Month: December 2024

Intro

As dividend growth investors, we see ourselves as an asset management business. Our “assets” are the many high-quality dividend growth companies we own in Canada and the United States.

One of the most powerful lessons I’ve learned about both investing and running a business came from two of my greatest mentors: Bill Gates and Warren Buffett. In a memorable moment, they were each asked to write down the one word they believed was most responsible for their success. Remarkably, they both wrote the same word: focus.

Gates and Buffett believe that focus, concentration on key goals, and the ability to say “no” to distractions are crucial to success in their respective fields.

Inspired by their words, I’ve created ‘The List’—a curated watchlist of quality dividend growth companies. This focused approach helps me avoid the noise of the broader market, making it easier to track key metrics and develop a deeper understanding of the selected businesses I may invest in.

‘The List’ is not a portfolio but a coaching tool that helps us think about ideas and risk manage our model portfolio. We own some but not all the companies on ‘The List’. In other words, we might want to buy these companies when valuation looks attractive.

To begin our selection for 2025, we review the listed companies on the Toronto Stock Exchange (TSX). The TSX is one of the world’s largest stock exchanges and the third largest in North America. It is home to over 700 companies across all sectors of the Canadian economy.

Here are the criteria to be considered a candidate on ‘The List’:

1. Dividend growth streak: 10 years or more.
2. Market cap: Minimum one billion dollars.
3. Diversification: Limit of five companies per sector, preferably two per industry.
4. Cyclicality: Exclude REITs and pure-play energy companies due to higher cyclicality.

By screening for the first two criteria, ten years of consecutive dividend growth and a market cap of one billion dollars or more, we narrow our candidates down to only 67 companies (less than 10% of the companies on the TSX).

We then winnow further using the final two criteria, diversification and cyclicality to ensure the companies selected represent stable businesses in all sectors of the Canadian economy.

Unless their dividend streaks are interrupted, we typically don’t remove companies on ‘The List’. All 28 companies currently on ‘The List’ increased their dividends in 2024, securing their place on our watch list for 2025.

Intro

A couple of weeks ago, we discussed how the short-term predictability of dividend growth serves as the cornerstone of our dividend growth investing strategy. Knowing we can rely on the steady income generated by our investments allows us to sleep well at night, even during periods of market volatility. Moreover, the dependable growth of that income stream helps eliminate concerns or panic about whether it will keep pace with inflation and continue meeting our spending needs when we eventually retire. What may not be immediately obvious is how this same predictability extends to our long-term capital returns.

John Bogle, the founder of Vanguard Group, and Ed Easterling of Crestmont Research both claim they can accurately calculate expected long-term capital returns for dividend growth companies.

They believe stock market returns can be broken down into three key components:

1. Dividend Yield – The income generated by dividends relative to the stock price.
2. Growth – The increase in earnings and dividends over time.
3. P/E Change – The shift in price-to-earnings (P/E) ratios, reflecting changes in market valuation or “expensiveness.”

By focusing on these fundamental drivers, investors can better understand and forecast the long-term performance of dividend growth stocks.

Bogle calls the first two components, Yield + Growth, investment aspects of the investment return and the last component, +/- Change in P/E Ratio, the speculative return – what will people pay for a dollar’s worth of earnings. 

The table below presents the ten-year dividend growth and annualized returns for ‘The List’ as of January 1, 2024. The highlighted averages at the bottom assume an equal investment in each company on January 1, 2014, regardless of valuation.

Intro

Political turmoil in Ottawa and the threat of tariffs on Canadian companies adversely affect Canadian markets. South of the border, healthcare companies are under siege after the United Health shooting. Lots to ponder. This issue should give you lots of ideas to dig a little deeper.

Below are the ten most undervalued dividend growth companies from our Canadian and U.S. watchlists, based on last Friday’s closing prices.

We refresh these lists annually during the first week of January. Be sure to catch the December 31 issue of our newsletter for the highly anticipated release of next year’s updated watchlists!

We own some but not all the companies on these lists. In other words, we might want to buy these companies when valuation looks attractive.

