In the current volatile market, it’s better to analyze a company’s dividend growth to gauge performance than look for high yield.
“A company with a high yield does not translate to a good company, nor a safe investment,” says Craig Jerusalim, portfolio manager of Canadian equities at CIBC Global Asset Management. He co-manages the Renaissance Diversified Income Fund. “Over the long term, the majority of total shareholder return [can] come from dividends—a figure that some peg as high as 67% to 80%.”
But he warns, “A large negative price movement can completely wipe out years of dividend payments, in the short-term. That’s why it’s imperative to focus on dividend sustainability and dividend growth opportunities, rather than outright yield.”
Energy is one sector where this type of analysis pays off, says Jerusalim. “There are at least a dozen energy companies on the TSX with yields greater than 10%, all of which have one year total returns ranging from -30% to -80%. [There’s] clearly a lack of price support from dividends.”
As such, these energy companies will likely have to further reduce their dividends because of low energy prices.
Meanwhile, companies in other sectors may have low yields but better dividend outlooks. “Despite weak share price performance, these companies [are] seeing significant growth opportunities, and have the capacity and wherewithal to increase dividends without increasing operating risk.”
There are two indicators to look at when determining whether a company’s dividends have growth potential and are sustainable, says Jerusalim.
- Whether a company has “the flexibility of a low payout ratio.” If companies forecast positive earnings growth, payout ratios typically trend lower, for example.
- Whether a company has return on capital that exceeds its cost of capital, “so that each dollar of earnings can be properly reinvested in [the] business for additional future growth.”
Currently, Jerusalim favours companies such as Brookfield Asset Management, Telus and Manulife Financial. He explains, “Manulife is trading as if [it’s] going to be hit with large write-off in their oil and gas investments, and negative earning trends in their three core operating regions: Canada, U.S. and Asia.” But in reality, Manulife’s book value is growing and its sales are positive in each region quarter-over-quarter, particularly in Asia and Canada.
As a result, “The company expects core return on equity to expand by 13% in the medium term from about 8% today. And they’ve increased their dividends by 9% this quarter.”