Chasing Yield: The Power of Dividends

Investors love dividends. It’s no secret.

All you have to do is search “dividend investing” on Google to see just how many websites, bloggers and media moguls are championing this strategy – present company included.

The truth is this: dividends count. But they aren’t everything.

Time horizon and dividends matter.
So do cycles in the stock market.

The charts above show how important dividend growth has been to total returns over time. Again, others might champion a different strategy. Rightly so – the graph below shows that dividends played a varied role in total returns by decade. In the 1990s, dividends accounted for 16% of total returns. We know the tech boom drove the market in that decade, and anyone seeking only dividends missed out on total returns. That’s not to say everyone investing in tech made it out alive – a lot of companies went bust, and investors lost money then too. However, over time, dividends do play a significant role in total returns, not to mention compounding dividend growth over time.

A balanced dividend growth approach is an optimal strategy. Compounding dividends over time (buy and hold strategies) prove effective.

You must also consider the payout ratio.

High payout ratios can lead to dividend cuts.
During a recession, companies with low payout ratios and high cash flows have a better chance of maintaining their dividend. I use FASTGraphs to view historical payout ratios and current cash flow. You really have to consider each company on a case by case basis; there is no magic payout ratio considered safe in a recession.

With that said, dividends are never guaranteed.

During the Great Recession of 08-09, companies across the S&P, TSX and global markets slashed dividends at heights not seen since the Great Depression. I am currently sitting leveraged on a mostly dividend income portfolio. You can imagine my concern. However, the majority of my overall investment holdings (60%) did not cut dividends in 08-09. They are blue chip stocks with healthy balance sheets and strong fundamentals (ENB, TD, CU, BNS, SU, for example). That’s no guarantee these companies will continue paying dividends if we enter recessionary territory again. However, that’s a risk I’m willing to take.

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