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Union Pacific, which operates in the western and central U.S., has faced headwinds from COVID-19 induced supply-chain issues, but its performance for 2021 has still been good.The Associated Press

Surging inflation and looming interest rate hikes are poised to give stock markets a rough ride this year, but a dividend-growth strategy can help smooth out some of the bumps.

These dividend equities, which offer rising payouts and potential for capital gains, tend to be companies that are well-managed and are financially strong. They have regularly scheduled dividend payments that can cushion the blow when markets struggle and help protect against inflation.

The stocks of companies with growing dividends will also often fare better than many high-yield dividend payers that face competition from other yield-generating sources, such as bonds, when interest rates keep rising.

We asked three fund managers for their top picks among dividend-growth stocks in Canada and the U.S.:

Donny Moss, senior portfolio manager, Industrial Alliance Investment Management Inc.

Funds: IA Clarington Dividend Growth Class, IA Clarington U.S. Dividend Growth Fund and IA Clarington Canadian Dividend Fund

Canadian pick: Canadian Apartment Properties Real Estate Investment Trust (CAPREIT) CAR-UN-T

52-week range: $48.45 to $62.77 a share

Forward annual dividend and yield: $1.45 (2.5 per cent)

Canada’s largest apartment REIT offers more upside potential as rents are starting to increase significantly in a recovering economy, Mr. Moss says. Toronto-based CAPREIT, which focuses on the Ontario, Quebec, and British Columbia markets, is now getting about a 6-per-cent rent hike when new tenants move in. “As house prices continue to rise significantly, that’s going to increase the renter pool,” he says. The REIT trades attractively at about 5 per cent below net asset value versus a historical premium of 5 per cent and a 17-per-cent premium in 2020 before COVID-19 hit. CAPREIT can raise its distribution easily given that it has a 67-per-cent payout ratio [on projected adjusted funds from operations] versus the mid-70-per-cent range for its peers, he says. Slowing immigration and rent controls in response to a serious COVID-19 wave are risks.

U.S. pick: Union Pacific Corp. UNP-N

52-week range: US$193.14 to US$254.71 a share

Forward annual dividend and yield: US$4.72 (1.9 per cent)

U.S. railway giant Union Pacific is an attractive play given projections for robust earnings growth, Mr. Moss says. The Omaha, Neb.-based railroad, which operates in the western and central U.S., has faced headwinds from COVID-19-induced supply-chain issues, but its performance for 2021 has still been good, he says. Its operating ratio, a measure of efficiency, is expected to keep improving and fall to 55.5 per cent this year from 56.75 per cent in 2021. Consensus estimates indicate earnings growth of 15 per cent this year and 11 per cent in 2023, he notes. Its stock trades at about 22 times 2022 earnings, which is “not inexpensive,” but is reasonable given Union Pacific’s strong management. A risk is supply-chain problems dragging on longer this year and affecting earnings estimates negatively.

Peter Hofstra, senior vice-president, senior portfolio manager, CI Global Asset Management

Funds: CI North American Dividend Fund, CI Canadian Dividend Fund and CI U.S. Dividend Fund

Canadian pick: Thomson Reuters Corp. TRI-T

52-week range: $99.11 to $156.62 a share

Forward annual dividend and yield: $1.62 a share (1.4 per cent)

Thomson Reuters, a provider of business information services, is a compelling play because of its monopolistic position, recurring revenue stream, and 20-plus years of dividend history, Mr. Hofstra says. The Toronto-based company, which sells software mainly to the legal and accounting sectors, has a “sticky customer base,” so it can still do well when inflation and interest rates rise, he adds. Excluding its minority stake in London Stock Exchange Group PLC, Thomson Reuters’s stock trades at a reasonable multiple of enterprise value to earnings before interest, taxes, depreciation, and amortization in the low 20-per-cent range, he says. “Investors can expect a high single-digit to low double-digit total return from this stock.” The risks stem from any missteps in executing on its core business or acquisitions.

U.S. pick: CME Group Inc. CME-Q

52-week range: US$177.73 to US$232.64 a share

Forward annual dividend and yield: US$3.60 a share (1.6 per cent)

The Chicago-based derivatives exchange operator, which has a near-monopoly position, will benefit from increased hedging activity that typically occurs when interest rates rise, Mr. Hofstra says. CME Group owns the Chicago Mercantile Exchange and three other derivatives markets offering futures and options products for risk management. CME, which has paid a regular and an annual variable dividend since 2011, is a very high, free-cash-flowing business. Its stock trades at a forward earnings multiple in the low 30s, he says. “It has always traded at a premium to the market, but yet has compounded value better than the market.” A risk stems from the price that CME is willing to pay if it does make a takeover bid for Chicago-based Cboe Global Markets Inc. as been rumoured, he adds.

Michael Simpson, portfolio manager, NCM Asset Management Ltd.

Fund: NCM Norrep Fund

Canadian pick: Intact Financial Corp. IFC-T

52-week range: $140.50 to $178.28 a share

Forward annual dividend and yield: $3.32 (2 per cent)

Canada’s largest provider of property and casualty insurance is an attractive play given its cheaper valuation versus the market and some U.S. peers, Mr. Simpson says. Toronto-based Intact Financial, which underwrites automobile, home, commercial, and specialty insurance policies, trades at about 13 times forward earnings and recently increased its dividend by 10 per cent, he says. “It also has a five-year dividend growth rate of 8 per cent.” Intact Financial is a well-run company, which has grown by acquisition, and makes significant use of analytics to make sure its pricing is correct, he adds. Last year, it acquired the Canadian, British, and Irish operations of RSA Insurance Group PLC. Canada now makes up 67 per cent of its revenue. The risk stems from catastrophe losses, but it “does a good job of reinsuring worst-case weather events,” he says.

U.S. pick: Raymond James Financial Ltd. RJF-N

52-week range: US$62.94 to $109.12 a share

Forward annual dividend and yield: US$1.04 (1 per cent)

Raymond James Financial is a compelling investment because it is focused on the growing wealth-management industry, while its stock valuation is still attractive, Mr. Simpson says. “It shares trade at about 13 times forward earnings.” The St. Petersburg, Fla.-based financial services firm gets 95 per cent of its revenue from its U.S. operations, with 65 per cent coming from its private client group. The company, which has a strong balance sheet with net cash, recently raised its quarterly dividend to 34 cents from 26 cents, he adds. “It also has a five-year dividend growth rate of 14 per cent.” Raymond James Financial, which offers banking services, recently did a deal to buy U.S. bank-holding company Tristate Capital Holdings Inc. A major market downturn and top advisor teams leaving could be risks to the stock.

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