Investors are keen to know what works in the stock market. But it’s also useful to know what doesn’t work.
Today I’m going to look at some of what has – and what hasn’t – worked when picking Canadian dividend stocks over the past quarter century. The Stable Dividend portfolio has worked well over the years. On the other hand, avoiding stocks with low dividend-coverage ratios (or high dividend-payout ratios) hasn’t been so successful.
The Stable Dividend portfolio starts by looking at the 300 largest Canadian common stocks on the Toronto Stock Exchange (TSX) by market capitalization.
Collected together, the 300 stocks gained an average of 8.6 per cent annually over the 25 years to the end of 2023 when put into an equally-weighted portfolio and rebalanced annually. The market (as represented by the S&P/TSX Composite Index) gained an average of 7.5 per cent annually over the same period. (The returns herein reflect annual or monthly data from Bloomberg and include dividend reinvestment, but not fund fees, commissions or other trading costs.)
Investors got better returns by forming an equally-weighted portfolio of the dividend payers from the largest 300 stocks on the TSX. The dividend portfolio gained an average of 10.2 per cent annually over the same 25 years when rebalanced each year.
But the Stable Dividend portfolio goes a step further. It looks through the dividend payers from the largest 300 stocks and picks the 20 with the lowest volatilities over the prior 260 days. The Stable Dividend portfolio gained an average of 10.9 per cent annually over the 25 years to the end of 2023 when rebalanced annually. It also experienced a less volatile ride than the dividend portfolio.
Income investors are naturally worried about stocks that earn less than they pay in dividends because the companies might cut their dividends. Many investors avoid such stocks in the hopes they’ll reduce their downside risk and earn more money over the long term.
The theory sounds good, but it didn’t work well when applied to the Stable Dividend portfolio.
The covered-dividend version of the Stable Dividend portfolio starts with the largest 300 stocks on the TSX, narrows in on the dividend payers with coverage ratios of more than one (their earnings more than cover their dividends) and picks the 20 with the lowest volatilities over the prior 260 days.
The covered-dividend portfolio gained an average of 10.8 per cent annually over the 25 years and trailed the Stable Dividend portfolio’s returns while being slightly more volatile.
The divergence between the two portfolios grows when they are rebalanced monthly rather than annually. The regular Stable Dividend portfolio gained an average of 12.7 per cent annually over the 25 years to the end of 2023 when rebalanced monthly. The covered-dividend portfolio gained an average of 12.1 per cent annually over the same period when rebalanced monthly, and did so with about 7 per cent more volatility. The combo of lower returns and higher volatility isn’t a great one.
While dividend coverage failed to help the Stable Dividend portfolio, it doesn’t hurt to investigate stocks with poor ratios before investing. After all, it is important to understand why a company isn’t performing well and to determine its ability to reverse its fortunes.
Speaking of reversals, the Stable Dividend portfolio had a weak year in 2023, with a return of 5.3 per cent (when rebalanced annually), and it trailed the market index’s return of 11.8 per cent. The jump in interest rates over the past couple of years was not kind to many utility and financial stocks, which tend to populate the portfolio.
But if inflation continues to moderate, interest rates will likely subside, which should help the Stable Dividend portfolio in 2024. At least, that’s the theory.
You can find the stocks in the Stable Dividend portfolio via this link , which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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