December 2009
Dining on dividends
Amidst the massive swings we’ve seen in equities, with huge capital losses followed by nearly as impressive capital gains, those little quarterly dividend payments tended to get lost in the shuffle. But equity prices don’t soar by 50 per cent every six months, and longer term, dividends still account for a significant chunk of the return on equity. For example, a C$100 investment that was made in the Toronto Stock Exchange (TSX) composite in 1975 would have grown to C$1,200 today. Throw in re-invested dividends, and the portfolio would be nearly C$3,500.
With interest rates now at historic lows, and even mid-rated corporate bonds hardly offering generous payments, the attraction of dividends could tell a greater part of the story in 2010. As we write, dividend yields on TSX stocks are the closest they’ve been to corporate bond yields in decades, and they are at an enormous spread over t-bill yields.
Canadian retail investors are still quite chastened by the losses on stocks in 2008 and early ’09, and most have sought yield in bonds or preferred shares rather than common equities. But we have seen modest net buying of dividend and income equity funds in 2009 as investors pulled out of nearly zero-yielding money market funds. As income trusts convert to common equities, there will be additional demand for income earning assets.
Dividend stocks also have attractive risk-return features. Consistent dividend payers have outperformed the overall TSX in the last half decade, but have also suffered less downside in each of the six bear markets seen since 1974.
Of course, the greatest risk in investing in a high-dividend-paying equity is the axe that falls when a dividend cut is announced. Fortunately, such risks appear to be diminishing as the economy turns from recession to growth. Corporate debt burdens in Canada remain low, leaving less pressure to use cash to pay down debt rather than send out dividends. A flood of dividend cut announcements early in 2009 had almost completely died down by the fourth quarter. While not yet back up to norms, announcements of dividend hikes ran at roughly four times the roughly 2 per cent share of TSX companies revealing dividend cuts in the latest quarter.
The other risk to dividend stocks comes when interest rates move sharply higher. While that day will come, the recovery in 2010 will be too fragile to prompt a steep monetary policy tightening, particularly if the Canadian dollar already provides a braking force against growth and inflation. A strong loonie will therefore be a dividend stock investor’s best friend.
By Avery Shenfeld, managing director and chief economist, CIBC Word Markets Inc.
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Trade Talk® is provided for general information purposes only and CIBC Mellon Global Securities Services Company, CIBC Mellon Trust Company, CIBC, The Bank of New York Mellon Corporation and their affiliates make no representations or warranties as to its accuracy or completeness. Readers should be aware the content of this publication should not be regarded as legal, tax, accounting, investment, financial or other professional advice nor is it intended for such use.
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