Why dividends offer downside protection

By Sarah Cunningham-Scharf | November 13, 2014 | Last updated on November 13, 2014
2 min read

Investors seeking yield should look to dividend-paying stocks.

That’s because they offer more downside support, says Stephen Carlin, vice-president and senior portfolio manager of Canadian equities at CIBC Asset Management. He manages the Renaissance Canadian Dividend Fund.

“Historical studies that have shown that dividend-paying stocks are less volatile in choppy markets,” he adds. “If the market believes dividends are sustainable, that’s the key to success in a yield strategy.”

Read: What factors influence returns?

To determine whether a company’s dividend price is sustainable, calculate “the payout ratio, which is the percentage of net income that’s paid out to investors as a percentage of the total profits.” Then, compare that ratio to historical data as well as industry peers. You’ll also want to keep that number in mind as the stock moves.

Read: Changes to small business dividends

He prefers lower ratios, since those can remain in place even when markets are volatile. “If a bank stock in Canada yields about 4%, that dividend yield could remain in place [even if] volatility in the marketplace causes that stock to drop 10%.”

In that case, the dividend yield would actually rise slightly, going from 4% to 4.4%. That helps soften the blow of stock prices falling.

“So,” Carlin notes, “provided [investors] are comfortable with the sustainability of a stock’s dividend payment strategy, [dividend stocks] offer an element of downside support.”

Read: Alternatives a solution to high correlations

Further, government bonds have an average yield of 2% in the current low interest rate environment, while the average dividend yield is rising in Canada.


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Sarah Cunningham-Scharf