Investors who find winning ways to pick stocks usually rejoice. They might dream of bulging bank accounts, living the high life, or retiring early.
I have similar happy thoughts, but I also like to look for drawbacks and downsides before diving in. Today I’m going to put Canadian dividend stocks under the microscope to see how they measured up in past bullish and bearish periods.
Kenneth French of Dartmouth College calculated the return history of Canadian dividend stocks in one of his many market studies. In this study, Prof. French sorted the Canadian market by dividend yield and put stocks into three portfolios. The high-yield portfolio contains the 30 per cent of stocks with the highest yields. The low-yield portfolio tracks the 30 per cent of stocks with the lowest yields while the no-yield portfolio follows stocks that do not pay dividends. A market portfolio is also formed from all the Canadian stocks in his database. Each portfolio is held for a year before it is refreshed to reflect the then-current yields.
The return histories of the portfolios are shown in the first accompanying graph, which stretches from the start of 1977 through to the end of 2018. The Canadian stock market gained an average of 10 per cent annually over the period. The high-yield portfolio topped the competition with average annual gains of 13.8 per cent, while the low-yield group trailed with average annual gains of 9.3 per cent. The non-dividend payers performed horribly over the long term with average annual gains of 2.7 per cent.
That’s good news for investors who love stocks with generous dividend yields and it helps to explain the popularity of dividend stocks. But they also suffer from poor periods.
The Upside of Canadian Dividend Stocks
Growth per $1 invested (log scale)
1,000
Market
High yield
Low yield
Zero yield
100
10
1
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: norman
rothery (data:prof.french)
The Upside of Canadian Dividend Stocks
Growth per $1 invested (log scale)
1,000
Market
High yield
Low yield
Zero yield
100
10
1
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: norman
rothery (data:prof.french)
The Upside of Canadian Dividend Stocks
Growth per $1 invested (log scale)
1,000
Market
High yield
Low yield
Zero yield
100
10
1
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: norman rothery (data:prof.french)
To explore the downside, I’m going to focus in on the high-yield portfolio and compare it with the market portfolio. The second graph looks at periods when the high-yield portfolio and the market fell from their prior peaks. (All of the return figures and calculations herein use monthly data. As a result, peak-to-trough declines would be larger when measured using weekly or daily data.)
The downside news is mixed for dividend investors. The high-yield portfolio often fell roughly as much as the market during downturns but it tended to recover a little more quickly. I’ll highlight a couple of notable exceptions.
The Downside of Dividends
Fraction of prior peak
1.00
0.90
0.80
0.70
0.60
Market
High yield
0.50
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
john sopinski/the globe and mail
source: norman rothery (Data: Prof. French)
The Downside of Dividends
Fraction of prior peak
1.00
0.90
0.80
0.70
0.60
Market
High yield
0.50
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
john sopinski/the globe and mail
source: norman rothery (Data: Prof. French)
The Downside of Dividends
Fraction of prior peak
1.00
0.90
0.80
0.70
0.60
Market
High yield
0.50
1975
1980
1985
1990
1995
2000
2005
2010
2015
2020
john sopinski/the globe and mail, source: norman rothery (Data: Prof. French)
The high-yield portfolio fared well when the internet bubble burst and Nortel crashed. You can see the impact of the Nortel-led decline in the market’s returns starting in the summer of 2000. But the high-yield portfolio was relatively unfazed because Nortel was in the low-yield group.
Nortel’s decline highlights the risk of owning a concentrated portfolio because it formed a hefty part of the market index at its 2000 peak. It also points to the influence that one giant stock can have when looking at historical return patterns.
The market fared better in some downturns than the high-yield portfolio.
For instance, the market declined 14 per cent after hitting a peak in 2015 but the high-yield portfolio gave up 24 per cent.
Over all, high-yield stocks provided some downside protection relative the market. But it’s an observation that largely rests on having avoided Nortel’s fall from grace. As a result, it seems unwise to rely on a high-yield portfolio holding up better than the market in the future.
Nonetheless, for income-focused investors, dividend stocks generally retain their allure.
You can find Canadian dividend stocks with generous dividend yields by heading to the online version of this article (tgam.ca/insidethemarket), which contains a table with dozens of potential picks. It highlights common stocks on the TSX that pay dividends, have market capitalizations in excess of $100-million, and share prices north of $1. The highest yielding 30 per cent of the stocks in the list have yields of more than 4.5 per cent. (Wise investors take extra care when it comes to stocks with extraordinarily high yields.)
While Canadian dividend stocks with generous yields have fared well and may continue to do so, it is important to remember they’re still stocks.
