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What are we looking for?

Canadian stocks with sustainable, growing dividends.

The screen

Many Canadian investors continue to rely on our banks as a part of their core equity holdings for very good reasons. Our banks have a history of stability, have historically paid consistent dividends and also make up a large percentage of the S&P/TSX composite index. However, the recent slew of commentaries from bank executives citing the challenges of low interest rates and depressed economic growth due to oil prices may lead investors to seek out additional ideas to supplement a dividend portfolio.

This week, I look at companies in Canada that have had a history of growing dividends, but more important have the capacity to continue to grow these dividends in the future. A key measure of this sustainability can be observed through the payout ratio, which is the ratio of dividends paid to either cash flows or earnings. A company paying out too high of a percentage in dividends is likely unable to continue to do so in the future. In this week's screen I ranked stocks according to their five-year annualized dividend growth rate.

Qualifying companies must have a current payout ratio on cash flow of less than 60 per cent, as well as a payout ratio on earnings of less than 60 per cent. For both of these ratios, CPMS looks at the latest four quarters of trailing dividends and divides this by the latest four quarters of trailing cash flows or earnings. Only companies with a market cap greater than $1.4-billion were considered.

More about Morningstar

Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.

What we found

I used CPMS to back-test this strategy from January, 1991, to January, 2015. During this process, 20 stocks were purchased and equally weighted. Stocks would be sold if they fell outside the top 25 per cent of the database. Over this 24-year period the strategy produced an annualized return of 12 per cent, while the S&P/TSX composite total return index gained 9 per cent. Here are the current top 20 qualifying stocks. Interestingly enough, none of the Big Six banks show up in the top 20 under this strategy.

Investors are always advised to conduct independent research before purchasing stocks listed here.

Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.

Canadian stocks with sustainable dividend growth