Imagine a portfolio that pays 3.5% from dividend paying stocks, the dividends grow by 7% annually and are reinvested into the portfolio. In ten years the yield on these investments would be more than three times the original yield. You could spend the dividend income to fund your lifestyle – just like collecting rent from a rental property.
Now imagine a decade that witnessed central banks engineer an unprecedented amount of liquidity creating one of the longest running bull markets where stock market valuations have been driven up. Imagine, the legalization of Cannabis in Canada, where a proliferation of new companies are attracting large amounts of investor capital, driving up valuations to lofty levels even though profitability in these new ventures could be a long way off. Finally, imagine an economy in the later stages of the economic cycle coupled with trade tensions between the U.S. and China. Ten years ago you might have a hard time imagining all of this, but today it is reality.
How do we manage through this uncertainty?
We stay focused on our investment discipline and long term goals. We don’t allow news headlines or Tweets distract us.
Our process starts with constructing a portfolio that is tailored to each individual’s objectives and risk tolerance. We believe in owning companies that are sustainable and persistent dividend growers. This strategy lends itself to an investor who is looking for a more consistent return in order to reach their savings goal or someone who needs to generate an income in retirement. Market volatility can often lead to people becoming unsettled and nervous about the stock market. Investing in dividend paying stocks of companies that have strong free cash flow, solid balance sheets, and consistent, reliable income streams can help an investor stay the course during volatile markets.
A recent feature article in our May edition of Global Insight called “Defense mechanisms” was an insightful look at investing in quality companies that pay dividends. (Click Here)
The article points out that “We think the recent rally has created an opportunity to take a more defensive posture by upgrading U.S. equity portfolios with an eye to swapping into dividend-paying stocks and improving the overall quality of holdings”. Throughout the various shocks to the stock and bond markets over the years, “a basket of large-capitalization U.S. dividend paying stocks has outperformed the S&P 500 in all but one decade since the 1930’s.” (Bogdanova & Allworth, 2019)
These types of companies tend to have strong management teams and are leaders in their industry. We prefer companies that grow their dividends but not just at any cost. They need to reinvest into their business and show discipline with their capital. Therefore, other attributes we look for are companies that have a high internal growth rate and a strong management team.
Given the uncertainty of being in the later stage of an economic expansion and the continued China-U.S. trade tensions, a more defensive posture is warranted. In our opinion, the investment approach of investing in dividend growing companies can align the long term prospects of the portfolio that helps create certainty for income and growth investors.
References
Bogdanova, Kelly, and Jim Allworth. “Defense Mechanisms for U.S. Equity Portfolios.” RBC Wealth Management, 2 May 2019, www.rbcwealthmanagement.com/ca/en/research-insights/defense-mechanisms-for-us-equity-portfolios/detail/.