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In your recent column regarding the model Yield Hog Dividend Growth Portfolio, you failed to mention that the dividend payout ratio for Capital Power Corp. and Canadian Utilities Ltd. are 123 per cent and 173 per cent, respectively, which is the only reason they have the yields that they do. I think it would have been appropriate to include this information as a caveat.

I’ve said it before and I’ll say it again: Don’t rely on the payout ratios you see on financial websites to gauge the sustainability of a company’s dividend. These numbers are generated automatically and, because they lack human input and provide no context, often paint a highly misleading picture of a company’s payout ratio.

With power producers generally, the traditional definition of payout ratio – dividends per share divided by earnings per share – isn’t appropriate. That’s because power producer earnings are often depressed by accounting charges such as accelerated depreciation that don’t affect the company’s cash flow or its ability to pay dividends.

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In Capital Power’s case, analysts use a measure called adjusted funds from operations (AFFO), which is a more accurate indicator of the cash available to fund dividends. In a recent note, analyst Maurice Choy of RBC Capital Markets estimated that Capital Power’s AFFO payout ratio will be 38 per cent in 2021 and 43 per cent in 2022. Both are below the company’s long-term AFFO payout target range of 45 per cent to 55 per cent.

On Capital Power’s website, you’ll find a recent investor presentation that provides more detail about its payout ratio. Keep in mind that, in July, Capital Power raised its dividend by 6.8 per cent – its eighth consecutive annual increase. If the company were really paying out more than it could afford, the shortfall would have likely caught up with the company by now.

With regulated utilities, analysts often use a modified version of earnings – called “adjusted earnings” – to determine the payout ratio. In Canadian Utilities’ case, earnings are adjusted for one-time gains and losses, the timing of revenues and expenses in its regulated operations, asset impairment charges and other items that aren’t the result of day-to-day operations.

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Mark Jarvi, an analyst with CIBC World Markets, calculates Canadian Utilities’ dividend payout ratio – based on adjusted earnings – at about 82 per cent for 2021. That’s on the high side, but it’s not egregious. In a recent note, Mr. Jarvi said he expects the company will continue to deliver annual dividend growth – as it has done for 49 consecutive years – although at a slower pace than previously. Canadian Utilities’ most recent increase, in January, was just 1 per cent.

I’ll say it one more time: Don’t take the payout ratios on financial websites as the last word on dividend sustainability. Treat them as the starting point for further research.


You mentioned in your column last week that you bought additional shares of Royal Bank and Toronto-Dominion Bank for your model portfolio. Aren’t you worried about the Liberal Party’s plan to impose a 3-per-cent surtax on bank profits above $1-billion?

Not enough to stop investing in bank stocks. The proposed surtax on large banks and insurers, combined with a separate, temporary surcharge called the “Canada recovery dividend,” would add about $2.5-billion to government coffers annually over the next four years, according to the Liberal Party’s fiscal and costing plan. To put that into perspective, it represents less than one-fifth of the roughly $15-billion in earnings the six biggest banks made in just the most recent quarter.

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But here’s the thing: None of this is a done deal. First, the Liberals have to win the election, and that’s no shoo-in. Then, assuming they have the political will to move forward, they plan to consult with the Office of the Superintendent of Financial Institutions to determine exactly how much the big banks and insurers would pay. Count on pushback from the financial industry, which doesn’t want to be treated as a piggy bank by the government, and from pension funds and other investors who don’t want anyone messing with their beloved bank dividends.

Here’s one more reason I’m not worried: Bank stocks dropped when the proposals were first announced, which suggests the bad news is at least partly baked in to share prices.

Bottom line: Regardless of what happens in the election, Canadian bank stocks will continue to be a great long-term investment.

E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.

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