What are we looking for?
Canadian dividend payers trading below their sector valuations.
After a market rally such as last year’s, value-oriented investors will be hard pressed to find new ideas at this point. This week’s strategy seeks to find dividend payers that are trading near or below their industry in terms of their valuation ratios. To find these companies, I first ranked the largest 250 names in Canada by market float (outstanding shares that are publicly available to trade) on the following metrics:
- Dividend yield;
- Five-year historical beta (a measure of historical sensitivity to the index. In trending markets, a company with a beta of less than one has moved less than the index, which is preferred here);
- Price-to-earnings, price-to-free cash flow, and price-to-sales relative to the sector median (in the accompanying table, a figure of 0.9, for example, implies that the valuation metric is 10 per cent lower than that of the sector median).
To qualify, companies must have an average five-year return on equity in the top one-third of the universe (today that figure is 13 per cent or higher). Additionally, to ensure dividends are reasonably sustainable, companies must have a payout ratio on earnings of less than 80 per cent or a payout ratio on cash flow of less than 60 per cent.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market.
What we found
I used Morningstar CPMS to back test this strategy from September, 2004, to the end of December, 2019. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than four stocks in a sector. Once a month, stocks were sold if their rank fell below the top 35 per cent of the universe, or if the company’s dividend payout ratio on earnings exceeded 90 per cent. Over this period, the strategy produced an annualized total return of 11.7 per cent while the S&P/TSX Composite Index gained 7.5 per cent on the same basis.
The stocks that qualify for purchase are listed in the table below. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.
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