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What are we looking for?

Sustainable dividend income from Canadian free cash flow generators.

The screen

Following a very challenging year in 2015, the Canadian market has staged an impressive comeback so far this year. A significant contribution of the returns have come from natural resource sectors such as energy, metals and mining, but if we look deeper under the hood, we can also see that dividend-paying companies have been outperforming those without payouts. For instance, the S&P/TSX dividend composite total return index is up 16.9 per cent year-to-date while the full S&P/TSX composite total return index is up 14.8 per cent.

Investors are often tempted by the highest yielding firms, but chasing high dividend yields alone could be very risky if those payouts are not sustainable. Firms that are able to generate and increase free cash flow, that is, operating cash flow left over after capital expenditures, may be in a better position to maintain their distributions.

To search for some potential investments offering sustainable dividend income, my colleague Lawrence Ullman and I used Bloomberg to rank Canadian dividend-paying firms from the S&P/TSX composite with the best mix of:

  • Forward earnings yield;
  • Forward free cash flow yield;
  • Forward return on equity greater than 5 per cent;
  • Three-month consensus earnings estimate revision no worse than minus 10 per cent.

We screened for firms with a dividend yield greater than 2 per cent; payout ratio (dividends as a percentage of earnings) less than 80 per cent; and a forward 12-month free cash flow expected to be positive – and greater than trailing free cash flow.

More about the Ullman Group

The Ullman Group is an independent provider of strategic private capital management services to high-net-worth individuals, corporations, endowments, charities and foundations.

What we found

We used Bloomberg to perform a back-test starting Sept. 30, 2006, reselecting an equally weighted portfolio of the top 10 qualifying stocks every quarter.

Over the full period, this strategy would have generated an annualized total return of 7.5 per cent compared with 5.3 per cent for the S&P/TSX composite total return index. Over the latest 12 months, this strategy would have posted a return of 17.8 per cent while the TSX came in at 14.2 per cent.

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Ltd. or its affiliates. Investors should contact a professional or do their own research before investing in any of the stocks shown here.

Craig McGee, CFA, is a portfolio manager and Lawrence Ullman, MBA, is a director, wealth management and portfolio manager with the Ullman Group at Richardson GMP in Toronto.

Richardson GMP Ltd. is a member of the Canadian Investor Protection Fund. Richardson is a trademark of James Richardson & Sons Ltd. GMP is a registered trademark of GMP Securities LP. Both used under licence by Richardson GMP Ltd.

Canadian dividend companies with strong free cash flow