The recent sharp correction in some large Canadian sectors has shone a spotlight on the concept of dividend sustainability and how it is far more important than simply the dividend yield.
There are a number of stocks in Canada which were seen as "stable dividend payers" often based on the ability to satisfy two criteria:
- They are large companies
- They pay a dividend
The issue here is that this ignores many other factors which are far more important, but often overlooked. That is, until a driver of business changes and brings into question the sustainability of the dividend.
Many businesses in Canada, particularly within the energy space, are very poor candidates for those seeking stable and growing income streams over time. They are by definition cyclical, price takers, capital intensive, and often carry meaningful financial leverage which further amplifies the cyclicality. While we do own a number of energy names, we are very careful to match the correct business model with the risk profile of a fund. An energy producer with high financial leverage and the need to invest heavily to maintain production levels is not an attractive candidate for investors seeking consistent dividend income (we believe royalty models differ in a number of key respects). This is especially true when valuations were high due to them being valued like stable “bond like” instruments.
Another area to be mindful of is the payout ratio. Because companies have been rewarded for raising dividends, many have continued to do so simply by raising payout ratios. This is an unsustainable source of dividend growth and in a number of cases has left companies highly vulnerable to major or even minor changes in their businesses. It is important to remember that just because a business has a track record of raising dividends, it does not make it a high quality dividend investment. A prime example is AGF, which until recently was in the top position on the S&P/TSX Canadian Dividend Aristocrat Index. AGF just announced the need to cut its (unsustainable) dividend 70%, resulting in an initial 15% fall in the share price and bringing the year-to-date decline to 32% (including the dividend of course).
We make mistakes, as all investors certainly do, however we always try our best to learn from these mistakes. One misstep we see being made over and over again by the investing public is the willingness to ignore the underlying fundamentals of companies and instead choose investments based on yields alone. This applies to debt as well as equities.
Below is a direct comparison of the top holdings in our Cambridge Canadian Dividend Fund to the iShares S&P/TSX Canadian Dividend Aristocrats Index ETF. We believe there is value in true active management and that working to understand the fundamental drivers of companies helps in protecting capital and improving the quality of returns over time.
|iShares S&P/TSX Canadian Dividend Aristocrats Index ETF||Cambridge Canadian Dividend Fund|
|Exchange Income Corp.||4.4%||US Bancorp||5.2%|
|AGF Management||3.9%||Thomson Reuters||4.5%|
|Emera Inc.||2.7%||PrarieSky Royalty||4.4%|
|Northern Property REIT||2.5%||Loblaw Companies||4.3%|
|SHAW Communications||2.5%||Viacom Inc.||4.2%|
|Laurentian Bank||2.4%||Granite REIT||4.1%|