The year 2022 marked a significant shift in the global investment environment, which – for more than a decade – has been underpinned by a mix of low interest rates, stable inflation and moderate economic growth. This trifecta of conditions had a positive impact on many parts of the market, particularly growth stocks. Today, investors are grappling with a reversal in these trends in the face of rising interest rates, high inflation and the looming threat of a global recession. In this climate, quality has become more important than ever and dividend stocks, in particular, are increasingly seen as more attractive as investors look for companies with business models able to generate appealing risk-adjusted returns in all types of market conditions.
But not all dividend stocks are created equal and it’s important to ensure a company is able to generate stable payouts over the longer term. The Global Equity & Income Team at Mackenzie Investments has identified what it calls a “Dream Team” list of companies that are curated for quality and that feature high returns on capital as well as fairly predictable long-term economics. The team believes these work well within a strategy that blends dividend yield with growth. These “compounder companies” range from household names with global scale to smaller, lesser-known companies with unique tangible or intangible assets capable of delivering healthy margins.
To identify “Dream Team” companies, Mackenzie’s Global Equity & Income Team looks at several key metrics, including these four:
1. Resilient revenue streams - Assessing whether or not a company is high quality involves close scrutiny of the operating model and the unit economics over time in order to understand the operating leverage as well as the underpinnings of profitability and returns on capital. Understanding these characteristics illuminates a company’s ability to support its dividend payments through cycles.
2. Commitment to dividends - While companies always have options for uses of capital, dividend payments are a sign of integrity. In other words, if a company is not planning to use capital and returns it to shareholders rather than simply expanding the corporate empire and raising management compensation, that’s a good thing, the team contends.
3. The right time in the cycle - Whether or not dividends make sense depends on where the company is in its growth cycle. Some companies need to reinvest cash flows in the business to take advantage of growing opportunities. Microsoft, for example, has been spending large amounts of capital on its cloud computing division, Azure, in order to enter a massive new market. In such a case, it makes more sense to spend on building a potential multibillion-dollar service than it does to pay shareholders.
Companies like Visa, on the other hand, could raise its payout ratio as it typically generates far more cash than it needs to reinvest in the business. The optimal company is one that offers both a higher payout and higher growth.
4. Regional differences matter - Dividends have historically been higher in Europe than in the United States in part because of cultural differences and partly due to sector weightings. European companies tend to have a greater power balance between executive management and the board than in the United States. In Europe, investors can expect higher payout rates based on these different approaches to corporate governance, where the board has a strong position representing shareholder interests.
Sectors also matter. The United States is the most dynamic economy in the world and technological innovation has been a big driver of growth. In that context, more capital can be invested into the growth of the company and there might be less available for dividends.
Investors can compound their returns over time through the power of dividends
Investors may want to look for strategies that blend dividend yield with growth and reinvest dividends to compound returns faster. As the chart below shows, reinvested dividends can lead to better risk-adjusted returns over the long term.
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