What are we looking for?
Canadian dividend growth companies.
With kids heading back to school, now may be a good time to sit down and teach your children about the importance of saving and what it means to invest. Of course, investing can seem like a daunting subject to broach for the first time with a youngster. One way you can help make it more interesting and applicable is to focus on companies they would be more likely to have heard of, in other words, larger businesses they may have encountered in their day-to-day activities.
Today we’ll be looking at a strategy that selects dividend-paying stocks from the S&P/TSX Composite Index (currently holding 221 constituents) that may be suitable for a newer investor. This strategy ranks stocks based on five-year dividend growth (an annualized number, higher values are preferred); five-year beta (beta measures a company’s sensitivity relative to historical changes in the benchmark – here we use the S&P/TSX, lower values are preferred); and expected dividend yield (expected annual dividends divided by stock price, higher values are preferred).
To be included, stocks had to satisfy all of the following criteria:
- Five-year beta less than one;
- Positive five-year dividend growth rate (annualized);
- Dividend payout ratio less than 80 per cent to ensure not all earnings are paid out as dividends and some remain for future growth/projects. It is calculated as expected annual dividends divided by expected earnings per share (EPS);
- Expected dividend yield in the top half of peers – today this has a value of 3.2 per cent or higher;
- Earnings variability in the lower two-thirds of peers – today this has a value of 17.4 per cent or lower. Earnings variability represents the volatility of a company’s EPS.
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. With more than 120 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
Younger investors would probably be most familiar with the banks on our list: Toronto-Dominion Bank, Bank of Nova Scotia and Royal Bank of Canada. (The other two of Canada’s Big Five, Bank of Montreal and Canadian Imperial Bank of Commerce, both had a five-year beta slightly above one, removing them from the list of qualifying stocks.)
I used Morningstar CPMS to back-test this strategy from December, 1990, to July, 2020. During this process, a maximum of 10 stocks were purchased. Stocks were sold if their five-year beta rose to 1.2 or higher or if their five-year dividend growth rate fell below zero. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 11.6 per cent while the S&P/TSX Composite Total Return Index advanced 8.2 per cent on the same basis. It’s also worth noting that the model outperformed in 74 per cent of down markets (defined as quarters where the S&P/TSX declined) compared with the benchmark.
Only nine stocks qualified for purchase into the strategy today and are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
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