Dividend investing is going through a rough patch. If you’re a devoted dividend investor – and that describes just about every Canadian I know – you might want to ponder what has caused this odd state of affairs.
A good place to begin is by noting just how unusual it is for dividend stocks to underperform in Canada. For decades, high-yielding dividend stocks made a habit of leaving the broad Canadian market in their dust.
Between 1977 and 2023, high-yield Canadian stocks generated total returns of 13.6 per cent a year on average, according to Norman Rothery of StingyInvestor.com. In comparison, the broad Canadian stock market produced total returns of only 10.1 per cent a year. (For the purposes of these calculations, high-yield stocks are defined as the 30 per cent of stocks with the highest dividend yields.)
The huge outperformance of high-yield stocks over this long stretch of time offers a powerful argument for dividend investing.
Yet the past five years have seen this dividend advantage shrivel. Big dividend funds, such as the iShares Canadian Dividend Aristocrats ETF and the BMO Canadian Dividend ETF ZDV-T, have produced mediocre, market-lagging results. Meanwhile, several prominent dividend stocks – including BCE Inc. BCE-T, TC Energy Corp. TRP-T and Toronto-Dominion Bank TD-T – are trading at or below where they were prior to the pandemic. Even with dividends included, their performance has been underwhelming.
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Why has dividend investing lost its mojo? Conventional wisdom blames it on the big rise in interest rates since 2022. Higher yields from bonds and guaranteed investment certificates have made the payouts from dividend stocks less appealing – or so the story goes.
I’m not so sure about this explanation. On paper, a rise in interest rates should hit all stocks.
Indeed, financial theory suggests soaring bond yields should hit risky, speculative stocks harder than steady, reliable dividend payers. The logic goes like this: Once people realize they can achieve a safe, high return by putting their money into boring old bonds and GICs, they should drastically dial down their enthusiasm for gambling on dicier propositions that have uncertain payoffs far in the future.
Yet things haven’t worked out as theory would predict. Over the past few years, Canadians’ supposedly reliable dividend stocks have suffered more than the rest of the stock market and performed much worse than risky growth stocks. This is difficult to explain purely as an effect of interest rates.
So what’s driving the dividend-stock malaise? A more disturbing hypothesis is that we’re witnessing a long-run sectoral decline. Big-dividend payers in Canada now tend to cluster in a few industries – notably banking and telecom. Both are mature sectors. It could be that these dividend-spewing businesses are simply running out of natural growth opportunities.
Consider banks: Over the past few decades, Canada’s Big Six lenders have saturated the domestic market and helped drive household debt to unprecedented levels. Future expansion possibilities in this very mature market now seem limited – unless a bank ventures outside of Canada. Unfortunately, international expansion has its own risks, as TD Bank demonstrated with its recent U.S. money-laundering fiasco.
All things considered, “it is difficult to make a bullish call on the [Canadian banking] sector,” according to a recent note from Paul Holden, an analyst at CIBC. “Revenue growth is subdued and credit risk is elevated.”
It’s easy to make similar points about Canada’s underwhelming telecom stocks. Sure, BCE Inc., Telus Corp. and Rogers Communications Inc. dominate the domestic market and can poach customers from one another. However, generating overall growth for the entire industry is becoming increasingly difficult – and could become even more so if the federal government continues to push for lower wireless fees.
The stresses are showing. BCE, for instance, is facing questions about whether it will have to cut its lush dividend to conserve cash. A recent report on the company from Veritas Investment Research was headlined, “Best case may not be good enough.” That is true on many levels.
To be fair, the issues that now plague Canadian banking and telecom could turn out to be temporary. Maybe Canada’s big-dividend payers will stumble upon new sources of growth, or maybe new sectors will surge to the forefront, and Canadian dividend investing will resume its market-beating ways.
Still, it’s worth pondering the possibility that dividend investing in Canada could become more like dividend investing in the United States.
South of the border, dividend investing has gone through long periods of underperformance (including the past decade). Looking all the way back to 1927, U.S. dividend stocks have beaten the market but not by nearly as much as in Canada. Over that very long haul, high-yield U.S. stocks have generated returns of 11.2 per cent a year on average compared with 10 per cent for the U.S. market as a whole, according to Mr. Rothery.
This modest level of outperformance seems like a reasonable outlook for Canadian dividend stocks as well. Dividends are still worth paying attention to, but investors might want to start taking a broader perspective.
Two low-cost funds that provide that broader perspective are the iShares Canadian Fundamental Index ETF and the Vanguard Global Value Factor ETF. To my eye, they are worth considering if you’re looking to move beyond a pure dividend approach but don’t want to buy a standard index fund.