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Seeking dividend growth is a great investing strategy because it satisfies on both a strategic and emotional level.

Stocks that pay increasing amounts of quarterly cash year by year give you a hedge against inflation and help pad the total returns you generate through a combination of dividends and share price growth. Also, getting extra cash every year is a bit of a buzz. It’s like being told you own a piece of a strong company.

But there’s a more important goal in dividend investing than growth – avoiding dividend cuts. Companies under financial stress can lighten the load by reducing their dividends, as we saw with Algonquin Power and Utilities Corp. AQN-T earlier this year. Algonquin’s dividend was chopped by 40 per cent to conserve cash.

A recent report by CIBC Capital Markets offers a roadmap for avoiding dividend cuts by tracking both dividend increases and decreases in 11 sectors in the S&P/TSX composite index since 2006. Tech was the best performing sector in this analysis, but on a small scale. The two dividend payers in the sector have increased payouts 29 times, with zero cuts.

The 11 consumer staples stocks in the analysis raised dividend 135 times, with just a single instance of lower payouts. Another good sector for avoiding dividend cuts is pipelines – six stocks in this sector produced 90 dividend hikes and just two decreases.

Other sectors that offer good overall security against dividend cuts:

  • Utilities: A dozen stocks increased dividends 220 times, with just 10 cuts.
  • Financials: 24 stocks in this sector produced 436 dividend increases and 10 decreases.
  • Consumer discretionary: 17 stocks produced 103 dividend increases and seven cuts.

The sectors where dividend cuts are most likely are those that are vulnerable to economic cycles. The 40 energy companies tracked by CIBC increased dividends 258 times since 2006, with 69 dividend cuts. Among industrials, 19 companies produced 333 dividend hikes and 35 cuts. In the materials sector, 27 companies raised dividends 232 times and cut 30 times.

Real estate is another sector to keep an eye on if you’re trying to minimize the risk of a dividend cut. The CIBC report found that 19 companies in the sector produced 185 dividend increases, but also 18 dividend cuts.

Investing in cyclical dividend growth stocks involves a tradeoff of dividend hikes in good years and very real risk of cuts in bad times. In other sectors, keep your eye on the risk of dividend cuts by looking at factors like payout ratio and yield.

Inflated dividend yields can sometimes provide an early warning. Before the dividend cut in January, Algonquin’s yield soared into the high single digits.

– Rob Carrick, personal finance columnist

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Ask Globe Investor

Question: What is the best way to invest in the AI trend, in your opinion?

Answer: The short answer is: with caution.

The stock market in general, and the technology space in particular, are notorious for boom-bust cycles. When a hot sector takes over the collective imagination, stock prices rocket higher, pushing valuations to unsustainable levels. Eventually, common sense prevails and prices return to more reasonable levels.

We’ve seen this movie before with the dot-com madness of the late 1990s, the U.S. housing mania of the mid 2000s, the bitcoin bubble and, more recently, the COVID-19-related surge in tech companies that benefited from the shift to working, shopping and exercising at home. The market was assuming these trends would last forever, which presumably justified the inflated price-to-earnings multiples assigned to many of these pandemic stocks.

But, as interest rates rose and COVID-19 restrictions eased, the pandemic darlings got crushed. Now, the artificial intelligence boom has picked up where the pandemic rally left off. Perhaps no stock illustrates this better than the decrease of Nvidia Corp. NVDA-Q, which supplies the powerful graphics processing units used by ChatGPT and other AI applications. Shares of Nvidia – which recently reported a blowout quarter – have nearly tripled since the start of the year, closing Friday at US$422.09 a share. That implies a P/E multiple of about 54 times estimated earnings per share for Nvidia’s current fiscal year ending in Jan. 31, 2024, and 41 times estimates for fiscal 2025, indicating that investors are pricing in tremendous growth for Nvidia over the next few years.

A high P/E ratio isn’t a problem as long as a company meets or exceeds earnings expectations. But if it stumbles, even a little, watch out. It’s not just Nvidia. Many other tech stocks have also surged recently, including the aforementioned companies that were handing out thousands of pink slips just a few months ago. Even companies with the most tenuous connections to AI have been playing up the technology, because they know it’s the investing flavour du jour.

Just to be clear, I’m not trying to scare you away from investing in tech. It’s a hugely important part of the economy, and its importance will only continue to grow. AI is already changing how we live, work and play. However, I believe it would be a mistake to load up on AI companies in the hope of riding the boom to big riches. As we’ve seen countless times before, the stock market has a way of humbling investors who try to catch the latest wave.

A more prudent approach, in my opinion, is to invest a portion of your portfolio in an exchange-traded fund that holds a diversified basket of technology stocks – not just those focused on AI. For example, several Canadian ETF providers offer funds that track the tech-dominated Nasdaq 100 Index, such as the BMO Nasdaq 100 Equity Index ETF ZNQ-T. BMO and iShares also offer currency-hedged Nasdaq 100 ETFs, trading under the symbols ZQQ and XQQ, respectively. All three of these funds trade in Canadian dollars, which saves you from converting your loonies into U.S. dollars and paying stiff currency-conversion costs.

What many investors may not realize, however, is that they don’t need to buy a Nasdaq 100 ETF to get plenty of technology exposure. The much broader S&P 500 Index currently has a 28 per cent weighting in information technology stocks, with Apple Inc. AAPL-Q, Microsoft MSFT-Q, AMZN-Q, Nvidia, Alphabet GOOGL-Q and Meta META-Q representing the top five spots and accounting for more than one-quarter of the market capitalization of S&P 500 ETFs. So, if you invest in one, you may be getting all the tech exposure you need, with the benefit of additional diversification from sectors such as health care, financials, industrials and consumer stocks that have relatively low weightings in the Nasdaq 100.

The other nice thing about S&P 500 ETFs is that they are dirt cheap to own. The iShares Core S&P 500 Index ETF XUS-T and Horizons S&P 500 Index ETF HXS-T, for instance, each have a management expense ratio of 0.1 per cent, while the BMO S&P 500 Index ETF ZSP-T charges just 0.09 per cent. That compares with 0.39 per cent for the three Nasdaq 100 ETFs mentioned above.

Whatever you decide, I would look at your investment in technology as a long-term commitment, not as a way to play the hottest trend. The AI story is everywhere, and stock prices are already pricing in substantial growth. By spreading your bets across the technology sector and holding through the inevitable up and down cycles to come, you’ll be sure to participate in the gains that AI and other tech innovations generate, while controlling your risk.

– John Heinzl

What’s up in the days ahead

BlackBerry Ltd., General Mills Inc., and Micron Technology Inc. release results on Wednesday

Click here to see the Globe Investor earnings and economic news calendar.

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Compiled by Globe Investor Staff

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