Here’s a recap on how we select our ‘Timely Ten’:

Step three in our process involves monitoring our quality dividend growers regularly, which can become quite challenging depending on the number of companies we track. Fortunately, we rely on ‘The List’ instead of the vast array of stocks in the index, which streamlines our task. Nevertheless, we continually seek methods to enhance our efficiency. Through dividend yield theory, we’ve discovered an approach that has proven remarkably effective in aiding us with our efforts over the years.

Dividend yield theory is a simple and intuitive approach to valuing dividend growth stocks. It suggests that the dividend yield of quality dividend growth stocks tends to revert to the mean over time, assuming that the underlying business model remains stable. In practical terms, if a stock pays a dividend yield above its ten-year average annual yield, its price will likely increase to return the yield to its historical average. Knowing that price and yield go in opposite directions, this theory helps us find stocks poised for a positive price correction.

We have pre-screened our candidates using the criteria we initially laid out in building ‘The List’. This helps us considerably narrow the universe of investable stocks.

1. Dividend growth streak: 10 years or more.
2. Market cap: Minimum one billion dollars.
3. Diversification: Limit of five companies per sector, preferably two per industry.
4. Cyclicality: Exclude REITs and pure-play energy companies due to high cyclicality.

Next, we rank ‘The List’ by how significantly each stock is priced below its fair value (Low Price), as calculated using dividend yield theory. To determine fair value, divide the current dividend by what you consider to be the stock’s historically high yield.

All companies above the thick black line have a current price below fair value (sensibly priced). The stocks above the thick black line make up our ‘Timely Ten’.

Intro

Last week, we highlighted the resilience of dividend stocks with long dividend growth streaks. Remarkably, none of the 24 Canadian companies with 10+ years of consecutive dividend growth heading into the Global Financial Crisis of 2008/2009 cut their dividends. This resilience offers peace of mind to income-focused investors, providing a reliable income stream no matter what challenges the future holds.

Another key aspect of quality dividend growth stocks is the dependability of their dividend increases. Once a company enters our universe of quality dividend growers, management typically prioritizes consistent dividend growth. It’s common to find these commitments clearly articulated in their dividend policies and growth strategies, often featured prominently in quarterly earnings reports.

For instance, here are a few examples from Q4 2023 earnings reports (from a year ago) of companies we track on ‘The List’. These examples underscore how management teams take their dividend-growth commitments seriously and make them a core element of their investor value proposition.

“Last year Fortis was proud to celebrate 50 consecutive years of increases in dividends paid to shareholders,” said Mr. Hutchens. “We remain focused on extending this track record as we execute our$25 billion five-year capital plan in support of our annual dividend growth guidance of 4-6% through 2028.“

– Fortis Inc.

“We will continue to develop quality projects within our secured capital program, with approximately $7.0 billion of assets expected to be placed in service in 2024. Our commitment to limiting annual net capital expenditures to $6.0 to $7.0 billion, with a bias to the lower end beyond 2024, will not waver. We believe that adhering to our net capital expenditure limit beyond 2024 will allow TC Energy to continue delivering an attractive and sustainable dividend growth rate of three to five percent.”

-TC Energy

“This quarterly dividend reflects an increase of 7.1 per cent from the $0.3511 per share dividend declared one year earlier and consistent with our multi-year dividend growth program.”

-Telus

Let’s examine how these companies performed in 2024. The table below showcases the five-year dividend growth history for the companies featured on ‘The List,’ highlighting their commitment to rewarding shareholders.

Intro

If you’re new to dividend growth investing, you’re beginning to see that our success isn’t just about total returns—it’s about the steady growth of our dividend income year over year. The ability to rely on this growing income, no matter what the market is doing, provides a sense of stability and peace of mind, especially in retirement.

Looking back at how well Canadian stocks with 10+ years of dividend growth streaks performed during the Global Financial Crisis solidified my confidence in this strategy. Despite one of the most challenging economic periods in recent history, their dividend income held strong. That resilience showed me that dividend growth investing isn’t just a strategy—it’s a reliable foundation for long-term financial security.

To illustrate, let’s look back at the Global Financial Crisis of 2008/2009, a period of extreme financial stress:

At the end of 2007, before the crisis began, there were 24 Canadian stocks with dividend growth streaks of 10+ years.

Of these 24 companies, how many do you think cut their dividends during the crisis?

The answer might surprise you.