Tuesday, 31 May 2011

Stocks & Board Governance - Do the Good Guys Finish First or Last?

Many investors take a keen interest in the ethics and business practices of the companies in which they invest. Leading institutional investors think that taking into consideration so-called Environmental, Social and Governance factors and even active involvement with companies to further such goals can enhance long-term investment returns. For example, the Canada Pension Plan Investment Board's pursuit of Responsible Investing evidently takes up much time and effort because it believes that "... responsible behaviour regarding environmental, social and governance factors by these companies can have a positive influence on their long-term financial performance and therefore, to our investment return". Internationally, many major pension funds subscribe to the United Nations Principles on Responsible Investing, as is evident in the reports on the PRI website.

All investors object to being taken unfair advantage of by crooked or avaricious company insiders. To prevent that happening, shareholders rely upon a company's Board of Directors, in other words the Governance part of ESG. In Canada, the Clarkson Centre for Business Ethics and Board Effectiveness within the Rotman School of Management at the University of Toronto publishes annual ratings for Board Shareholder Confidence that assess various aspects of Board best practice and give an indication of how likely it is that a company Board will serve shareholder interests well. There are two sets of ratings: 1) Companies in the TSX Composite Index for 2003 to 2010; 2) Small and Medium companies for 2009 and 2010.

The big question is how well do the rankings correspond to investment results? Does governance best practice earn the best returns, or at least good returns? To get an idea, we've compiled a few tables below. Note that it is by no means a definitive scientific answer. A Board that is good today may not have been so five years ago; future results are really what we would need to compare, while we compare with past investment performance. Our unproven assumption is that the best Boards today would generally have been better in past years too as improvement happens gradually.

Investment Performance of Top-Rated 2010 Boards - Mixed Results
Taking all 19 companies in the top two ratings CCBE governance categories of AAA and AA shows us that excellent ratings have not guaranteed success. Four top-rated companies have not even managed a positive total return over the past five years. Manulife (symbol: MFC) has had particular trouble. On the other hand, eight companies of the companies on the list have regularly and steadily increased their dividend payouts, as further detailed below. Almost are solidly profitable and the worst rating by professional analysts is Hold, no Sells at all.

Investment Results of TSX Companies vs Board Ratings Overall - Advantage to the Good Guys
When the latest ratings came out in the autumn, the Globe and Mail's Report on Business published Board Games 2010, a series of articles on the ratings which are well worth reading. The material published includes a different version of the TSX table that includes 5-year returns for each company. Filtering through the list, we find that amongst the top 25 scoring companies, 16%, or four, had negative 5-year returns. However, in the entire list of 187 companies, a greater proportion - 26% or forty-eight companies - had negative returns. The well-governed-Board stocks have done better overall.

Dividend Growers & Board Governance - No Discernible Effect
Since we recently reviewed stocks that have been steadily increasing their dividends - here for low-yielders and here for high-yielders - we decided to look at them too. We added the CCBE rating against this select group of potentially attractive stocks to see if they all have high Board ratings. Result: not so at all, as there are just as many dividend growers with the terrible lowest "C" Board rating as with the high AA and AAA ratings. Nevertheless, all the companies with high rated Boards showed quite healthy five-year returns and none had negative returns while none of the losing negative return stocks had high ratings.

Bottom Line
Good governance seems to have had a mild positive effect so far on stock returns but it is not a guarantee of success. It is a useful addition to the mix of factors for a stock investor to assess. Perhaps its best role is to provide a measure of risk to investors on the chances that bad things may or may not come from within the company, either from management or dominating majority shareholders, at the expense of the average individual investor.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 24 May 2011

Cross-Border ETFs - Here's a Free Tool to Compare Costs

Our last post ended by suggesting that investors should compare the total costs of investing in US-listed ETFs vs Canadian-listed versions. We've taken up our own challenge and offer a spreadsheet (click here for download) to help readers assess their candidate foreign ETFs. Here is a screenshot of the spreadsheet.

