You won’t believe this, but not every e-mail I receive is full of gushing praise for the work I do. That’s good. I rely on readers to keep me on my toes. Today, I’ll respond to three readers who politely challenged me on some of my columns this year. For clarity, I’ve edited and paraphrased their words. Thanks to everyone who wrote in with questions this year – let’s do it again in 2017.
Why do you always report returns before tax? This is misleading as there are taxes on dividend and interest income and taxes on capital gains when a security is sold. I wish financial writers would acknowledge the impact of taxes more often.
Financial writers aren’t trying to make returns look better than they are by reporting them on a pre-tax basis. It’s just that reporting returns on an after-tax basis isn’t practical, because the amount of tax – if any – varies depending on the individual’s circumstances and the type of account.
For example, if I hold shares of XYZ in a tax-free savings account and they post a total return of 15 per cent, the entire return will be mine to keep. But if you hold XYZ in a non-registered account, you’ll likely pay some tax on XYZ’s dividends and capital gains and your after-tax return will be less than 15 per cent. Another person might pay more – or less – tax than you do depending on his or her province and income level.
That’s why the accepted convention is to report returns of stocks and indexes on a pre-tax basis. I should also point out that in my Investor Clinic columns, I frequently discuss tax matters, often with the help of outside experts. I’ll continue to do that in 2017.
If dividend investing is so fantastic, why is the performance of the S&P/TSX Canadian Dividend Aristocrats Index so ordinary? The 10-year annualized return is just 1.9 per cent and the five-year annualized return is 3.8 per cent.
It looks like you are quoting the simple price returns of the index – excluding dividends – which is going to paint an unflattering picture given that the index holds dividend stocks exclusively. But even taking this into account, the returns you quoted are too low.
According to S&P/Dow Jones Indices, the S&P/TSX Canadian Dividend Aristocrats Index had a 10-year annualized return of 3 per cent and a five-year annualized return of 4.75 per cent for the periods ended Dec. 22. These returns are for the index value only and exclude dividends.
What about the total return, including dividends? For that, I looked up the performance of the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (CDZ), which is designed to replicate the performance of the index (minus fees and expenses).
Over the past 10 years, CDZ posted an annualized total return of about 7.2 per cent, according to longrundata.com. Over the past five years, CDZ’s annualized total return was about 9.8 per cent. These returns assume all dividends were reinvested.
The comparable annualized total return figures for XIC, which tracks the S&P/TSX composite index, were 4.7 per cent and 8.5 per cent, respectively. So, on a total return basis, the dividend aristocrats index topped the composite index for both periods.
It’s worth noting that the S&P/TSX Canadian Dividend Aristocrats Index is weighted by yield and is composed of stocks with a history of raising their dividends. Dividend indexes or ETFs that employ a different methodology may have produced higher – or lower – returns.
Why would you own a stock such as Brookfield Infrastructure Partners LP (BIP.UN) when it is paying out way more than its net income? This does not seem sustainable.
It’s true that BIP.UN’s distributions exceed its net income. In the third quarter, for instance, it distributed about 39 cents (U.S.) a unit – more than double its reported net income of 16 cents a unit.
But with a business such as BIP.UN, which owns a lot of long-life assets, net income does not provide an accurate picture of its ability to pay and sustain a distribution. That’s because net income is reduced by accounting charges such as depreciation and amortization that don’t affect the company’s cash flow.
For that reason, BIP.UN – and similar companies – often report their payout ratio as a percentage of cash flow. In the third quarter, BIP.UN’s “funds from operations” or FFO – which is defined as net income excluding depreciation, amortization and a few other items – was 68 cents a unit. The payout ratio – including incentive distributions to parent Brookfield Asset Management and preferred unit distributions – was 68 per cent, which is within BIP.UN’s target range of 60 per cent to 70 per cent.
Not only is BIP.UN’s distribution sustainable, but the company has stated that it intends to raise its distribution by 5 per cent to 9 per cent annually. (Disclosure: I own BIP.UN units both personally and in my Strategy Lab model dividend portfolio).Report Typo/Error
- iShares S&P TSX Canadian Dividend Aristocrats Index ETF$25.650.00(0.00%)
- iShares Core S&P/TSX Capped Composite Index ETF$24.080.00(0.00%)
- Brookfield Infrastructure Partners LP$50.700.00(0.00%)
- Brookfield Asset Management Inc$38.540.00(0.00%)
- Updated July 27 3:59 PM EDT. Delayed by at least 15 minutes.