Dividend Investing in Canada: What You Need to Know to Get Started

There are a variety of ways where you can invest and grow long-term wealth. You can invest across asset classes such as equities, bonds, cryptocurrencies, and commodities. Even in equities, you can look to purchase growth stocks, value stocks, ETFs, blue-chip stocks, and dividend stocks.

One form of investment strategy that has always remained popular is dividend investing as it combines the benefits of stocks and bonds. Dividend investors can generate a steady stream of passive income and derive capital gains over the long term as well.

A dividend is part of the company’s profits that are distributed among its shareholders. Investors have the opportunity to reinvest these dividends and buy additional shares of the particular company to benefit from compounded gains. Alternatively, these payouts can also be withdrawn and invested elsewhere.

It also means companies that pay a dividend to shareholders need to generate consistent profits that can be distributed. These profits and cash flows need to originate across business cycles. Further, the ideal dividend-paying company is one that increases payouts over time. So, the company also needs to improve its earnings year over year and support dividend increases.

Top metrics for Canadian dividend investors

Canada has a ton of dividend-paying companies trading on the TSX. However, just because a company pays you a dividend does not make it a good bet. You need to identify stocks with strong fundamentals and robust balance sheets that can survive multiple economic cycles. Here, we take a look at some of the few financial metrics you can look at before you make an investment decision.

Dividend yield

One of the most important metrics for investors, the dividend yield is expressed as a percentage of a company’s stock price. For example, Enbridge stock is trading at a stock price of $47.17, and it pays annual dividends of $3.34 per share. It means ENB stock has a forward yield of 7.08% which is ($3.34/$47.17) * 100. It also suggests $1,000 invested in Enbridge stock will generate $70.8 in annual dividends.

A company’s stock price and its dividend yield are inversely related. So, if ENB stock falls to $40 per share its yield will rise to 8.1%. Alternatively, if its stock price increases to $55, the yield will be around 5.9%.

While this high yield will help you beat inflation rates making it attractive to income investors, it might not always be the case. Another Canadian company that has a high yield is Chemtrade Logistics. This stock has a forward yield of 8% but has lost over 60% in market value in the last six years. It has also reduced its dividend payouts in the last year burning significant wealth for investors.

Dividend payout ratio

The dividend payout ratio is extremely essential for investors. It is calculated as a percentage of a company’s net earnings or its distributable cash flow. For example, Enbridge aims to keep its payout ratio below 70% giving it enough room to reinvest in capital expenditure which will allow it to increase future cash flows.

If the payout ratio is low, it will also provide it with an opportunity to increase dividends over time and reduce its debt balance.

Long-term capital gains

Capital gains are the increase in a company’s share price as well as dividends paid. Enbridge stock was trading at $45 per share in June 2020. It means the stock has gained over 5% in the last year and after accounting for its dividend yield of 7.5% total returns were closer to 12.5%.

The ideal dividend-paying company should have the ability to beat the broader indices over time.

Avoid the yield trap

If you are just starting out your investment journey, you need to be wary of stocks will high dividend yields. As we know a fall in stock price will send its yield higher. So, investors need to look at the factors that are driving the stock lower. Is it just a broader market sell-off or is the company inherently weak?

During the onset of the COVID-19 pandemic, oil prices slumped lower due to lower-than-expected demand. This meant most oil producers will post massive losses in the following quarters which in turn led to dividend cuts and suspension across the industry.

A company that has a significantly higher yield compared to its competitors can be considered a red flag. There are other factors that need to be considered including its payout ratio, debt levels, and available liquidity.

The final takeaway

We know that dividend payments are not a guarantee and can be suspended at any time. However, there are several Canadian companies that have increased dividend payouts for several consecutive years. For example, Canadian Utilities has increased dividends every year since 1972 and Fortis has increased payouts for 47 consecutive years. Further, Enbridge has been able to increase dividends at an annual rate of 10% since 1995.

There are several other blue-chip Canadian stocks that pay a dividend and have increased these payouts consistently.