What the spreadsheet does
Our approach is to start with assumptions about growth of an index that two ETFs aim to track and adjust returns taking into account the various factors explained below. The spreadsheet takes into account these factors by allowing you to enter the data for pairs of ETFs and applying costs, taxes, rates and fees that influence net returns.
  • US holdings and International holdings - Each type has its own sheet since a) each would be a separate asset class within a portfolio - thus we want to compare within an asset class - and b) the tax consequences are different.
  • RRSP (& other registered retirement accounts like RRIF, LIRA, LIF), TFSA, Taxable account choice - Tax consequences differ for each type of account.
  • Direct or Indirect ETF holdings - Instead of holding foreign stocks directly, some Canadian ETFs hold US ETFs inside, which we call Indirect ETFs. Again, there are different tax effects.
  • Capital gains and Distribution/Dividend yield - The amount and proportion of each source of return affects the net return due to the interplay of the other factors. A usual starting point for picking numbers to enter is historical data. For example, the current distribution yield for the SPDR S&P500 ETF (symbol: SPY) is 1.74%. Estimating Capital gains can be a lot more problematic - are we looking forward to years of low 2-3% growth or higher 5-6% gains? The usefulness of the spreadsheet is that we can quickly plug in different numbers to see if the best choice of ETF and account varies and by how much.
  • Tracking error - This is the amount by which the ETF performance differs from its index. Although a very few ETFs may actually outperform the index in the occasional year, the typical and expected result is under-performance over the long term, which is what interests us. A key element of Tracking error is the ETF's Management Expense Ratio (MER) and that figure should be the minimum value to enter. However, it is not the only one and especially with International ETFs or currency-hedged ETFs, not necessarily the biggest component. Other Tracking error sources include: Sampling/optimization or Replication strategy, Rebalancing and Reconstitution efficiency, Cash dividend reinvestment drag, Trading costs, HST (Canada only), Currency hedging costs, Concentration limits on holdings and Securities lending (a source of revenue for many ETFs). Larry MacDonald's Investopedia article ETF Tracking Errors: Is Your Fund Falling Short? explains this topic well. As Tracking error rises to the 1% or more range it starts to heavily influence net results, as playing with our spreadsheet will quickly show. Canadian Couch Potato's tally of Tracking Errors on US and International ETFs listed in Canada shows widely varying errors amongst funds for 2010. Keep in mind that errors can vary, sometimes a lot, year to year. Some ETFs seem to be quite stable, others not. Tracking error very often turns out to be the key factor in differentiating ETF performance.
  • International withholding tax - The actual amount paid to foreign non-USA governments varies within various ETFs - often 8 or 9%, but up to the 15% maximum of international tax treaties. In only one combination of circumstances, a Canadian listed ETF that directly holds international securities in a taxable account e.g. Claymore's International Fundamental Index (CIE), can a Canadian investor recover that tax through a tax credit.
  • US withholding tax - Though not a variable you need to estimate or change in the spreadsheet as it is always applied at the 15% rate specified in the Canada-USA tax treaty, US withholding tax can have a big influence on performance at times, especially when the ETF distribution yield gets to 2% or more and account type is brought into play.
  • DRIP brokerage commission and auto-DRIP - Many brokers now charge $10 per trade so we have set that as the amount in the input cell. If you want to see how reinvesting more often e.g. twice a year or quarterly when the ETFs make distributions, simply enter the total brokerage trading commissions you will incur per year. The same input adjustment can be made if you unfortunately are paying higher brokerage commission rates. Two ETF providers in Canada - BMO and Claymore - will automatically reinvest distributions for free, so our spreadsheet will adjust for that savings too. Some discount brokers even offer a so-called synthetic DRIP for ETFs (call your broker to find out if it offers that service; see also this article from CanadianFinancialDIY), absorbing the cost of distribution reinvestment.
  • Transaction fees on foreign exchange - The amount charged by discount brokers to convert Canadian into US dollars or vice versa varies from broker to broker, ranging from 0.5% up to 1.5% - see MillionDollarJourney's broker comparison. Forex can have a significant influence, mainly when Tracking errors of ETFs are close and where Withholding taxes do not differ.
  • Annual contribution - See how rich you might get! Just for the fun and as a reference point, since it does not affect which ETF is a better choice, the annual contribution you invest in the ETFs can be varied.
What the spreadsheet does NOT do
  • Compare different indices - It is assumed the ETFs compared track the same index. Different ETFs, even within the same asset class, such as US equity, can produce markedly different returns and portfolio growth. Look at the variability of fund returns in 2010 in Couch Potato's Tracking error article we cited above. If you compare ETFs with different indices, remember that you are only comparing costs, not total returns.
  • Exchange rate variability - There is no attempt to incorporate effects of changes over time in the value of the Canadian dollar against the US dollar or international currencies. Year to year and over multiple years, the evolution of currencies strongly affects foreign investment net returns. Whether to hedge or not is a fundamental choice for the investor and comes before the choice of a specific ETF.
Examples (numbers in the download spreadsheet)

