Month: September 2025

Intro

The quote above speaks to the S&P 500, but the lesson applies no matter where you invest: valuation matters. In our dividend growth investing process, we spend a lot of time emphasizing undervaluation and the importance of buying at a sensible price. For today’s article, though, I want to flip the script and look at the other side of the coin, what can happen when you buy stocks that are overvalued.

Dividend growth investing works because it combines two of the most powerful forces in wealth building: rising income and compounding. The best companies increase their payouts year after year, and over time the snowball effect creates serious results.

But there is a catch. Even the highest-quality dividend grower can deliver disappointing returns if you buy it at the wrong price. Paying too much for a great business is one of the most common mistakes investors make.

Why Quality Alone Is Not Enough

It is tempting to believe that a wide-moat business with a long dividend streak is always worth owning. The problem is that returns depend not only on business quality but also on the valuation you lock in when you buy. If the stock is trading far above its fair value, future returns get squeezed.

A strong dividend record cannot save you from a poor entry point.

The Three Levers of Returns

Three factors drive every dividend growth investment:

1. Dividend yield at purchase
2. Future dividend growth
3. Valuation multiple

If the starting yield is low because the stock is overpriced, the compounding engine is weakened from the start. Worse, when the valuation multiple eventually drifts back to its historical average, you can face years of stagnant or negative price performance.

Imagine a stock that usually yields 3 percent but now yields only 2 percent because the price has run ahead. For that stock to return to its normal yield, the price would need to fall by one-third. That is enough to wipe out several years of dividend growth. 

The Hidden Cost of Overpaying

Buying an overvalued dividend stock does more than hurt your immediate returns. It also carries a heavy opportunity cost. Capital tied up in a stretched valuation is capital that could have been compounding at higher yields elsewhere.

Dividend Yield Theory helps investors avoid this trap. By comparing the current yield to long-term averages, you can quickly spot when a dividend grower has become too expensive.

Investor Psychology at Work

Many investors still pull the trigger on expensive stocks because of behavioral traps:

• Fear of missing out after a big run
• Anchoring to recent performance
• Confirmation bias from hearing only bullish commentary

These biases can push you into thinking that valuation no longer matters. History shows otherwise.

Lessons From the Past

Even legendary Canadian dividend growers have gone through long stretches of poor returns when purchased at extreme valuations. Canadian National Railway (CNR-T) is a good example from the last few years.

The following colours/lines on the FASTgraphs chart shown below represent: 

Black line: Price

Yellow line: Dividend

Orange line: Graham average of usually 15 P/E (price/earnings) for most stocks

Blue line: Normal P/E

Dashed or dotted lines: Estimates only

Green area: Earnings

Green dots: Purchases

Intro

Our Timely Ten list remains the fastest way to assess valuation, which explains why it continues to be the most-read article each month.

On the Canadian side, there was little movement at the top this month. The only change was goeasy Ltd. (GSY) and Enbridge Inc. (ENB) swapping places in the tenth spot. While goeasy remains a quality name, it does not look deeply undervalued at present since its ten-year average yield still sits just below our high-yield estimate.

One stock worth watching is Waste Connections (WCN). It climbed two spots from last month, even as its share price has drifted lower since March. The company’s latest earnings were solid, suggesting this may be more a case of valuation cooling after a frothy run. Magna (MG) also deserves attention: its valuation metrics are appealing, and if tariff headwinds ease, it could be a timely opportunity to begin building a position.

Turning to the U.S. list, I want to correct an oversight. In last month’s update I mistakenly included Accenture (ACN) and Elevance Health (ELV), both strong holdings in my portfolios, but left out American Water Works (AWK) and Home Depot (HD), which are part of our watchlist. That error has now been corrected. From time to time, we do invest in companies that are not currently on our watchlists, which is what caused the confusion here.

As for current opportunities, Zoetis (ZTS), Amgen (AMGN) , and NextEra Energy (NEE) continue to get cheaper, making them good candidates for deeper research. UnitedHealth (UNH) still looks significantly undervalued despite a modest rebound in its share price. We already hold a full position there, so patience is the best course.

These names should keep us busy on the research front until Q3 earnings season ramps up at the end of October.

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 favourable price correction.

We have pre-screened our candidates using the criteria we initially laid out in building our watchlists. 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 our Canadian and American watchlists based on how far each stock’s price is below its fair value (Low Price), as determined by dividend yield theory. To find fair value, divide the current dividend (Dividend) by the stock’s historical high yield (High Yield).

Since price and yield move in opposite directions, a lower price results in a higher yield, and vice versa. The ten companies above the thick black line have a current price (Price) below fair value (Low Price). Put simply, these stocks have a current dividend yield higher than their historically high yield. According to dividend yield theory, these companies are sensibly priced and have the highest probability of a price increase in the short term. These are our Timely Ten.

Intro

The List has kicked off 2025 on a strong note, rising more than 11% year-to-date in our equal-weighted example that we track weekly in the newsletter. We use the Canadian version of The List to demonstrate our dividend growth investing (DGI) process in action.

It is important to emphasize that The List is not a portfolio. It is a coaching tool. While many of the companies on The List do eventually find their way into our model DGI portfolios, its primary purpose is to guide decision-making, not to serve as a ready-made portfolio. The same principle applies to our U.S. version, The List (USA).

Long-time subscribers will recall the process we go through each January when curating our watchlists for the year ahead. In addition to applying our four key criteria for identifying quality dividend growers, we follow a disciplined approach: additions or removals occur only once per year, on January 1.

Around this time of year, we begin looking ahead to identify new candidates for potential inclusion.

Identifying Potential Candidates

We’ve identified four companies on the TSX that will soon meet our first two criteria for inclusion on The List:

1. Dividend Growth Streak: At least 10 years.
2. Market Cap: Minimum of one billion dollars.

Intro

When I launched our model portfolios for coaching purposes in Canada in May 2022 and in the United States in May 2023, I had two clear goals.

The first and most important goal was to generate a steadily rising stream of dividends from high-quality companies. The second goal was to build portfolios capable of delivering above-average total returns over the long term (five to ten years). By “average,” I mean the benchmark indexes: the TSX Composite in Canada and the S&P 500 in the United States.

Achieving our second goal (outperforming the indexes) has proven to be challenging in the short term.

This past week I shared the quarterly performance results for our Canadian and American model portfolios. Both are now delivering annualized returns above 10% since inception.