This High-Yield Asset Class is on Sale
Best Canadian Dividend Stocks to Buy Now
Today I’m introducing a new series, which I will revisit in my Cabot Wealth Advisories for the next few months, highlighting the Best Canadian Dividend Stocks to Buy Now. The idea came mostly from subscribers who asked for Canadian stock ideas, but is also in recognition of the fact that some of the best dividend stocks for any investor are Canadian.
But first, I want to mention an important but largely overlooked piece of news out of the high-yield income investing space. (If you’re not interested in high yield investing news, you can safely skip to the Canadian stock pick at the end now.)
In late February, S&P sent shockwaves through a small sector of the income-investing world when it decided to remove Business Development Companies (BDCs) from its indexes. BDCs are special types of investment companies that primarily make loans to and invest in small and mid-size companies. Income investors like BDCs because they pay fat yields, plus they trade on major exchanges like any other stock, so they’re easy to buy and sell.
After the S&P decision, Russell followed suit, announcing that it would remove BDCs from all its indexes, including the Russell 2000, the most widely-followed small cap index.
The reasoning has to do with the way that BDCs report certain fees. These fees aren’t charged directly to investors, but the way they are reported can make it look like funds that hold BDCs have higher fees than they actually do. S&P and Russell didn’t want this happening in the ETFs based on their major indexes, so they decided to eliminate the problem by removing BDCs from the indexes altogether.
Shortly after the announcements, Barron’s reported: “Since an estimated 8% of all BDC shares are held by funds benchmarked to the indexes, such as iShares Russell 2000 ETF (IWM), ‘it will take weeks’ worth of trading volume for index funds to sell those positions,’ says Bryce Rowe, an analyst at Robert W. Baird.”
Since S&P and Russell made their announcements, BDCs as a group have declined an average of about 8%, and the Market Vectors BDC Income ETF (BIZD), which tracks U.S.-listed BDCs, is down about 7%.
Bottom line, BDCs are on sale.
However, I suggest waiting to buy until the group’s downtrend ends, whether that’s caused by the SEC changing its fee reporting rules (Russell urged it to do so by May 15) or simply by an abatement in selling pressure and an upturn in the market.
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Today I’ll introduce the first stock in my new series highlighting the best Canadian dividend stocks to buy now. This series is partly a response to subscriber demand for Canadian stock ideas, and partly a recognition of the fact that Canadian waters are an excellent place to fish for great dividend yields. So over the next few months, I’ll profile some of the best buy and hold Canadian stocks for dividend-focused investors.
I found the stocks by running screens for Canadian stocks with good yields, good earnings trends and good IRIS ratings. (IRIS stands for Individualized Retirement Income System and is the ratings engine that powers Cabot Dividend Investor, our new income-oriented advisory.
My first pick is Toronto Dominion Bank (TD), which is listed on both the TSX and the NYSE and currently yields about 3.6%.
Toronto Dominion is the largest Canadian bank in terms of assets, thanks in part to a successful expansion into the U.S. over the past decade. But while the bank has become more American in its operations, it has maintained the enviable financial discipline of a Canadian bank. Most of TD’s revenues come from traditional operations like retail banking (which accounted for 89% of adjusted net income in the latest quarter), not higher risk investment banking-type activities. TD was one of the few financials (along with some other Canadian banks) that were not forced to cut their dividends during the 2008 financial crisis.
Here’s a five-year chart of the stock showing the price (blue) and rising quarterly dividends (orange):
As you can see, TD pays a slightly variable dividend from quarter to quarter, declared in Canadian dollars. Over the past five years, the annual dividend amount has grown at a compound annual rate (CAGR) of 6.54% per year. Growth has accelerated in recent years, with an 11% increase from 2011 to 2012 and a 12% increase in 2013. And since inception (1993), Toronto Dominion has increased the dividend at an annualized rate of 11% per year.
The current payout ratio is 42%, and the company targets a payout ratio of 40% to 50%. This is generous to investors, but not overly aggressive.
TD’s cash flow supports the dividend growth. Over the past five years, TD’s adjusted EPS have grown at a CAGR of approximately 9% per year. Going forward, the company is targeting adjusted EPS growth of 7% to 10% for the “medium-term.”
Free Cash Flow (FCF) growth is also positive. Over the past two years, FCF per share has nearly doubled from $16.06 to $30.67. (I consider FCF when analyzing dividend-paying stocks because dividends are paid out of cash.)
If you don’t need current income, TD Bank also offers a direct investing option (you must own your shares in your own name) that allows shareholders to reinvest their dividends in TD shares, sometimes at a discount (the discount is at the discretion of management).
For risk-averse investors who want dividend income now or down the road, Toronto-Dominion Bank (TD) is one of my favorite Canadian stocks to buy now.
Chloe Lutts Jensen
Chief Analysts, Cabot Dividend Investor