There's more to choosing dividend stocks than yield alone

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John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.

As a columnist, I receive a lot of comments and questions from readers. Most of these people are courteous and respectful, but occasionally I hear from a reader who got up on the wrong side of the bed.

When people get surly, it's often a sign of a misunderstanding. At least that's been my experience. So today, in the spirit of spreading love and kindness, I'll be responding to a couple of these comments.

The first one was posted in response to my recent column discussing five stocks poised to raise their dividends:

"Wow, John, so glad you aren't managing my portfolio!! There are at least 10 companies on the TSX that pay in excess of a 5-per-cent dividend yield that aren't even on your list … Like I said, keep publishing articles, investing isn't your thing."

The companies I profiled – Canadian Utilities, Coca-Cola, TransCanada, Tim Hortons and Shoppers Drug Mart – are all solid, growing businesses with a history of dividend increases. But the reader was evidently miffed because the highest yield was just 3.7 per cent. A second reader e-mailed (more politely) to express similar disappointment and suggested I examine "companies yielding 7 per cent to 10 per cent to make their purchases worthwhile."

The problem with chasing such lofty yields is that they often come with higher-than-average risk. Investors seduced by the outsized yields of AGF Management and TransAlta, for example, paid a heavy price in the past year. In some cases, a hefty yield can signal a dividend cut, as happened with Yellow Media and Manulife Financial, among others. Not all stocks with above-average yields are ticking time bombs, of course.

In Tuesday's Number Cruncher column, my colleague Ian McGugan listed 15 dividend stocks with yields averaging more than 4 per cent, and which have rising earnings, cash flow and revenue to boot.

But a high yield can also indicate slowing growth. Consider BCE, which I own personally and in my Strategy Lab model portfolio. It yields 5.3 per cent, yet just four analysts rate it a "buy," with 16 "holds" and one "sell," according to Bloomberg data. Evidently, there are concerns about BCE's growth prospects.

The key thing to remember is that a stock's return is composed of two parts – dividends and capital gains (or losses). By focusing on yield alone, investors risk missing out on companies that have modest yields now, but whose dividends and stock prices will grow.

The next comment (actually it's two comments that I've combined and edited for clarity) was posted in response to a column about Tim Hortons, in which I am a proud owner of 100 shares:

"Zzzz … another article by John Heinzl pumping up a stock he already owns to drive up the price of the shares. You'd think the G&M's editors would want some impartial analysis."

It's true that I often write about stocks that I own, but I always disclose my interest, in accordance with Globe and Mail policy: "Staff members who write investment columns and also hold securities mentioned in the column will state their ownership clearly."

Far from being a hindrance to fair analysis, having my own skin in the game – and having years of experience managing my own portfolio – makes me a more informed columnist.

I'd like to think readers benefit as a result. Also, I'm not the only columnist, at The Globe and Mail or elsewhere, to write about stocks in his own portfolio, and I also cover stocks that I don't own.

Now, I can understand that people would object if I was writing glowing articles and then selling my stocks for a profit. But apart from being repugnant to me from an ethical standpoint, it would be inconsistent with my dividend growth investing philosophy, which is to hold companies for years so that I can collect the rising income. Unless a company's outlook changes, I generally don't sell it.

What's more, I'm still in the asset accumulation phase of my life, so driving up the price of stocks that I'm still buying would be counterproductive. Not that I have that kind of power, anyway: The day that the column appeared, Tim Hortons fell 4 cents. So much for pumping up the price.

Finally, because I invest exclusively in dividend-paying stocks, with a heavy bias toward blue-chip companies that raise their dividends regularly, I own a lot of Canadian banks, utilities, telecoms and real estate investment trusts, plus a handful of large U.S. consumer stocks. As an investing columnist, my motivation for writing about these stocks is to share what has worked for me, not to make a few hundred dollars while putting my credibility at risk.