The influential Aleph Blog is back after a lone hiatus, and its principal author, financial professional and former actuary David Merkel, has published an article called Dividends Can Lie.
Mr. Merkel admits that he loves dividends, but he is “more fickle than most of their fans admit.” Each dividend payment is money in the investors’ pocket but analysis is necessary to make sure future payments are safe.
The author focuses on steady free cash flow as the surest sign of sustainability of dividend payments and the potential for dividend increases. For signs of danger, Mr. Merkel watches debt levels. He writes, “If the debt levels are persistently increasing as a fraction of assets, it is likely a sign that the company is borrowing to pay the dividend… businesses have their limits, and paying a dividend beyond those limits leads to an eventual dividend cut.”
Population demographics and extremely low government bond yields have made dividend-paying stocks arguably more popular than they’ve ever been. Investors in the past decade have become accustomed to income and capital appreciation in virtually every case they’ve added a dividend stock to their portfolio.
There is no imminent sign of a changing market environment, but Mr. Merkel notes that there have been periods, like the 1970s, where dividend cuts were common. Rising bond yields at the time attracted the majority of the income investor assets away from dividend stocks that underperformed significantly.
Canadians got a small, if painful, reminder of this phenomenon in late 2018 when equity income payers sold-off as North American central banks began tightening financial conditions and raising interest rates. The S&P/TSX Utilities Index fell 5.4 per cent between June and December last year.
Again, there is no hit at present of rising interest rates or any other market trend that would threaten dividend stocks. If pressure does appear, however, Mr. Merkel’s advice to watch free cash flow and debt levels for investor holdings would help prevent outsized losses.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
Morneau Shepell Inc. The human-resources consulting and technology provider’s stock appeared on the positive breakouts list at the beginning of the month with its share price closing at a record high at the end of the third quarter. The company has a solid track record of delivering revenue growth combined with a stable dividend, writes Jennifer Dowty.
Boyd Group Income Fund If you hold your units in a non-registered account, you could be facing a hefty capital gains tax hit when it converts from an income trust to a corporation, warns John Heinzl.
Crucial earnings season will put Canadian stock gains to the test
With Canadian stocks having their strongest year in a decade, a pivotal earnings season will put those gains to the test in the weeks ahead. The torrent of third-quarter financial results gets started this week, and the expectations going in are low, according to Tim Shufelt.
Mark Twain’s financial investments are a cautionary tale on risk-taking that all investors should heed
We know Mark Twain as the 19th-century humourist who authored The Adventures of Tom Sawyer and other classics in American literature. Less well known are his financial speculations, which didn’t go well. They culminated in a bankruptcy that left his family in dire circumstances – until he staged a remarkable comeback in his 60s, writes Larry MacDonald.
How to protect yourself from a Black Monday-like shock
This past weekend marked the 32nd anniversary of Black Monday. Obviously, this is not an anniversary anyone wants to celebrate. “Record drop” are words no investor wants to hear, but we need to remember that these events happen periodically and to be prepared when they do. History shows us that any decline will be temporary, but the length of time it takes to recover can sometimes be years. Gordon Pape looks at some steps investors can take to prepare for the next fall.
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Ask Globe Investor
Question: What do you think of using DRIPs as an investing strategy? I was thinking of using the hybrid DRIP with Questrade. And what do you think of the DRIPs that buy you partial shares?
Answer: DRIP is short for dividend reinvestment plan. Many companies offer them to allow people to reinvest their dividends in new shares. No commissions are charged and, in some cases, companies offer a small discount from the market price.
DRIPs are an excellent option if you don’t need the cash flow from dividends and if you want to build your position in a company over time.
I’m not a big fan of buying partial shares as it complicates the calculation of adjusted cost base.
I asked Questrade for an explanation of their hybrid DRIP. They replied that these are fairly common among discount brokers and are also known as synthetic DRIPs.
“Essentially the customer is registering their intent to reinvest cash dividends with the brokerage vs. a share purchase plan directly with the underlying issuer as with a traditional DRIP,” Questrade said.
“The hybrid approach is much easier and quicker for the customer to set up, and ‘traditional DRIPs’ are becoming somewhat less common as, for amongst other reasons, the issuer is required to increase the number of shares in circulation each quarter which can have a negative impact on price.
“There are some differences between a hybrid and traditional DRIPs – for example with the hybrid approach only whole shares are purchased, whereas with a traditional DRIP fractional shares can be purchased. We’ve supported the hybrid DRIP for a long time, and we don’t hear from customers asking for us to support a ‘traditional DRIP’.” – G.P.
-- Gordon Pape
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Compiled by Globe Investor Staff