US Holdings
  • US-listed = PowerShares FTSE RAFI US 1000 Portfolio (PRF)
  • Canadian-listed = Claymore US Fundamental Index (non-hedged) (CLU.C)
  • Forex fee = 1.0%, rate applied at big bank brokers
  • Distribution yield = 1.5%, current rate per PowerShares; could also try 1.99% cited on Claymore (rate as of end of March)
  • Account type = 1 RRSP
  • ETF type = 4 Direct i.e. CLU.C directly holds shares of companies, not a US ETF
  • Auto DRIP = 1 since CLU.C is a Claymore fund
  • Tracking error US ETF (PRF) = -0.48%, estimated using historical results on page 11 of the 2010 Annual Report here on the PowerShares website
  • Tracking error Canadian ETF (CLU.C) = -1.5%, estimated future error. The 2010 error was a horrible -2.3% from page 12 of the Annual Report here on Claymore's website, but in future it should be much lower as the ETF switched to full replication in September 2010, holding all 1000 stocks in the index, instead of the partial replication by 400 or so stocks it had previously carried.
  • Bottom Line = Under the above assumptions, PRF gets ever further ahead till it is up more than 20% over its competitor after 30 years due to the harmful effects of CLU.C's high tracking error.
International Holdings
  • US-listed = PowerShares FTSE RAFI Developed Markets ex-US 1000 Portfolio (PXF)
  • Canadian-listed = Claymore International Fundamental Index (CIE)
  • Forex fee = 1.0%, rate applied at big bank brokers
  • Distribution yield = 3.2%, current index rate per Claymore; could also try 2.3% cited on PowerShares though that is net of international non-USA withholding taxes already deducted
  • Account type = 2 Taxable
  • ETF type = 4 Direct i.e. CIE directly holds shares of companies, not a US ETF
  • Auto DRIP = 1 since CIE is a Claymore fund
  • Tracking error US ETF (PXF) = -1.2%, estimated using historical results on page 11 of the 2010 Annual Report here on the PowerShares website
  • Tracking error Canadian ETF (CIE) = -1.5%, estimated future error. The 2010 error was a terrible -2.1% from page 9 of the Annual Report here on Claymore's website, but in future it should be much lower as the ETF switched to full replication in September 2010, holding all 1000 stocks in the index, instead of the partial replication by 300 or so stocks it had previously carried.
  • International withholding tax = 9%, estimate from Foreign Tax Paid actuals on page 123 of the Annual Report
  • Bottom Line = Under the above assumptions, CIE comes out a constant 3% or so better than PXF. Put the CIE into a TFSA, however, and its advantage grows over the years, reaching over 10% after 25 years. Beware of withholding taxes!
There you have it. Use the spreadsheet to see which costs matter and which don't under reasonable assumptions, or to check how far things would have to change to make a difference in choosing ETFs and which account to put them in.

