Give a top dividend growth stock five years of your life and you'll get something in return that no bond or GIC can ever provide.
A steadily rising yield simply isn't available from bonds or guaranteed investment certificates, although there are some GICs sold with a come-on about rates that step up every year. Ignore these because they're all about packaging designed to make you forget you're getting a blended, overall rate that is nothing special.
The rising dividend yield strategy is the real thing, though. Every time a dividend-paying company cranks up its quarterly payout, a ka-ching sound is heard by all existing shareholders because the flow of income they receive is rising.
Let's illustrate with the example of a company that you might want to consider as a way of playing an economic rebound. Toromont Industries Ltd. is a major dealer for Caterpillar construction equipment, and it produces industrial equipment such as compression systems for natural gas transmission and refrigeration systems.
While not widely known as a dividend growth stock, Toromont has been steadily increasing its payout for 20 straight years. The most recent increase, which amounted to 7 per cent, came during the dark days of February, 2009.
You may recall that the risk of dividend cuts was top of mind for investors back then, not the potential for dividend increases.
Toromont shareholders now receive 15 cents per quarter, up from 6.5 cents five years ago. Here's how the rising yield strategy has worked for the company's shareholders:
September, 2004: Toromont shares trade around $19, which means that the 6.5-cent dividend provides a yield of 1.4 per cent.
September, 2005: The dividend jumps to 8 cents, which means the yield on those shares purchased at $19 rises to 1.7 per cent.
September, 2006: Ka-ching - the dividend rises to 10 cents, and the yield on the amount invested two years ago rises to 2.1 per cent.
September, 2007: The dividend rises to 12 cents, the yield to 2.5 per cent.
September, 2008: The new 14-cent dividend yields 2.9 per cent.
September, 2009: The 15-cent dividend yields 3.2 per cent.
So what do Toromont shareholders have after five years? First off, they have a dividend yield that beats the return from almost all five-year GICs in the marketplace today and blows away the returns retail investors can get from five-year government bonds.
Toromont's dividend yield looks all the better against bonds and GICs when viewed on an after-tax basis. Remember, dividends are taxed much more favourably than interest income.
A more subtle benefit of the rising yield strategy is that it often brings you share-price gains as well as a rising flow of income. The reason is simple: Investors are naturally drawn to companies that are financially strong enough to raise their dividend every year for several years in a row. Toromont dipped as low as $19 last October, but in late August it traded around $23. That means it has delivered a five-year, 3.9-per-cent compound average annual share-price gain (from $19 in September, 2004) over a period that included a wicked global recession.
The big risk with the rising yield strategy is that a once-stalwart dividend grower either stops bumping up its quarterly payout, or cuts it. The big banks have lately stalled out as dividend growers, while the insurance giant Manulife Financial went further and halved its dividend in August.
Bank dividends can reasonably be expected to rise when profits do likewise, and even Manulife will likely start increasing its dividend again at some future date.
In the meantime, there are lots of companies like Toromont that have maintained their dividend growth through the recent financial turmoil and thereby reminded investors of the benefits of the rising yield strategy (start your search for these stocks with names like Enbridge, Fortis, TransCanada Corp., Canadian National Railway, Shaw Communications and SNC-Lavalin).
This article first appeared in Trade By Numbers: The Strategy Issue. To read the rest of this month's edition go to
© The Globe and Mail
Only GlobeinvestorGOLD combines the strength of powerful investing tools with the insight of The Globe and Mail.
Discover a wealth of investment information and and exclusive features.
