What are we looking for?
Dividend growers outside of the S&P/TSX composite index.
The screen
Generally speaking, companies paying growing dividends seem to reside in the large-cap space in Canada. Looking at any income-bearing portfolio, one is likely to find a few Canadian Schedule I banks, coupled with exposure to large utility companies (both industries have historically paid steady dividends). But this doesn't mean there aren't reasonable dividend payers in the smaller-cap space in Canada. Having exposure to both large-cap and small-cap companies adds additional diversification to a portfolio. Particularly in bull markets, small-cap companies tend to appreciate more quickly than large caps. This week, I use Morningstar CPMS to look for Canadian companies outside of the S&P/TSX composite index and rank them based on the following factors:
- Yield on expected dividends (here we used what the company has announced that it will be paying, but has not yet paid);
- Five-year normalized dividend growth rate (on average, how much a company has grown its dividend each year in the last five years);
- Expected growth rate of dividends (the percentage difference between the expected annual dividend rate and the actual trailing dividend paid in the past four quarters);
- Annual cash flow momentum (the latest four quarters of reported cash flows, compared against the same figure four quarters ago);
- Latest reported return on equity.
To qualify, companies must not be a member of the S&P/TSX composite index and must have traded at least 600,000 shares over the past month.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back-test this strategy from September, 2007, to September, 2017. During this process, a maximum of 10 stocks were purchased with a maximum of three per economic sector to ensure reasonable diversification. Once a quarter, stocks would be sold if their rank fell below the top 40 per cent of the universe or if a stock's dividend-payout ratio exceeded 100 per cent. When sold, the positions were replaced with the highest ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 13.8 per cent while the BMO Nesbitt Burns small-cap total return index produced 1.9 per cent. The stocks that meet our requirements for purchase are listed in the accompanying table.
As always, it is recommended that investors conduct their own independent research before purchasing any of the investments listed here. In particular, investors are cautioned on the liquidity concerns when investing in small-cap companies.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.