Investors have a glorious and fleeting opportunity at their fingertips: the chance to earn plump dividends and capital gains in companies that don’t have to grow to deliver oversized returns. That might sound as believable as a diet that melts fat while you eat French fries, but it’s true. At the root of this opportunity are two inescapable forces: the power of interest rates and the aversion many investors have had to the stock market.
Let’s start with interest rates, which are near historic lows and not headed up soon. Canadian rates generally follow U.S. rates, and Federal Reserve chairman Ben Bernanke says he likely won’t raise those until 2014. He doesn’t want to tip the United States—and much of the rest of the world—into a recession.
Plenty of investors, meanwhile, are giving the stock market a wide berth to avoid volatility. Many of them have taken refuge in GICs and bonds, only to watch their returns decline along with interest rates. They’re struggling to survive on the payouts from their paltry coupons.
So what can income-hungry investors do? They can search for higher yields, and lots of them are already doing that by buying solid stocks that pay healthy dividends. Telus ’s annual dividend is $2.44 per share. At the company’s recent stock price of about $57, that’s a dividend yield of 4.3%.
The trouble is that investors tend to bid up the share prices of the biggest and safest dividend payers—utilities such as phone companies, pipelines and the like. That drives down the yield. So where else can you turn?
The logical alternative is smaller companies that pay big dividends, many of them real estate investment trusts or former income trusts. A lot of these companies are quite stable, yet they have dividend yields in the 6.5% to 11% range.
Let’s look at an example: Pizza Pizza . The chain generates fairly steady profits from year to year, and demand for pizza isn’t affected by what happens in Greece or China. The company pays a 70-cent dividend, giving it a yield of about 7.5%. Even if more investors start buying and drive the share price up by 25%, the dividend yield would only drop to 6%.
That’s how you make outsized returns even on no-growth companies. And those companies may not have to do much to boost their share prices. If dividend yields on BCE and Telus decline to, say, 3.5%, investors may push up the prices of the smaller companies so that their yields sink to 5% to 7%.
Of course, there are possible pitfalls. Some stocks have high yields because they’re risky. Just Energy sells natural gas and electricity contracts. It’s carrying a lot of debt, which scares investors. So, the yield is close to 10%. If the company cut its dividend, investors might sell shares in a panic, which would push the price down and the yield up. EnerCare, which rents water heaters and other household items, yields about 7%, because the market considers it safer.
There are lots of fine dividend-paying companies with stock market values of less than $1 billion. Some of them may even grow modestly. In any event, their share prices will likely get a lift as money flows into smaller stocks hunting for income. To be early is to be rewarded. Just be ready to bail before the powers that be raise interest rates.
THIS MONTH'S TIP SHEET
GROWTH Automated Benefits Corp. Three-year growth in revenue: 81% Many claims adjusters—the people who show up after a fire or flood to determine how much money an insurer will pay in compensation—still use pen and paper to describe and draw sketches of the damage. Toronto-based Automated Benefits makes software to do the work. The company has just signed up the third-biggest property insurer in the United States, stealing the account from its biggest competitor.
VALUE Olympia Financial Group Inc. Dividend yield at recent prices: 7% Calgary-based Olympia’s $2.80 dividend is higher than the share prices of a lot of other firms listed on the TSX Venture Exchange. But CEO Rick Skauge says he saves $200,000 a year by not upgrading to a listing on the TSX’s big board. That’s also the way he runs the company, which is involved in the trust, foreign exchange and health-benefits businesses. Earnings grow nicely and the dividend is increased like clockwork.