Disclaimer: This post is my opinion only and should not be construed as investment advice. Calculations and formulas are believed to be accurate but are not guaranteed to be so. Use at your own risk. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 17 May 2011

Pros and Cons of Cross-Border Shopping in the USA for ETFs

Cross-border shopping in the USA has long been a favorite activity of Canadians when the exchange rate vs the US dollar has swung in our favour. Investors looking for ETFs can shop cross-border too, as online brokers all provide seamless access to US stock markets with a click of the mouse on a drop down menu. What are the possible advantages and drawbacks of buying ETFs on US markets instead of the TSX in Canada?

The high Canadian dollar is not a reason to buy in the USA - The rise in the Canadian dollar does not create the same bargains in ETFs as it can in shoes. Buying the same thing in the USA and in Canada will not present the same bargains in ETFs because the much greater speed, volume and ease of moving money brings about a high degree of stock market efficiency – the same thing will at every instant cost the same amount, factoring in the exchange rate, on both sides of the border.

Pros – Reasons that favour buying ETFs in the USA

1) Management expense ratios – The lowest MER for an asset category is most often found in a US-based ETF. A good example is a fund that tracks the flagship large cap equity S&P 500 Index or something very similar. In Canada the lowest MER is Claymore's CLU.C with an MER of 0.71%, while in the US, the SPDR S&P 500 tracker (SPY) has a 0.09% MER.

2) Range of choice – US financial markets are many times larger than Canada's and that results in a much greater selection of ETFs. Whether it is US equity, international equity, emerging market equity or bond funds, there are more ETFs available. Sometimes there isn't even a comparable ETF in Canada for a key category, e.g. a whole of market US equity fund. Other worthwhile categories where there is a dearth of ETFs available in Canada include: Value stocks, Small cap stocks, foreign bonds.

3) High liquidity, reduced bid-ask spreads and lower tracking error – The size of the US market is reflected in the size of ETFs sold in its markets. Often the net asset value of a US fund is many times greater than that of a Canadian alternative. Trading volumes are consequently much higher and that tends to keep these sources of cost down and allow the investor to achieve returns that are higher and closer to the index they aim to track. For instance, the tracking error of Claymore's International Fundamental Index ETF (CIE) came out to 2.1% below its index in 2010 according to this Couch Potato blog post while the parallel US ETF, PowerShares' FTSE RAFI Developed Markets ex-US fund (PXF) has been tracking only about 1.1% below the same index. That amounts to a 1% extra “cost” of using CIE instead of PXF. It's worth checking several years of tracking error to see if it has varied a lot or if the pattern is consistent.

4) Unhedged versions of US and international funds – Due to anxiety amongst Canadian investors that our dollar will keep rising, it seems that almost all foreign equity ETFs sold in Canada come only in versions that hedge against currency shifts. Whether that is the best approach or even necessary is not cut and dried (see our post here on the pros and cons). Also, Canadian Capitalist has discovered that hedged ETFs are prone to especially bad tracking error.

5) US 15% withholding tax charged in registered accounts (RRSP, TFSA, RRIF, LIRA etc) – For Canadian-listed ETFs with foreign holdings consisting of US ETFs, such as iShares' MSCI Emerging Markets Fund (XEM) which holds only the US-listed EEM, the US government levies a 15% withholding tax on distributions that cannot be recovered. The constant reduction in net return is the 15% withholding tax times the fund dividend/distribution rate – e.g. 0.15 x 2% = 0.3% less. Other ETFs with this return-reducing problem include: Claymore's Emerging Markets (CWO), iShares Canada's S&P 500 (XSP), Russell 200 Index (XSU), MSCI EAFE Index (XIN), China Index (XCH), World Index (XWD). Our table below shows the various situations that can arise in ETFs regarding withholding tax. Green boxes show the minimal tax situation, red is bad with two layers of (US and international) withholding taxes that cannot be avoided or claimed as a credit against Canadian taxes and the clear boxes are where one withholding tax applies.

