Category: MP Market Reviews

This week, I was reading a white paper by one of my mentors, Tom Connolly. He posed an intriguing question: Would you purchase an apartment building if the tenants did not pay rent?

At first glance, the answer is obvious: of course you wouldn’t. But isn’t that what most investors do when buying a stock that doesn’t pay a dividend?

Our strategy focuses exclusively on companies that pay dividends and, even better, those that offer growing dividends. The more income our quality dividend growers produce, the higher another investor is willing to pay. This growing income is the secret sauce in our strategy and what sets us apart.

It might take a few years to see how a growing dividend drives the price forward in your Dividend Growth Investing (DGI) portfolio, but when it eventually happens—and it will—you’ll wonder why it took you so long to figure it out.

As a bonus, this week, we’re offering free subscribers a snapshot of all the trades in our model DGI portfolio since its inception on May 1, 2022. The model portfolio is an example of our strategy and process in action. Although we are only a couple of years into our business plan, the chart clearly shows that, on average, dividend growth (DIV UP %) and price growth (PRICE UP %) are in sync.

Ideally, you will have created a Dividend Growth Investing (DGI) business plan that outlines your objectives and how you are going to deploy your hard-earned capital. Next, you will have a list of companies that meet your investment criteria and will select from this list when they are sensibly priced. Finally, you will be patient and build your portfolio over a few years, as not all quality companies will be sensibly priced at the same time.

Our blog follows this process with our model dividend growth portfolio. Paid subscribers can build their portfolios alongside ours, saving time on research and eliminating much of the emotion of investing. We send alerts for every buy or sell action and conduct quarterly performance reviews to track our progress.

But what if you’re new to the blog, have a lump sum to invest, and want to start quickly? The answer is simple: invest in our All Canadian ‘No-Look’ DGI Portfolio. This portfolio is a streamlined version of ‘The List’ we follow, featuring a diversified selection of the top twenty Canadian stocks, rated for quality by reputable third-party agencies (Value Line and S&P) as of January 2024.

By investing equal amounts in each of these twenty companies, you’re on your way to building a robust DGI portfolio. For more details on how we manage risk and determine when to buy or sell, read the business plan in the premium content section of our site.

                                            All Canadian ‘No-Look’ DGI Portfolio                                                                                                     (As of July 19, 2024)

Weeks like the one we just experienced remind me of the benefits of our dividend growth strategy. As retirees, we invest in quality companies, allowing us to generate income without the need to buy and sell frequently. Our approach is backed by decades of data demonstrating the challenges of timing the market.

Consistently timing the market is impossible. There literally is no human being who can claim that he or she has been successful at that task with any degree of honesty. However, timing the market is not only unachievable, attempting to time the market can lead to poor investment returns.

The next chart, taken from CNBC, gives insights into the impact on a portfolio when an investor misses the 10 days in each decade when the market registers the largest gains.

It’s been a few months since we last reviewed our ‘Timely Ten’ dividend growth stocks. For those new to the blog, these are the ten most undervalued stocks on ‘The List,’ determined by one of our key valuation metrics, dividend yield theory.

This latest update of the ‘Timely Ten’ reveals a fascinating trend: a significant number of companies from ‘The List’ are signalling undervaluation. Fourteen stocks meet the criteria based on dividend yield theory—representing half of the companies on ‘The List.’ Even more encouraging, some of our highest-quality companies are now meeting our threshold, making our investment decisions even more straightforward.

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

Not every stock on ‘The List’ ends up in our dividend growth investing (DGI) portfolio. ‘The List’ is a teaching tool that screens for candidates based on a set criterion across the universe of dividend growth stocks in Canada. To end up in our portfolio a candidate would need to score high on ‘quality’ using our many quality indicators. Then and only then would we look at valuation.

Despite the superior quality of our dividend growers, we exercise caution and do not initiate or augment a position unless the stock is ‘sensibly priced.’ Here are the four methods we use to assess valuation. 

1. Historical Fundamentals
2. Dividend Yield Theory
3. CAPE Ratio
4. Graham Value 

In today’s post we will review the ‘historical fundamentals’ method of arriving at a sensible price using Fortis Inc. (FTS-T), one of the highest quality candidates on ‘The List’. 

