John Heinzl is the dividend investor for Globe Investor's Strategy Lab. This is his first column. Follow his contributions here. You can see his model portfolio here.
There are a lot of reasons that I like dividend investing. It's easy to understand; studies have shown that it produces superior returns; it's fun to invest in companies whose products and services I use.
Heck, if I'm going to buy a Big Mac and fries at McDonald's, heat my home with natural gas from Enbridge or pay for phone and Internet service from BCE, I might as well get something in return.
Which leads me to the number one reason I became a dividend investor: I like it when people hand me money. All of the above companies – and many others – deposit cash into my brokerage account every three months, and I don't have to lift a finger.
Getting paid to do jack squat – that's my kind of job.
It gets better. Virtually all of the companies that I own raise their dividends every year, so the amount of cash I receive is always growing. In many cases, these companies have been raising their dividends for so long, and at such regular intervals, that I can predict – sometimes to the day – when the next increase is coming.
For example, I'll bet you a box of Chicken McNuggets that McDonald's will raise its dividend later this month. After all, it has hiked its dividend for 35 consecutive years. Likewise, Enbridge will probably announce a dividend increase in December. BCE is a bit trickier; lately it's been hiking its dividend, not once, but twice a year.
Can you predict when a company's stock price will rise? I can't. Yet many investors focus on price movements, thinking that the trick to building wealth is to flip stocks for a profit. I disagree. I believe that, if you focus on solid companies that reward you with rising dividends – supported by growing profits – the stock price will eventually follow.
Indeed, studies have shown that dividend-paying stocks outperform non-dividend-payers, and dividend growers perform best of all. For example, RBC Dominion Securities looked at the period from 1986 to 2011 and found that dividend growth companies produced an average total return of 12.7 per cent annually, compared with 7.3 per cent for the S&P/TSX composite index and 2.4 per cent for stocks that paid no dividends.
Other studies have found that dividends account for more than half of the market's total return over long periods. In fact, the contribution from dividends may be as high as 90 per cent, according to U.S. fund manager Daniel Peris, author of The Strategic Dividend Investor: Why Slow and Steady Wins the Race.
What else do I like about dividends? Well, in a non-registered account they qualify for the dividend tax credit, so more of the cash stays in your pocket compared with fixed-income securities. A rising dividend also provides protection from inflation, which is critical for investors like me who intend to rely on dividends to finance part of their retirement.
Are dividends foolproof? Nope. Yellow Media paid a juicy dividend, and even raised it for a number of years, and we all know how that story ended. That's why, when I'm selecting stocks, I try to stay away from companies that are facing fundamental threats to their business. In Yellow Media's case, it was the rise of the Internet and online advertising that turned its print directories – long a source of fat profits – into door stoppers.
The best dividend stocks are those that have some sort of competitive advantage that will endure for decades to come. McDonald's, for example, has a powerful brand name and global scale that give it a huge edge over competitors. The same goes for the other consumer stocks I own, including Coca-Cola, Wal-Mart, Procter & Gamble and Johnson & Johnson.
For similar reasons, I'm also a big fan of the big Canadian banks. They dominate the lending, wealth management and investment banking landscapes in this country, and their ever-growing clout is reflected in dividends that have risen steadily over the years, with occasional pauses when the economy hits a rough patch.
Pipelines and utilities are another great source of rising dividends. The fact that many of their operations are essentially regulated monopolies translates into predictable earnings, so these stocks tend to be less volatile than the market. Enbridge, TransCanada, Fortis, Canadian Utilities and Emera – among others – have rewarded shareholders with growing dividends.
Finally, although I have no interest in being a landlord, I think real estate deserves a spot in every income investor's portfolio. Real estate investment trusts let you invest in shopping centres, apartments, office buildings and other properties. You get to collect "rent" cheques in the form of distributions, but you'll never get a call at 3 a.m. about a broken toilet.
That, after all, would be work.
You can see John Heinzl's model portfolio here.
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John Heinzl