Investing in dividend stocks is simple. Just pick the stock with the highest yield, right?
Wrong. There’s more to it than that.
For Greg Newman, associate portfolio manager and senior wealth adviser with the Newman Group at ScotiaMcLeod, a solid dividend is just the starting point.
When choosing stocks, he also evaluates the company’s anticipated dividend growth rate, prospects for capital appreciation and the stock’s risk level. Valuation – whether the stock is cheap or expensive based on various measures – also factors into the equation.
Here are five dividend stocks that pass his tests. Remember to do your own due diligence before purchasing any security.
Yield: 4 per cent
Three-year annualized dividend growth: 9.1 per cent
Canada’s largest bank is a “lower-risk name with steady dividend growth and capital appreciation over time,” Mr. Newman says. Consider: If you’d bought $10,000 worth of RBC shares 10 years ago and reinvested all of your dividends, your shares would be worth about $33,000 today – equivalent to a total return of 12.7 per cent annually.
There’s almost certainly more where that came from. Driven by improving global capital markets and strength in wealth management, RBC’s earnings are poised to grow by more than 7 per cent annually over the next couple of years, he estimates, and the dividend will probably grow even faster.
The shares trade at just 12 times estimated 2014 earnings – slightly below the five-year average – even as the global economy is improving.
Yield: 3.2 per cent
Three-year annualized dividend growth: 185 per cent
Fertilizer producer Agrium has been growing more than crops: Its dividend has shot up more than fourfold since 2012. With adjusted earnings and free cash flow poised to increase at double-digit rates over the next couple of years, helped by cost-cutting and consolidation of previous acquisitions, “we see its track record of impressive dividend growth continuing,” Mr. Newman says.
The stock trades at about 12 times estimated 2014 earnings, which is below the five-year average of 14.6, making this a “reasonable entry point,” he says.
Yield: 3.8 per cent
Three-year annualized dividend growth: 4.8 per cent
Thanks to the steady cash flows from its pipeline, power generation and natural gas storage assets, TransCanada is a relatively low-risk holding that’s expected to deliver growing dividends and capital appreciation. Mr. Newman estimates that the dividend will rise by about 4.7 per cent annually through 2015.
With an enterprise value to EBITDA (earnings before interest, taxes, depreciation and amortization) ratio of about 12.5 based on 2014 estimates, TransCanada “is still compelling relative to many of its peers,” he says.
Yield: 2.9 per cent
Three-year annualized dividend growth: 9 per cent
Intact Financial sells home, auto and business insurance through subsidiaries Grey Power, belairdirect, BrokerLink, Jevco and Intact. Mr. Newman expects earnings to climb over the next couple of years, driven by organic growth, merger synergies and industry consolidation.
“We expect their impressive dividend growth to continue over time given their low payout ratio,” he says. The payout ratio has averaged 44 per cent of earnings over the past three years, according to Bloomberg.
The price-earnings ratio of about 11.3, based on 2014 earnings estimates, compares favourably to the five-year average of about 12.6.
Yield: 4.4 per cent
Three-year annualized dividend growth: 11.5 per cent
Algonquin offers “an appealing combination of growth and value,” Mr. Newman says. The company, which operates regulated utilities and contracted power generation facilities, trades at a “compelling” free cash flow yield of about 10.1 per cent (based on 2015 estimates) compared with an average of about 7.7 per cent for its peer group.
And Algonquin’s free cash flow is expected to rise, thanks to acquisitions, new projects and favourable rate decisions from regulators. As a result, he sees the dividend growing at about 7.8 per cent annually through 2015.
Disclosure: The author personally owns shares of RY, TRP and AQN.