The case for dividend stocks in uncertain times

Wake up, investors, and smell the dividends.

Okay, you can't smell dividends. But you can certainly touch them as they flow into your RRSP, TFSA or unregistered investment account every three months.

Of course, you have to actually own dividend-paying stocks to get dividends, and that's a problem. Unsettled by sharp stock market ups and down, investors have parked billions of dollars in safe havens like savings accounts and bond and money market funds.

There are plenty of dividend stocks paying 3 to 5 per cent, just as there are plenty of money market funds paying 0.1 per cent, and plenty of savings accounts paying no more than 1 per cent. If you're hooked on safety, you're smothering your portfolio with caution.

But you're nervous about stocks, right? It's natural, even sensible. While investors tried to find their equilibrium after the horror of 2008, the Canadian stock market surged 33 per cent. Then stocks weakened in early 2010, prompting dire warnings about how a bad January often presages a down year. Now, it's February and stocks are doing all right again.

"From last spring to the present, the level of anxiety has gone way down, but the level of uncertainty hasn't changed much," said Bob Gorman, chief portfolio strategist for TD Waterhouse.

Mr. Gorman's suggestion on how to deal with this uncertainty: Take a look at blue-chip dividend stocks like Shaw Communications, Rogers Communications, Shoppers Drug Mart and Power Corp. of Canada.

Is there a risk of losing money in these stocks? Yes, but consider Mr. Gorman's analysis. First, he said that many solid dividend-payers were also-rans in a rally last year that favoured smaller, riskier companies. This means dividend stocks aren't expensive, which in turn suggests they're less vulnerable to a sharp decline in price.

It's also worth noting that the risk of dividend reductions has eased. We did see some companies cut their dividends as a result of the global financial crisis - like Manulife Financial - but business conditions are improving along with the economy.

A second point made by Mr. Gorman is that dividend-paying stocks offer higher yields than bonds. "Historically, bond yields greatly exceed dividend yields," Mr. Gorman said. "But that's not the case right now."

The dividend payers mentioned just above have an average yield of about 3.5 per cent, which compares with 2.5 per cent for a five-year Government of Canada bond. Mr. Gorman said a 3.5-per-cent dividend yield is equivalent to getting roughly 4.5 per cent from a bond, if you factor in the benefit of the dividend tax credit in non-registered accounts.

It's natural to wonder how much juice can be left in the stock market after last year's rally. Mr. Gorman said TD Waterhouse expects high single-digit returns from the Canadian market this year. "But let's suppose that doesn't happen," he said. "With dividend stocks, you're getting paid to wait."

Cat:e528746c-3414-401a-b14b-50247e3bdf01Forum:726cb897-65e7-4529-a1da-c5192c9aa85a

Here's another reason to put your faith in dividend stocks. While the economy remains sluggish, many dividend-paying companies have actually increased the amount of cash they pay each quarter. Examples from the past couple of months include Shaw, Canadian National Railway, Cameco, AGF Management, Metro Inc., Fortis Inc., BCE, Laurentian Bank and Enbridge. Suncor Energy is reportedly considering a dividend increase for late in 2010, and there's some speculation that Rogers will boost its dividend, too.

The size of dividend increases is typically modest at about 4 to 7 per cent in many cases. But that's well above today's inflation rate, and matches up well against the higher cost of living increases we'll see in the years ahead.

Can't see yourself buying individual dividend stocks? Then consider a mutual fund or exchange-traded fund that focuses on dividend stocks. The big bank fund families do a good job on dividend funds.

Some market-watchers are cautious about 2010 and are advising investors to be conservative. But burying yourself in money market funds and savings accounts is overdoing it. You've tamped down risk to inconsequential levels, and your returns as well.

So think about ramping up your risk level and your returns at the same time. Blue-chip dividend stocks make it easy. They're familiar, they're financially strong and those quarterly cash payments give you something to hang onto while you wait for the markets to move higher over the years.

Portfolio Strategy

This Saturday, I look in greater detail at some dividend stocks that are poised to do well in 2010, as well as some stocks that soared last year and look vulnerable.

Follow me on Facebook. I'm at Rob Carrick - Personal Finance.

Going up: Who's been raising their dividends?