Doing some dividend detective work

One of the most dependable investment strategies of them all used to be holding bank stocks to collect an ever-growing stream of dividend income.

The financial crisis forced the banks to kill dividend growth for almost three years, but now it's coming back. Which are the best banks for income-focused investors? Let's apply some dividend detective work that you can use when investigating any dividend-paying stock.

The most basic requirement of a dividend stock is that it keeps the cash coming every quarter without interruption despite business setbacks, recessions and such. All the banks managed this through the financial crisis, though there were some tense times spent speculating whether Canadian banks would follow their U.S. counterparts and slash dividends to conserve cash.

If the Big Six banks could sustain dividends through the crisis, then dividend security is not something we need to worry about in today's improving economic environment. This brings us to dividend growth, which characterizes the best blue-chip stocks. Rising dividends are a great way to keep your flow of income rising with inflation, and there's also a correlation between them and long-term share-price increases.

National Bank of Canada in December became the first of the big banks to raise its dividend since the financial crisis, and both Toronto-Dominion Bank and Bank of Nova Scotia announced dividend increases earlier this month. For Bank of Montreal, Canadian Imperial Bank of Commerce and Royal Bank of Canada, you have to go back to, well, let's find out by consulting the first source of information dividend detectives should consult.

It's the investor relations area of a company's website. Go right to it by doing a Google search along the lines of "Bank of Montreal investor relations." Next, look for a link to information on common share dividends, specifically a dividend history.

The best of the big banks for providing a long-term perspective on dividend payments could be TD, which shows quarter-by-quarter payouts going back to 1970 (back then, TD paid 17 cents a share each quarter). National Bank's quarterly information goes back to 1980, while CIBC goes back to 1997 and RBC to 2000. Scotiabank tracks annual dividends paid back to 1892, while BMO shows annual dividends paid back to 2006.

Let's see what's available to flesh out BMO's long-term dividend record. If you download the bank's 2010 annual report, you'll find a handy chart in the Supplemental Information area that shows fiscal year dividend payouts going back to 2001.

It turns out that BMO's annual dividend has grown to the current level of $2.80 (the bank took a pass on raising its payout when releasing first-quarter results late last month) from $1.20 a decade ago. That works out to a compound average annual growth rate of 8.8 per cent over the 10-year period from 2002 through 2011.

Let's compare that to TD, which last week bumped up its quarterly dividend to 66 cents a share from 61 cents. After its recently announced increase, TD's annual dividend for the current fiscal year can be estimated at $2.59 a share. TD's annual dividend 10 years ago was $1.12, so the latest increase gives it a 10-year compound average annual dividend growth pretty much on par with BMO.

Are TD and BMO peers when it comes to dividend growth, then? The savvy dividend detective will probe further to find out by looking at recent patterns.

TD's quarter-by-quarter dividend history shows the bank established a pattern in the middle of the last decade of paying two small dividend increases a year. Annualized dividend growth from 2007-10, a tough period for the banks, was 3.7 per cent.

Over at BMO, they put through some very juicy dividend increases in mid-decade and then ran out of gas. The four-year dividend growth rate was just 0.8 per cent. The lack of recent dividend growth squares with BMO's status during the crisis as one of the banks most likely to cut dividends. You can see this in the fact that its dividend yield reached double digits in late 2008, a freakish occurrence that proved to be a huge buying opportunity for the shares.

You'll get more insight into BMO's dividend history by looking in the annual report for dividend payout ratios, which measure how much of a company's earnings are being paid out to shareholders each quarter.

BMO's payout ratio of 58.8 per cent for 2010 is way down from an alarming 91.8 per cent in 2009, but it's still above the 35- to 45-per-cent range of the precrisis years. TD only offers three years of payout ratios in its annual report, but they show a bank that is having a much easier time affording its dividends. According to TD's annual report, the ratio last year was 42.1 per cent and in 2009 it was 45.6 per cent.

An easy way to track the payout ratio and five-year dividend growth of the banks and any other stocks is to use the new and improved Watchlist feature on Globeinvestor.com. Add the stocks you want to follow - the Big Six banks, for example - and then select the Dividends option from the menu labelled View. There are up-to-date numbers for payout ratio, one-year dividend growth, five-year annualized dividend growth and both one- and five-year total returns (share price gains plus dividends).

Finally, there's dividend yield (annual dividend per share divided by price per share) to consider as part of your analysis of a dividend stock. Yield is a measure of the return you get from a stock's dividends and can be found in the stock quotes on Globeinvestor.com or any other investing website. BMO is the yield king these days among bank stocks at 4.5 per cent, while TD anchors the low end of the scale at 3.2 per cent.

The story those yields tell is that investors are impressed with TD and lukewarm on BMO. Could be they're paying a lot of attention to dividends.

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Several of the big banks have started increasing their dividend again after a freeze that began during the financial crisis almost three years ago. Here's a look at the long-term dividend growth records of the Big Six banks.

Notes:

-2011 dividends are an extension of dividends paid in the first two quarters of the current fiscal year (bank fiscal years end Oct. 31)

-2002 dividends are what was actually paid in that fiscal year

-Total return means dividends + share price gains

-Share price information is to March 10

Source: Bank websites and annual reports, Globeinvestor.com