The Canadian stock market hit a series of new highs in recent months, and Canadian dividend payers fared even better.
Add up the gains and the S&P/TSX Composite Index climbed 32.9 per cent over the 12 months to the end of June, while today’s featured portfolio of dividend stocks with generous-but-not-extreme yields advanced by 35.5 per cent.
To set the stage, low-fee passive investors in Canada enjoyed solid gains over the long term with the S&P/TSX Composite Index climbing at an average annual rate of 9.0 per cent over the roughly 25.2 years from the end of April, 2001, through to the end of June this year. It’s a big reason why many investors adopt, and stick with, broadly diversified low-fee index funds such as the iShares Core S&P/TSX Capped Composite Index ETF (XIC), which tracks the market index while charging a modest annual fee of 0.06 per cent.
But income investors might have been better off adopting a largely buy-and-hold approach to building and maintaining diversified portfolios of Canadian dividend stocks. The method can be explored by picking dividend stocks from within the constituents of the S&P/TSX Composite Index itself.
In backtests, simply buying all of the dividend payers in the index resulted in portfolios with average annual returns of 10.8 per cent and 9.9 per cent over the 25.2-year period, when the portfolios were equally weighted and size-weighted respectively.
(The returns herein are based on data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are rebalanced monthly.)
The return boost suggests that investors can do well – and possibly better than the index – by buying a diversified portfolio of Canadian dividend payers for the long term. Along the way, dividends can be used to buy new stocks or to top up existing holdings. Similarly, withdrawals can be used to help rebalance the portfolio over time.
However, investors might opt for a slightly more active dividend portfolio focused on stocks that pay generous – but not extreme – dividend yields.
As a first step, investors who focused on buying an equal dollar amount of the 30 per cent of the index constituents with the highest dividend yields would have gained an annual average of 10.5 per cent over the 25.2-year period. They beat the index but lagged the portfolio that held all of the index’s dividend payers.
Stocks offering extreme yields can be problematic. Companies that run into trouble usually see their share prices fall dramatically before a dividend cut (or bankruptcy), which pushes up their yields and prompts the backtest to buy more of their shares on the way down. In other words, there’s the risk of throwing good money after bad, and it’s a big reason why investors should seek out stocks with generous but not extremely high yields.
For instance, a portfolio following the 30 per cent of the index constituents with the highest yields, excluding the 5 per cent with the very highest yields, gained an annual average of 11.5 per cent over the 25.2-year period. It handily beat both the index and the broader group of all dividend payers in the index.
I’ve high hopes that Canadian dividend stocks will continue to fare well as a group over the long term. But they aren’t risk-free. Some will disappoint and the whole group might lag the market from time to time.
Details on a broader selection of dividend and value stocks can be found via this link.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
