Recently, dividend-paying corporations were considered old-economy firms whose managers lacked the vigour to use the money for acquisition or reinvestment.
During the technology bubble, interest in dividend yield waned. Investors were often less interested in a quarterly income flow than double-digit capital gains. But the bear market has changed perspectives.
Dividends have become a successful investment theme. The demand for income generating investments appears to be driven by several forces, none of which is expected to go away soon.
Factors such as demographics, low yields offered from government bonds and new tax legislation in the United States, which proposes to end taxation of dividends, will likely keep yield as an important investment theme.
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The aging population requires stable income for retirement. Investors with a conservative strategy emphasizing yield tend to be more concerned with preserving wealth than capital gains. Unfortunately, the increased demand for income investments comes when income is relatively scarce.
Bond yields are at multi-year lows, as are the number of companies paying dividends.
This is reflected in the low yields of the major stock indices, which only recently are showing signs of improvement.
In the mid-1980s, roughly 90 percent of senior U.S. companies paid a dividend. Today, only 60 percent have a dividend policy.
Encouragingly, this trend appears to have reversed after bottoming a few years ago.
One reason for the ebb and flow of dividend payments has been U.S. tax law.
After eliminating the tax exemption for dividend income in 1986, the U.S. has recently passed new legislation that will substantially lower the tax rate on dividend income.
It is now conceivable that the change in tax legislation will help raise the demand for dividends.
This will likely influence the shift to higher payouts in Canada as well.
Every newspaper stock listing features the dividend and percentage yield.
Finding companies that have a sustainable dividend is a little more tricky.
For instance, some companies pay more in dividends than they earn, burdening their balance sheet with debt.
A good indicator of dividend payout capability and growth in dividend payout is the amount of free cash flow that a company can generate. That is shown by the cash flow generated from operations, minus dividends paid and capital expenditure.
These funds are free from any obligation and so can be used to fund the dividend policy.
In Canada three sectors typically have the sharpest focus on maintaining distributions.
The financial sector yields 2.8 percent, the telecommunications services sector 3.6 percent and utilities 4.2 percent.
Telecommunication services and utilities are also among the highest free cash flow generating sectors.
The energy sector has provided strong free cash flow during the past year, but this may ease with the decline in commodity prices.
The financials, specifically the banks, combine an attractive dividend yield with one of the longest and strongest tracks records for steadily increasing dividends.
Some examples of companies in the utility sector that generate the strongest free cash yield are Emera Inc. and Terasen Inc.
Emera Inc. owns Nova Scotia Power Inc., along with several smaller pipeline and power-generation investments.
With an indicated dividend of 86 cents per share, Emera Inc. provides for a dividend yield of 4.93 percent based on a closing price of $17.45 on June 30.
Terasen Inc., known formerly as B.C. Gas Inc., provides domestic gas distribution to about 850,000 customers in Western Canada.
It should benefit from rising Canadian oil sands production, which require additional pipeline capacity to U.S. markets. Terasen owns one-third of the 2,700 kilometre Express system, running from Edmonton into the U.S.
With an indicated dividend of $1.56 per share, Terasen Inc. provides for a dividend yield of 3.58 percent based on a closing price of $43.55 on June 30. Further, Terasen Inc. recently hiked its dividend by 8.3 percent, the seventh year of consecutive increases.
These companies provide arguably the best opportunities for the redeployment of cash into either acquisitions, new capital projects or higher dividends.
Ian Morrison is an investment adviser with Wood Gundy Private Client Investments in Calgary and is licensed to sell insurance products. His views do not necessarily reflect those of CIBC World Markets Inc. or The Western Producer. Morrison can be reached at 800-332-1407 or by e-mail at ian.morrison@cibc.ca.