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Going into the first week of November, investors are being offered rarely seen dividend yields on many blue-chip companies as the ongoing bear market rolls on. At their lows in early October, the major indexes were down between 10% and 30% year to date. But investors were sufficiently worried about high inflation leading to rapidly rising interest rates and bond yields to ignore what have proven to be very attractive levels to buy dividend-paying stocks.
While inflation remains at 40-year highs, with Canadian headline inflation at 6.9% in September and US inflation at 8.2%, investors understandably are concerned that central banks will continue to raise interest rates until inflation at least stops rising. The US Federal Reserve Chairman Jerome Powell and numerous governors of the Fed have made it plain that short-term rates will continue rising until the end of 2022, reaching the 4.25%-4.5% level. Bank of Canada Governor Tiff Macklem has stated that the conquest of inflation remains a priority, implying rates will rise to at least 4% from their present 3.25%.
Yet investors are offered yields above 5% on many large, well-capitalized companies, which is still above that available on 10-year government bonds (3.5% in Canada, 4.1% in the US), especially with the dividend tax credit for Canadian companies. While buying short-term government bonds will also guarantee a yield over 4% along with the return of your capital in two years, it gives no chance of an increase in the payout or capital gains if sentiment towards equities improves from its present decade-low levels.
Just as an example, may Canadian large capitalization companies yield over 6%, such as pipelines (Enbridge, Gibson Energy, TC Energy, and Pembina), financials (Great-West Life, Scotiabank, Fiera Capital, AGF Management, IGM, Power Corporation, and Manulife), and telecom BCE A number of REITs also deliver higher yields (e.g., Slate Grocery, Plaza Retail, SmartCentres, Artis, Allied Properties, Automotive Properties, Crombie, Primaris). Some large capitalization U.S. and European telecoms (e.g., Vodafone, Verizon, AT&T and Orange) yield more than 7%!
Amongst those companies yielding more than 4.8%, we find such well-known names as CIBC, Canadian Western Bank, CI Financial and Sun Life in the financial sector, Capital Power, Emera, and Canadian Utilities in utilities, Telus and Quebecor in telecoms, and Barrick and Newmont in materials. REITs such as Choice, CT Reit, H&R, and Riocan also yield more than 4.8%. Incidentally, RBC, TD, and National Bank, the highest rated banks, all now yield more than 4.1%, a level at which investors have always made capital gains over a two-year period.
As long as these dividends are sustainable, then it seems hard to believe share prices will remain at these levels despite the growing risk of recession in the next 12 months. Utilities, pipelines, and telecoms are very stable, regulated businesses, with multi-decade records of maintaining or increasing their payouts.
After the Great Financial Crisis of 2008-09, financials are all much better capitalized and have been much more conservative in their lending practices. Insurers and asset managers benefit from rising interest rates and will benefit from equity and bond markets stabilizing or starting a rally. REITs have come through the worst markets any of these sectors. Without wanting to be too dogmatic, it’s hard to see any dividend reductions among these companies.
And we haven’t even mentioned energy stocks, partially because their prices are up substantially this year. The S&P 500 Energy sector is up 52%, and the S&P/TSX Energy Index up 46%, massively outperforming the broader indexes. This has the effect of reducing their dividend yields, although many energy companies are paying out special dividends to reflect their enormous cash flows. Suncor and CNQ yield more than 4%, and US integrated majors ExxonMobil and Chevron yield more than 3.5%.
If investors were to buy an equal-weighted portfolio of Canadian sector ETFs, with, say, 25% each in utilities, financials, REITs, and energy, the yields on the various sectors range from 3.05% on energy to 4.15% on REITs, which would effectively give a blended yield of around 3.5%.
This is comparable to the yield on the benchmark 10-year Government of Canada bond, with the added benefit of the dividend tax credit, making the post-tax yield more attractive. It would also have essentially been flat over the last year against a 10% decline in the S&P/TSX60 Index. Investors are being offered a once-in-a-decade opportunity to lock in extremely high and attractive absolute dividend yields in sectors that are already outperforming the broader index over the last year’s bear market.
Investors looking for a suitable candidate for the coming turnaround might consider Definity Financial Corporation (TSX: DFY). That’s the new name for the Economical Mutual Fire Insurance Company of Canada, which issued its first policy in November 1871 and is the sixth largest property and casualty insurance company in Canada, with 3,100 employees in 12 regional offices. Distribution is through a network of over 600 independent brokerage firms, in which channel it is the fourth largest insurance carrier. It demutualized in November 2021 and has a market capitalization of $4.5 billion.
In the year ended Dec. 31, 2021, Definity’s revenues (gross written premiums) were $3.23 billion, a 10% compound annual growth rate (CAGR) from $2.46 billion in 2018, while its combined ratio fell to 93.1% in 2021 from 111.8% in 2018. Net income went from a $73 million loss to a $213 million profit, and operating net income rose to a $220 million profit from a $101 million loss.
Definity pays a quarterly dividend of $0.125, which is considered a qualified dividend eligible for the dividend tax credit, giving it a yield of 1.3%. Before investing, consult with your advisor to ensure the stock aligns with your risk tolerance, asset allocation, and longer-term objectives.
Gavin Graham is Chief Strategy Officer of Calgary-based SmartBe Investments. He is a veteran financial analyst, money manager, and a specialist in international investing, with over 35 years’ experience in global investment management.
Notes and Disclaimer
Content © 2022 by Gavin Graham.
The commentaries contained herein are provided as a general source of information, and should not be considered as investment advice or an offer or solicitations to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication, however, accuracy cannot be guaranteed. Investors are expected to obtain professional investment advice.
The views expressed in this post are those of the author. Equity investments are subject to risk, including risk of loss. No guarantee of performance is made or implied. The foregoing is for general information purposes only. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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