Dividend growth lives - if you know where to look

After years of fat dividend increases, 2009 was a wake-up call for dividend investors.

The big banks failed to usher in any increases. A few companies, including Manulife Financial and Yellow Pages Income Fund, slashed their dividends. Others announced token increases of a penny or two. Big whoop.

So, is it time to give up on the dividend growth game and move on to something less stressful, like GICs or government bonds, perhaps?

Heck no, says dividend guru Tom Connolly. Buying stocks that raise their dividends is still a sound approach, particularly for investors who need income. Folks just need to lower their expectations a little, said the author of the Connolly Report newsletter.

"There is no strategy better than dividend growth," Mr. Connolly said. But we are in a "new normal," where investors can't count on the heady increases of recent years.

As banks retrench, he expects dividend hikes to be few and far between in the financial sector. That's consistent with past financial crises, when banks have gone for years with no dividend hikes. He also expects little growth in dividends from insurance companies as they rebuild their capital.

The good news? He sees dividend growth continuing for pipelines and gas and electric utilities, whose regulated businesses throw off predictable cash flows. They have been "stalwarts for decades.... Pipelines and utilities have sustainable dividend growth and the consistent cash flow to cover it," he said.

Companies such as Enbridge, TransCanada, ATCO, Canadian Utilities, Fortis, TransAlta and Emera all paid higher dividends in 2009 compared to 2008.

Several non-utilities also raised their dividends, including BCE, Rogers Communications, Metro, Canadian National Railway, Toromont Industries and SNC-Lavalin Group, among others.

So dividend growth investing is far from dead, he said.

"There were a lot more dividend increases in Canada than most people realize, and fewer decreases," he said. Dividends are still far less volatile than stock prices, but the market meltdown in 2008 and 2009 scared people "unjustifiably" about dividend investing.

One lesson that was driven home in 2009 is that "reaching" for yield is seldom a good idea, he said. As Yellow Pages shareholders found out the hard way, a double-digit yield often signals a dividend cut.

To minimize the chances of such disasters, Mr. Connolly said investors should be content with a yield in the 4-per-cent range and a dividend that grows at about 5 per cent annually.

Other dividend growth fans also remain committed to the strategy.

David Sherlock, associate portfolio manager with McLean & Partners Wealth Management in Calgary, likes utilities stocks, but says some have gotten expensive in the market rally.

His firm, which specializes in global dividend growth companies, recently sold part of its position in pipeline operator and power generator TransCanada.

"It's not because we don't like the company. It's actually because we like the company and have done very well on it, but now it's time to take some profits," he said.

Another way to play pipelines is to buy companies that provide products and services to the industry. McLean recently bought shares of ShawCor, which makes pipeline coatings, insulation, sealants and other products. The stock yields just 1 per cent, but annual dividends have more than tripled in the past five years. In addition, it paid a special dividend in May.

"It has a strong balance sheet; it's growing its dividend. Really, it's a valuation play," Mr. Sherlock said. The stock trades at a discount to its historical price-to-earnings multiple and generates strong returns on both equity and assets, he said.

Still need convincing that dividend growth stocks, and utilities in particular, deserve a place in a well-diversified portfolio? In his December investment outlook, Pacific Investment Management Co.'s Bill Gross - manager of the world's biggest bond fund - urged investors to move money out of ultra-low-yielding savings accounts and money market funds and into utilities stocks.

Utilities are reasonably priced, and "their growth in earnings should mimic the U.S. economy as they always have, and most importantly, they yield 5 to 6 per cent, not .01 per cent," he wrote.

That's why Mr. Gross is buying them for his own account, and thinks you should, too.

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The dividend aristocrats

Members of the Claymore S&P/TSX Canadian Dividend ETF. Each must have increased dividends for at least five consecutive years.