Best dividend stocks: Your questions answered

Today I’m going to address a few questions from readers about the Retirement 100, our ranking of Canada’s best dividend stocks of 2015, which was recently published online and in the November 2015 issue of MoneySense.

Q: “I note that Canadian Tire (CTC.A) did not make the retirement all star list this year, whereas it was a ‘B’ list entry last year. From what I see in the tables for the companies, it’s virtually the same as last year; what happened?”

—Franklin M. 

A: The Retirement 100’s grading methodology has both relative and absolute elements. That is, there are some firm hurdles a stock has to pass (for example it has to pay a dividend) and others it has to score well on in comparison to other stocks.

For instance, we like stocks with modest price-to-book-value ratios where modest is partly influenced by the state of the market. If you sort dividend payers on the TSX by P/B, half of them would have had ratios of less than 1.6 this year whereas half traded for less than 2.0 last year. As a result, this year’s P/B requirement was a little more stringent than last year’s. It’s one reason why Canadian Tire slipped down the list this time around.

Q: “The column ‘Dividend Growth’ is asterisked and at the bottom of the page says it is a five-year average growth. Is this the five-year growth divided by 5 to get an annual growth number?”

—Bruce C. 

A: It is the 5-year compound annual growth rate in dividends paid, which is an annualized figure.

Q: “I find the article on the best 100 stocks to retire on an excellent resource for selecting stocks for my own portfolio, but I wonder if your grades might be different if you did not include reinvested dividends in the analysis. After all, creating a dependable income stream in retirement means that the dividends would be spent, not reinvested.”

—Connie L.

A: Thank you for the kind remark.

I confess that your question had me scratching my head a little bit because it potentially touches on many topics.

First off, it is important to remember that the Retirement 100 portfolio (of A- and B- graded stocks) is re-balanced each year. As a result, those who don’t reinvest the dividends will largely miss out only on the compounding that reinvesting them would have provided. The withdrawal rate an individual selects shouldn’t impact the grades. But it will impact that individual’s long-term results.

I know that many investors like to live off the dividends they receive. It’s a good approach, but it is not without its flaws. To avoid running into trouble, it is also important to impose a safe overall withdrawal rate. Historical studies indicate that most investors should start by limiting themselves to a 4% withdrawal rate that is subsequently adjusted for inflation.

Thing is, the two ideas can clash when dealing with high yield stocks.

For instance, this year an equally weighted portfolio of A- and B- graded stocks started with an average yield of 4.4%. That’s above the safe withdrawal rule, which argues for consuming only 4%. For safety sake, roughly 9% (0.4/4.4 times 100%) of the dividends should be reinvested instead of consumed. Conservative investors should reinvest more.

The 4% rule can also help investors avoid the temptation of buying extremely high yielding stocks in an effort to boost their income. While such an approach might work in the short term, it comes with a great deal of risk.

I hasten to add that I’ve just touched on the complicated, and much debated, topic of safe withdrawal rates. A more detailed discussion will, alas, have to wait for another time.

I encourage anyone who has questions for MoneySense to reach out to us.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders.

The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada.

My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done.

Here’s the updated Safer Dogs of the TSX, representing the top yielders as of October 23. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.

Notes

Source: Bloomberg, October 23, 2015

Price: Closing price per share

P/B: Price to Book Value Ratio

P/E: Price to Earnings Ratio

Earnings Yield: Earnings divided by Price, expressed as a percentage

Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage

As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently.  Remember, stocks can be risky.  So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)

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