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Successful stock investors look at more than dividend yield

by Wayne Cheveldayoff, 2004-08-05

For investors who want to grow their portfolios over time, choosing a dividend-paying stock involves a lot more than simply looking at the dividend yield.

It would be wise to also check out the company’s ability to sustain the dividend payout, its record in raising the dividend over the years, its potential to raise the dividend again in the future, and its overall rating in returning cash to investors including through share buybacks (which a brokerage analyst recently termed “true yield”).

Take the example of TransAlta Corporation, an Alberta-based utility whose common shares a year ago were trading at around $19 and offered a healthy 5.2 per cent dividend yield based on the company’s annual $1-per-share dividend.

Many investors may have been attracted at that time to TransAlta’s relatively high yield but the total return over the past year has been abysmal. The shares were recently trading at around $15.60, a decline of close to 18 per cent.

The reason for the share-price deterioration is that many institutional investors have been selling because they fear that the 25-cents-a-share dividend that the company continues to pay out each quarter is not safe. In other words, the company is not earning enough at present to sustain the dividend over the long term and any hope that the dividend payout will continue indefinitely rests on the company showing improved results in the coming quarters.

While TransAlta’s present dividend yield, at 6.4 per cent, is even more attractive, any investors buying or holding the shares at this time are making an implicit bet that TransAlta’s management can pull off a recovery and not be forced to reduce the dividend.

Aside from a close look at the company’s books, another way to gauge the prospects of a dividend increase in the future is to check a company’s dividend history – a strong indicator of what management has been able to deliver in the past and how friendly towards dividends the board of directors has been

Top performers in this regard include banks, insurance companies and some industrial companies.

Over the past three years, Manulife has grown its common-share dividend by 24.9 per cent, although its present dividend yield is 1.6 per cent, according to UBS Securities Canada Inc. Sun Life, with a 2.3-per-cent dividend yield, has increased its dividend by 12.3 per cent.

The same statistics for other strong performers are: Royal Bank (3.5-per-cent yield) +14.7-per-cent three-year increase in the dividend; Loblaw (1.3-per-cent yield) +14.5 per cent; and auto-parts maker Decoma International (3-per-cent yield) +11.1 per cent.

TransAlta recorded no dividend increase in the past three years and other utilities and telecom companies with relatively high dividend yields were generally poor performers in this regard. BCE, with a 4.3-per-cent dividend yield, also had no change in dividend.

George Vasic, equity strategist and chief economist at UBS Canada Inc., believes investors should take their pre-investment analysis a step further and also review whether a company is increasing (through share issuance) or decreasing (through buybacks) the number of common shares outstanding.

“Given that companies can return capital to shareholders in two ways – that is by offering a dividend and/or repurchasing shares – the conventional dividend-yield measure really only tells half the story. Accordingly, it can generate misleading perceptions about a company’s payout strategy.”

In order to capture both, Mr. Vasic makes use of a measure called “true yield,” which adjusts the dividend yield by the three-year compound average growth rate of shares outstanding.

Taking share issuance or buybacks into account makes sense. For example, it allows investors to gauge whether a company has been able to deliver strong dividend growth despite net share issuance, or perhaps with buybacks lowering the number of shares outstanding whether a company would be in a better position to increase the dividend in the future.

Mr. Vasic said in a research report dated July 19, 2004 that applying the true yield metric reveals that “the financials come out better due to net reductions in shares outstanding while utilities and telcos, on the other hand, tended to suffer from varying degrees of net dilution (net increase in number of shares outstanding).”

At the top of the financials, National Bank, with a conventional dividend yield of 3.5 per cent, had a true yield of 6.2 per cent. CIBC, Royal and Bank of Montreal similarly had true yields in excess of their standard dividend yields in the 3-per-cent range.

TransAlta’s true yield of 2.1 per cent was below its 6.3-per-cent conventional dividend yield recorded on the same date. Other utilities showed similar patterns of having true yields below conventional yields.

Mr. Vasic’s analysis also revealed some unexpected star performers based on the true yield metric. Quebecor Group, for example, had the highest true yield (5.1 per cent) of the group. The company augments its moderate dividend yield (2.5 per cent) with an equal dose of share shrinkage and solid dividend growth (4.2 per cent over past three years).

One thing not mentioned in Mr. Vasic’s report, and which probably is on the minds of knowledgeable investors reading this column, is that income trusts in many cases may be a much better choice than dividend-paying stocks. There are numerous business income trusts with cash yields in the range of 9 to 11 per cent and with solid growth prospects that could mean higher cash payouts in the future.

For all investors, it pays to look around Canada’s investment scene and analyze the alternatives (or, if they feel they can’t do it themselves, to enlist the help of an investment advisor who can trade and is knowledgeable in stocks).

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2004 Wayne Cheveldayoff