Revisiting the ‘Dividend Deluxe’ Strategy

Even with interest rates at rock bottom, the dividend growth stocks in this ongoing portfolio have continued to provide an escalating flow of income, writes Rob Carrick, reporter and columnist for The Globe and Mail.

The buy-and-hold approach to investing never looks better than it does with companies that keep increasing their dividends.

Take Enbridge (ENB), which is a dividend star because its quarterly cash payout has been raised annually since 1996. If you bought Enbridge shares ten years ago, the dividend yield on your original investment would be 10.4%.

I called this mode of investing the Dividend Deluxe strategy in a column back in 2007. The idea is to take advantage of long-term dividend growth to generate a steadily rising flow of income from a stock.

Now, it’s time to update the Dividend Deluxe strategy to reflect the impact of the global financial crisis and the ensuing ups and downs for the economy and the stock market.

This recent experience shows that dividend growth stocks have continued to provide an escalating flow of income over a period of years, which is huge at a time when interest rates are low and not expected to rise dramatically any time soon. Also, dividend growth stocks, when held for a decade, have tended to do at least okay in terms of share price growth.

But there’s a big stipulation required here: While there are some smooth and steady dividend growers such as Enbridge on our list, there are also a few stocks that have cut or suspended dividends, temporarily halted dividend growth, or plunged in price.

Thanks to some screening by Craig McGee of CPMS, a division of Morningstar Canada that provides North American equity research and portfolio analysis, we have a list of the best dividend growers among the large, well-established companies with a market capitalization above $5-billion (market cap is share price multiplied by the number of shares outstanding). Dividend growth is measured as on the basis of compound annual growth rate (CAGR).

In addition to Enbridge, the companies that have increased their dividends enough over the past ten years to produce a double-digit yield are Teck Resources (Toronto: TCK.B), Potash Corp. of Saskatchewan (POT), and National Bank of Canada (Toronto: NA).

Shares of CI Financial (Toronto: CIX), Bank of Nova Scotia (BNS), Royal Bank of Canada (RY), and SNC-Lavalin Group (Toronto: SNC) bought ten years ago now yield in the range of 8%.

Buy, hold, and collect an increasing amount of cash each quarter from top dividend growth stocks. Just be sure to mind the lessons of the past little while, and prepare yourself for nasty surprises here and there.

Exhibit A is SNC-Lavalin, which ranks fifth on our dividend growth list and made the Dividend Deluxe list back in 2007 as well. SNC shares fell around 20% in a day this week, after the firm announced an expected loss of $23 million on its activities in Libya, and also an investigation into $35 million in undocumented payments.

As much as it’s an example of how even dividend growth stars can be slammed, SNC also shows the long-term benefits of owning this type of stock. Even after falling this week, the shares are still up by about 15% annually since 2002. The dividend yield on shares bought back then is 8.7%.

The past several years have shown us that resource stocks can be rewarding, and highly unreliable, as dividend growers.

Teck Resources is a good example. Its semi-annual dividend soared from 5 cents to 50 cents a share, on a split-adjusted basis, as commodity prices soared last decade. Then the payout was suspended as the financial crisis hit. The dividend was reinstated at 20 cents in 2010, and has now surged back to 40 cents.

Cumulatively, Teck is a dividend growth standout. But if commodities tank as they did in 2008 and 2009, so might this company’s dividend.

A less extreme example of how the market upheaval of the past few years affected dividend growers is Royal Bank of Canada. It used to be good for a dividend increase or two a year, but then took a hiatus on dividend hikes that lasted from 2008 through mid-2011.

RBC shareholders who stuck around over the past decade now have a yield of 8.3% on their initial investment, which looks great in a world where a 3% return on a five-year guaranteed investment certificate is a big win. (Note: This excludes the dividend increase RBC announced this week).

But back in 2007, RBC had a ten-year record of increasing its dividend at almost 18% annually. The lesson here is that dividend growth stocks sometimes stop growing, at least for a while.

The data from CPMS shows that the dividend growth champion in the Canadian market is Shaw Communications (SJR), which has cranked up its monthly dividend (yes, it’s a rare company that pays monthly) by a compound annual growth rate of 44%. Shaw paid a split-adjusted, semi-annual dividend of 1.25 cents back in 2002, and now it’s up to 8.1 cents a month.

Adjusted for splits, Shaw’s share price ten years ago was $16.89. CPMS’s numbers tell us that if we apply today’s annualized dividend of 97 cents to that cost, we end up with a yield of 5.7%.

Steady dividend growth supports long-term share price growth to the extent that all of the dividend growth stocks on our list have risen in price by at least 2.8% a year for the past ten years, and by as much as 24%.

Shaw’s on the low side of that range. The stock has an average annual growth rate of about 3% over the past decade, and over the past five years, it’s been pretty much flat.

And then there’s Enbridge, which has doubled in price in the past three years, and Canadian National Railway (Toronto: CNR) which has also done very well.

Split-adjusted, CNR shares traded in the mid-$25 range a decade ago. Since then, the shares have appreciated about 11% annually to $77, and the dividend has risen by 19% a year on average. Current yield on shares bought ten years ago: 5.9%.

By putting dividend growth stocks to work decades ahead of retirement, you stand a very good chance of building a portfolio that produces a dividend yield well into double digits. Again, let Enbridge serve as an example.

Way back in late February 1992, Enbridge shares traded at a split-adjusted $3.48. Based on that price and today’s dividend, your yield would be 32.5%. Hence the name Dividend Deluxe.