Cons – Reasons against buying ETFs in the USA

1) Currency exchange costs – Buying a US-listed ETF means having to pay in US dollars. The swap of Canadian dollars to buy the US currency can cost the individual investor up to 1.5% commission depending on the broker. Within a Canadian-listed ETF, the fund does the buying at lower institutional rates, which are usually so low as to be not worth worrying about. The problem is worst for registered accounts since selling the US ETF will result in conversion back to Canadian dollars at most brokers, a second big hit. The same hit happens to distributions by the ETF. An investor who wants to rebalance his/her portfolio by buying and selling might incur several round-trip currency conversions, each time with a return-reducing fee incurred. The problem is alleviated to a degree in several ways: by the fact that some brokers now allow US dollars to be held in a registered account after a sale; by many brokers allowing wash trades or by a fancy trading manoeuvre called Norbert's gambit (see Couch Potato's suggestions for reducing Forex fees)

2) Hedged ETFs not available – Despite the costs, some investors, such as those who are convinced the Canadian dollar will continue to rise or whose time horizon is too short for perhaps decades-long cycles to even things out, may still wish to diversify into foreign markets but with hedging against currency swings. In that case, US-listed ETFs are not the place to look – the only hedged US ETF hedges the US dollar against the rest of the world for the benefit of US investors.

3) Possible exposure to US Estate taxes – Only those whose worldwide assets exceed $5 million need to be concerned, but owning US ETFs makes one subject to US laws on estate taxes as we explained last December.

4) Automatic free dividend reinvestment, pre-authorized chequing purchases and systematic withdrawals – These extra services, available only in Canada from the likes of Claymore Canada and BMO Financial for their ETFs, avoid the costs of commissions on smaller purchases or sales and avoid having cash sitting around uninvested. Saving a $10 commission on a $200 purchase (a $10,000 holding with a 2% distribution gives off $200 a year) is a $10 / $10,000 = 0.1% saving on the holding's total expenses.

5) Withholding tax in a TFSA or RESP account – The US government levies a 15% withholding tax on distributions from US-listed ETFs to TFSAs, RESPs or non-registered taxable accounts i.e. anything other than accounts it recognizes as legitimate retirement accounts, such as RRSPs, RIFs, LRIFs, LIRAs, LIFs. That's on top of what the foreign countries already deducted in withholding tax. A Canadian-based ETF with direct international holdings such as BMO's International Equity Hedged to CAD ETF (ZDM), since it has nothing to do with the US, in contrast pays only the original foreign withholding tax and that tax shows up on T slips issued by the Canadian ETF provider as a foreign tax paid credit that can be used for taxable accounts. The RESP and TFSA still lose that amount but at least there is only one layer of taxation. How much can that reduce returns? Using for example a 2% distribution rate from the ETF holdings, the first level of withholding tax reduces it to 2% - (2% x 0.15) = 1.7% and the second level to 1.7% - (1.7% x 0.15) = 1.4%.

Bottom Line
Ask yourself whether you really want or need currency hedging. If yes, then Canadian-listed ETFs are the only option.

Otherwise, when there are directly parallel Canadian- and US-listed ETFs, add up the hard plus and minus costs associated with MER, Foreign exchange fees, Withholding tax, DRIP commission and Tracking error.

Happy cross-border comparison shopping from the comfort of your own computer!

