Why Investors Should Consider Canadian Dividend-Paying Stocks

Text transcript

Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Greg Zdzienicki, vice-president, client portfolio manager, equities, at CIBC Asset Management.  

As interest rates have started to come down, Canadian investors are starting to look for alternatives to some short-term assets that they’ve been investing in, such as GICs, high-interest savings accounts and other money-market assets. And I think Canadian dividend-paying stocks offer those investors a very good opportunity to invest in high-quality companies that have sustainable dividend yields that are supported by strong earnings growth.  

You know, in Canada right now, relative to, say, U.S. equities, we have the highest differential in terms of yield spreads that we’ve had in well over the last 20 years. I think there’s certainly an opportunity to invest in companies that have sustainable dividend yields and are going to be able to provide that steady income and grow that income.  

Right now, in Canada, we’ve got earnings growth of about 12 and a half percent, and if you look at some of the dividend growth metrics for things like telcos, bank and insurance companies, we’re expecting that dividend to grow anywhere from about seven to 12% in the next few years. So, you’ve got a lot of sustainability and a lot of predictability in that dividend yield.  

Secondly, I think you get favourable tax treatment by investing in dividend-paying securities. Unlike GICs or other interest-bearing type securities that are taxed at your marginal tax rate, dividend income is paid by after-tax dollars. So, the treatment that you get, the dividend tax credit, makes sure that, as an investor, you are keeping more of your actual income earned. 

Another important opportunity is the amount of money that can move from GICs and other short-term investments into equity-paying securities. There’s about $300 billion sitting in excess deposits in GICs and short-term investments. And all of this is coming now at a period of time when interest rates are coming down and the renewal rates are going to be a lot lower. You can’t get the GICs at 5% or higher that were locked in a number of years ago, and those are going to move now towards equity securities, or dividend-paying equity securities.  

We expect about $100 billion of that to be coming due in the next couple of quarters. So, by the middle of 2025 we can see a significant amount of money moving to equity-paying securities, which should be very supportive of equity prices going forward, even if there is any pullback in the economy or the markets.  

Right now, we’ve got some interest-sensitive stocks like REITs and telcos that are actually trading at about a 15 to 20% discount to their five-year average. So, if we start normalizing some of those long-term averages in terms of valuations, and that is supported by this massive flow of capital searching for yield, I think that could be very beneficial for dividend-paying equities.  

Going back to periods of time like 2022 and 2023 when we saw a quick rise in interest rates — that dramatically improved the characteristics of term deposits, GICs, money-market instruments, all of that, vis-a-vis sort of the high yield in Canadian equities and these dividend payers. But right now, as rates are heading lower, we think that we’re going to see a rotation from some of these products into higher-yielding Canadian equities, which really should result in outperformance and a normalization in terms of the historical average for things like REITs, utilities, telecoms and financials, all of which are trading now at attractive valuations relative to their history, and will have the opportunity to rerate as people start shifting money from short-term deposits into dividend-yielding equity.  

So, all of this is supported by an earnings recovery coming in Canada. For the first time since about 2021, forward earnings expectations are expected to rise for Canadian companies. This is regardless of the economic situation.  

Companies in the energy space, for example. Companies like CNQ [Canadian Natural Resources Ltd.] nowadays have high cash flows than they did a decade ago due to the fact that they’ve paid down so much.  

So, companies are going to be very profitable. That’s going to translate into better earnings, and they’re going to continue to kick back that excess capital to shareholders. 

Businesses that pay dividends tend to generate high, stable and sustainable returns on capital, as well as attractive levels of free cash flow.  

So, I talked about energy companies. They’re driving a lot of free cash flow. They have very long-life assets, with very good reserve profiles and at the margin are cheap energy producers. So, these attributes have allowed high-quality companies to continue to increase their dividends. Basically since the lows of Covid, when we saw companies cut their dividends or stop increasing dividends, energy companies have been driving so much cash flow that they’ve been able to increase their dividend payments to investors, as well as at the same time been able to buy back shares. So, really kicking back a lot of capital to shareholders since that period of time, and I think the energy sector is poised to continue to be able to deliver on that and to kick back more capital to shareholders in the coming years.  

So, within the energy space, companies like CNQ, companies like Suncor have continued to ramp up their dividends, increasing that capital returning to shareholders, and are doing it in a very sustainable manner. Also, other areas of the market, where we’ve talked about things like banks and insurance companies, we’re expecting to see dividend growth of seven to 12% over the next few years.  

Also, with respect to banks, some of their margins have not improved as much as insurance companies yet, and as we continue to see that improving in the banks, I think we’re going to continue to see dividend increases going forward.  

And even within insurance companies, we are taking a look at opportunities at companies like Trisura, for example. They haven’t initiated a dividend yet, but we are thinking that companies like Trisura are going to be initiating dividends in the future once their growth normalizes.  

I think when considering investments in Canadian dividend-paying securities, I think one very attractive opportunity right now that we have in Canada is the fact that we are actually more diversified than we’ve been in the past.  

And the opportunity right now for Canadian equities is that they are poised to benefit from this rare combination of attractive valuations, of secular and cyclical growth drivers, that are going to drive these robust dividend yields and will really lead to very competitive total returns and very good risk-adjusted returns for clients going forward.