 05, 2020 | Jonathan Yung


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So far, no love for dividend portfolios

For many equity investors, 2020 has proven to be more of a roller coaster ride rather than a clearly negative performing year. However, for dividend investors, 2020 has been a different story. The recovery for dividend-paying stocks has been lackluster since the equity markets bottomed in March. Typically during recessions, we expect the returns of a dividend portfolio to outperform the broader index, as investors usually gravitate towards more “conservative” dividend-paying companies. However, we believe this time is different due to the severity and swiftness of companies cutting their dividends.

At the time of this writing (Sept 23), the TSX high dividend index is still down a whopping -20% while the broader TSX composite benchmark is down a more manageable -6%. The high dividend index is a composite of companies that pay the highest dividend yields, including: Financials, Energy infrastructure (pipelines), telecoms, utilities, and REITs. Two of the hardest-hit sectors continue to be Energy (infrastructure) and Real Estate. Due to the economic shutdown in the spring, the Toronto Stock Exchange saw 27 companies in April and 29 companies in May cut or suspend their dividends. (See Chart below). We monitor dividend trends as we believe it indirectly represents the strength of corporate balance sheets, sustained free cash flow, and the overall market health.

By late spring, investors began to notice some companies increasing their dividends. This initially brought hope to some income investors that this could be signaling that the worst was over. However, dividend increases were not broadly seen across all sectors and hence overconfidence in a sustainable recovery may have been premature. The majority of increases were indeed from gold miners who had benefited from an increase in gold prices and in turn, returned more capital to shareholders in the form of higher dividends.

The strain on corporate cash flows appeared to be relieved as the economy and businesses reopened in the summer. This can be confirmed by the same chart above, whereby in July, the number of companies increasing their dividends outnumbered those that cut or reduced their dividends. Thus far we have yet to see a company announce a dividend cut in September. Equity income investors should start to breathe a sigh of relief as the outlook for dividend stocks appears to be improving. As the next chart shows below, dividend increases have broadened out to more sectors, representing a healthy and more sustainable recovery.

We continue to believe the dividend growth over the next year will be muted, as companies are grinding through the new normal. However, we expect to see some dividend increases in specific sectors like consumer staples, utilities, industrials, and pipelines. We continue to believe the bank dividends are safe but we do not expect any meaningful dividend increases in the short term. If the pandemic forces Canadians to go back into a state of emergency, payout ratios and balance sheets will continue to be a problem for the real estate, energy producers, midstream energy companies, and the financial sector.

Quick Sidebar: How about my Canadian Bank Dividends?

Many investors specifically ask us the above question. The Canadian banks reported fiscal Q3 2020 earnings that were, on average, better than feared. The strength of capital levels has been a key area of focus among investors, thus we were pleased to see that, on average, capital levels experienced modest improvement. The six-month mortgage deferrals are also near expiry and thus banks will no longer be able to classify deferrals as performing loans. With the labour market and broader economy still yet fully recovered, we suspect banks will have to make higher provisions for credit losses and defaults over the coming quarters. That being said, credit provisions decreased from Q2 to Q3, which in our view implies that the worst could be behind us. From a valuation perspective, the Canadian banking sector remains attractive as it is trading at approximately 1.2x price-to-book (P/B) compared to its 15-year average of roughly 1.9x.

Conclusion:

Historically, a risk of owning a dividend-oriented portfolio has been rising interest rates which decreases the relative attractiveness of one’s dividend yield and can cause stock prices to fall. With central banks around the world signaling that interest rates will be held “lower for longer”, this reduces the risk on dividend-oriented portfolios and could provide the support for an improved long term performance. Investors should speak to their advisor to review their strategy and timing for rebalancing one’s portfolio to include more dividend-paying companies at historically attractive valuations.

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