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 10 May 2011

How to Invest for Retirement Like a Pension Fund by Using ETFs

Pension funds, by definition, have the goal of providing retirement income for their members. Maybe there are some ideas to be gleaned from their operations for us individual investors to apply in our RRSPs. After all, the pension funds are the pros and we are the amateurs. Therefore, this week we look at the three largest pension funds in Canada (see Benefits Canada article and pdf of the top 100) who lead not only in net assets but in methods that are being copied by many other pension plans:
  • #1 Canada Pension Plan Investment Board: $140 billion in net assets - This is the investment arm of the CPP, from which all working Canadians receive payments in retirement. The CPPIB plans two portfolios. One is the reference benchmark portfolio, consisting of standard asset classes. The other is the actual portfolio, which deviates from the benchmark in specific investments in an attempt to outperform the benchmark, but which the managers still aim to keep within the same risk parameters.
  • #2 Ontario Teachers' Pension Plan Board: $105 billion in net assets
  • #3 Ontario Municipal Employees Retirement System: $53 billion in net assets
Pre- and Post-Retirement Equity vs Fixed Income Allocation
The CPPIB is still in savings mode, with about ten years till it will need to begin drawing on its investment portfolio to partially fund CPP payments. Meantime there is a net inflow of funds as CPP collection from paycheques exceeds payments out. We'll call this analogous for an individual as "retiring in ten years".

The OTTP and OMERS, in contrast, already have substantial numbers of retired members and outflow surpasses inflows. This situation we'll call "retired with a part-time job".

The key result to note (see comparison chart below) is that the CPPIB has a much higher allocation to equities - about 2/3rds in its benchmark - than OMERS and OTTP, which each have about a 50% allocation. As a pattern, the big three follow the familiar advice - when in retirement, the equity allocation goes down. There is also the fact that, even in retirement, the equity allocation remains substantial.

Inflation Protection through Specific Asset Classes
All three pension plans make protection against inflation an explicit key investment objective and they target various types of assets that they obviously feel will help achieve that. For that reason Real Return Bonds, Infrastructure (utilities, pipelines, water systems, airports, seaports, toll-roads) and Real Estate are in all their portfolios. The OTTP adds investments in general Commodities and in Timberland to the inflation-protection category.

We note as well that the allocations to inflation protection assets are: a) substantial and; b) higher for OMERS and OTTP which as we noted are in retirement mode already. This reflects the fact that one of the main retirement risks to income is inflation, even at the steady 2% rate we have been experiencing for the last fifteen years and which all three assume will continue. One of the important and valuable promises of all three plans is CPI-indexed income. As life expectancies have gone up (and retired teachers live longer than the general population according to the OTTP), the cumulative long-term effects of inflation on standard of living can be extremely debilitating. Isn't protection against inflation what all of us would desire too?

Foreign Investments and Hedging
There is a divergence of thinking amongst the three pension funds as to whether it is worthwhile to hedge exposure to foreign currency fluctuations through foreign investments, which all three have in considerable amounts. The CPPIB and OTTP hedge only minor portions relating to certain parts of their portfolios - CPPIB's foreign government bonds and some of OTTP's foreign real estate. The OMERS, on the other hand, hedges a lot - about 40% of its foreign equity portfolio. Readers may recall from our previous post Foreign Investments: to Hedge or Not to Hedge Currency that there are pros and cons to each strategy.

Non-Mainstream Investment Strategies
These funds employ some investment strategies that are not open to the average individual investor, the two chief ones being absolute return strategies and private equity. The OTPP provides this information in its 2010 annual report: "Absolute return strategies (which are managed internally) generally look to capitalize on market inefficiencies and also include external hedge fund assets that are managed to earn consistent, market- neutral returns ..." Private equity simply means that the funds invest money directly, mostly in equity though a bit also as lending, through direct private placements. Unlike absolute return, which is an entirely different animal and for which there are no ETFs available, private equity stills falls within equity or fixed income, so although there are no such ETFs, the individual investor can imitate the effect within ETFs that invest in public market securities.

Investment Returns and Expectations
The diversified and risk-controlled portfolios of CPPIB, OTTP and OMERS can serve as a guide and a benchmark for our own returns. The table below shows some recent results and what they aim for in future. One-year returns in 2010 ranged from 12 to 14%, an exceptional good year after the heavy declines of the financial crisis. Their expectations for future long term average returns are only 6 to 7% including an inflation component of around 2%, i.e. 4 to 5% future real returns.

