Why dividends are heading higher, unlike stocks

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If the economy is heading for a double dip, someone ought to tell Tim Hortons Inc., Telus Corp. and Canadian National Railway Co.

Even as stock markets suffer gyrations reminiscent of the 2008 financial meltdown, these and other companies have been rewarding shareholders with hefty dividend increases, providing a silver lining to the gloom that has descended on the economy.

Others, such as Teck Resources Ltd. and Domtar Corp., have reinstated dividends that they previously suspended. A few, including Starbucks Corp., have started paying dividends for the first time.

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At a time when governments and consumers are grappling with economic uncertainty and onerous debt levels, the flurry of recent dividend hikes underlines the strength of corporate balance sheets and the confidence companies have that the recovery will continue, analysts say.

"They're seeing revenue increases, they're seeing profit growth and they're confident enough to pay more of the cash flow back to shareholders," said Tony Demarin, president and chief investment officer of BCV Asset Management in Winnipeg.

A dividend increase "is the biggest signal one can receive" that the board of directors is optimistic about the future, he said. "It's them standing on the mountaintop saying, 'All is good.' "

Dividend hikes are coming in a range of sectors, including utilities, pipelines, telecoms and consumer goods. At High Liner Foods of Lunenburg, N.S., the board approved a 13.3-per-cent dividend hike last month - its third increase in less than a year.

"We're off to a good start in 2010 and our outlook for the rest of the year remains positive, despite the continued uncertainty in the economy," said president and chief executive officer Henry Demone, citing the beneficial effects of the strong Canadian dollar and lower raw materials costs.

Companies don't take dividend increases lightly. In most cases, investors interpret a dividend hike as a commitment to pay the higher dividend not just in the current quarter, but in subsequent quarters as well. Companies wouldn't be raising dividends unless they felt confident in their ability to maintain them.

"The last thing a company wants to do is raise it and have to cut it back," said George Vasic, strategist at UBS Securities Canada Inc. "It doesn't tend to sit well with investors. You're better off to not raise it than to raise it and then cut it back to the original level, because investors will flee to other stocks if you do that."

In contrast to the stretched finances of consumers and governments, corporate fundamentals have rarely been stronger, Mr. Vasic said. Many companies slashed costs during the recession and are emerging with low debt-to-equity ratios, ample cash reserves and growing profits to support higher dividend payments.

Mr. Vasic expects S&P/TSX composite index companies to collectively earn $800 a share in 2010, up 26 per cent from $635 in 2009.

When putting together a portfolio of dividend growth stocks, he says it's important to diversify across industries. "Utilities may have better yields but lower growth, and you want to mix that up with companies like CN Rail, which has a lower yield but a stronger dividend growth record."

CN Rail has raised its dividend every year since going public in 1995, including a 6.9-per-cent increase in January.

"When you look at corporate balance sheets, they're very, very strong," said Ric Palombi, portfolio manager with McLean & Partners Wealth Management in Calgary.

"Companies that are raising their dividends are saying they're confident that they can maintain or even increase their free cash flow. They see stability or growth in their business and that's a shot in the arm for different parts of the economy."

The dividend growth club

A dividend increase signals confidence about the future. Here's a sample of recent dividend hikes.