As interest rates move higher to combat inflation, investors are weighing what it means for dividend stocks.
“As interest rates rise, investors will have another alternative when they search for income in their portfolios,” said Colum McKinley, senior portfolio manager with CIBC Asset Management.
“They’re going to see higher rates on their traditional fixed income securities, like bonds.”
However, McKinley said high-quality dividend stocks will remain attractive in the changing environment.
“They’re going to provide the income that they need in the form of dividends, plus they’re going to provide long-term capital appreciation,” he said.
McKinley looks for strong companies with solid fundamentals and a track record of strong profitability.
“These are the types of businesses that by their very nature generate excess capital,” McKinley said. ” And when they do that, they can pay dividends today and they can grow those dividends.”
At the moment, he likes the big Canadian banks.
“The banking industry in Canada is one of the best in the world,” said McKinley.
Banks have significant excess capital on their balance sheets, which he said allows them to do two things: weather any uncertainty in the near term, and return capital to shareholders in the form of dividends or share buybacks in the future.
Dividend yields for banks are currently in the 3% to 3.5% range, on average, and McKinley said that’s likely to grow. So for investors looking for dividend income that will compound over time, the banks continue to be a great place, he said.
McKinley also sees potential in the energy sector, which is currently benefiting from high commodity prices.
In recent years, energy companies have shifted away from reinvesting capital into the ground, returning it to shareholders instead. Oil prices at record levels will create a windfall for Canadian energy companies, McKinley said.
“In our discussions with the leaders of those businesses, they see returning that excess capital to shareholders in the form of dividends or share buybacks as the most likely lever that they’re going to lean on,” he said.
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