The ETFs that Best Mimic the Pension Funds' Asset Allocation
Keeping as much as possible to ETFs sold in Canada, an individual investor can construct a portfolio, except for Absolute Return strategy as noted above, that models each of the pension funds. In our detail table, we have colour-coded across to show how one or more ETFs line up with the funds (in certain cases, like Emerging Markets equity where BMO's ZEM and Claymore's CMO can both fill the bill, there a couple of ETFs for an asset class). Only two asset classes - Foreign Government Bonds and Timberland - would require ETFs traded in the USA.

The perhaps surprising bottom line is that it is not complicated to come quite close to building a portfolio that mimics the pension funds' approach. Only six to eight ETFs in all are required.

To find details of the ETFs:
One must note that the massive scale of these pension funds gives them certain advantages (there are disadvantages too in being an investing elephant - see for example, CPPIB CEO David Denison's speech The Challenge of Managing CPP's Assets) that an individual cannot replicate with ETFs. For instance, the broadest Canadian equity ETF, iShares' XIC, contains 248 companies within it, while the CPPIB's portfolio (listed here) as of March 31st this year held over 400 different Canadian companies. Another difference is that their unit costs for investment management are much lower than ETF management expense ratios.

Nevertheless, it is encouraging to know that the small investor can construct a solid portfolio without much complication or trouble simply by imitating what some of our leading pension funds do.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 3 May 2011

Which Canadian Stocks with Growing Dividends? - The Low Yielders

Last week we looked at Canadian stocks that have consistently increased their dividends for several years and whose dividend yield of 3% or more exceeds the TSX Composite average. This week, we turn to the other batch of dividend growers, 20 in all, whose yield is below that of the TSX.

Is the lower yield a good or a bad sign? If these companies have been progressively increasing their dividends, how might it be that their dividend still does not come up to the broad market average? Several possibilities exist: the stock price has more than kept pace with the dividend rises so that the yield formula of Div/Stock Price produces a smaller number; the dividend started at such a low payout level or the amount of increase has been so small that the yield still has not risen much. A scan of our comparison tables below reveals that both explanations apply to different companies and in most cases that looks like good news. (Note that our tables this week have more columns and are based primarily on the superb recently beefed-up My Watchlist customizable tool available free on GlobeInvestor.)

Dividend Past Performance, Safety and Further Growth Potential
(click on image to enlarge)

  • Great Dividend Performance: Dividend growth rates, whether measured over the past year or five years, has been outstanding. The 5-year compounded annual growth of the bottom performer, Atco Ltd (ACO.X), at 6.8% is very satisfactory while that of the top performer, Tim Hortons (THI), at 35.3% is phenomenal. The high-yielders of last week showed much more modest growth rates as a group.
  • Strong Dividend Growth Potential: Dividend payouts as a ratio of earnings is low (under 30%) for almost every company indicating considerable leeway to give further increases despite very healthy - the lowest is 6.8% per year - compounded dividend increases over the last five years. This is in sharp contrast to last week's high-yielders which almost all have high payout ratios.
  • Strong Dividend Safety: Interest coverage is high enough at every company, except at Finning (symbol: FTT), that there appears little danger of an actual dividend cut in the short term and in the longer term, debt levels as seen in the various debt ratios, seems low enough to protect dividends of almost all the companies.
Stock Price Attractiveness - Are there potential good buys?

  • Many of the stocks exhibit attractive green indicators amongst the series of different value metrics, but five of them look to be good across the board with no negatives and lots of positives - rising sales and profits, healthy return on equity, low current stock price compared to past or analyst forecast future earnings, low stock price compared to sales, cash flow and book value, even analyst ratings:
  • Tim Hortons (THI)
  • Home Capital Group (HCG)
  • SNC-Lavalin Group (SNC)
  • Empire Company (EMP.A)
  • Atco Ltd (ACO.X)
The overall conclusion is that a good number of the low-yield dividend growing stocks appear to have good potential for further dividend rises and probably stock price gains too. Numbers are not the final answer, however, and the investor is still wise to look into each company's prospects through reading annual reports, news articles and whatever commentary can be found. It is not what has happened in the past, as reflected in the above numbers, but what will happen in the future, that matters.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.