Historical Fundamentals 

A company’s operating results will determine its stock price in the long run. Analyzing a company’s historical fundamentals provides insight into how the business has been valued over an extended period. Many of the stocks we invest in have a ‘narrow valuation corridor,’ meaning the stock price follows a path that rarely deviates from its historical trading range. A company’s P/E (Price to Adjusted Operating Earnings), OCF (Price to Operating Cash Flow), EBITDA (Price to Earnings Before Interest, Taxes, and Amortization), and Sales (Price to Sales) ranges tell us a lot about how a company has been traditionally valued.

Purchasing at the bottom of these ranges or selling at the top has helped us manage our entry and exit points to enhance returns.

We use the Fundamental Analyzer Software Tool (FASTgraphs) to visualize how a company has been historically valued. We like to see it trading within its typical ‘valuation corridor’ based on a ten-to-twelve-year timeline. This gives us a clearer picture of how the stock has traded in different economic cycles.

FASTgraphs – “FG” 

The following colours/lines on the “FG” chart shown below represent: 

• Black line: Price
• White 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

Our strategy and the safety of our capital hinges on the growing income generated by a select group of quality companies. While stock prices may vary, our overall income consistently increases. The downside is the need for patience for this growth. What are we waiting for? The dividend, the income, the yield.

Our strategy and our safety depends upon the growing income from a few leading companies, not the market, not a fund, nor over-diversification.

A quick test I like to perform is our “7% in 10 Years” test. This test helps identify dividend growth stocks that are attractive investments today. If your income stream (without reinvesting dividends) is projected to grow to a yield of 7% in ten years, then it has the potential to be a good investment opportunity.

In monetary terms, if you invest $10,000 today, you can expect to receive $700 annually from dividends alone within ten years. How does an investment bought today generate a 7% return on dividends alone ten years from now? The answer is that the dividend grows!

One reason I use 7% as my numerical goal is that equities have historically provided around 7% returns over the last 100 years. Generating a return within a decade equal to the stock market’s historical total return from the dividend alone demonstrates the magic of dividend growth investing.

Another advantage of using at least a decade as your investment horizon is that the distance between your purchase and current prices is typically significant.

Let’s look at an example of growing yield and its effect on price using a company on ‘The List’:

As we approach the midpoint of 2024, it’s the perfect time to start scouting candidates for next year’s list. Monitoring potential additions closely allows us to evaluate how they compare to our existing list of members.

While we’re comfortable building a portfolio of quality dividend growers from our current list, we always keep an eye on potential future candidates. This forward-thinking approach has paid off in the past, as evidenced by our early additions of TFII-N and MFC-T before launching our public-facing model portfolio in 2022, both of which have proven excellent choices.

Identifying Potential Candidates

We’ve identified six companies on the TSX that will meet our first two criteria for inclusion on ‘The List’ in 2025:

Dividend Growth Streak: At least 10 years.

Market Cap: Minimum of one billion dollars.

I was recently invited to join a prestigious investment club founded in 1979. Reviewing the club’s history and bylaws, I realized I was being asked to join the ‘Growth Stock Crowd’. I had tried this approach before and found it challenging. This prompted me to compare the differences between growth stock investing and my preferred method of dividend growth investing for our readers.

The Growth Stock Crowd

Growth stock investors aim to buy stocks at the right time, focusing on companies with rapid growth potential. The goal is to sell these stocks for significant profits and repeat this process continually. Even the most brilliant investors experience both wins and losses, averaging about 7%-9% long-term returns. Perfect market timing and stock selection are unrealistic, as no one can consistently win. Over time, investors hope to improve their skills and achieve more wins than losses.

The Dividend Growth Crowd

In contrast, dividend growth investors like me take a different approach. With years of experience, I may not consider myself extraordinarily intelligent, but I know basic math, how to research earnings reports, and how to assess valuations. More importantly, I have the discipline and patience honed from running my own business for twenty-five years.

Dividend growth investors are passionate about a steady, predictable way to build a secure financial future. Our investment time horizon is indefinite, so we remain undistracted by short-term market fluctuations. We invest in quality companies that consistently pay and grow dividends. Daily share price changes, the broader economic picture, and other details are secondary to a company’s ability to increase its dividend payments. Historically, as dividends grow, so does the stock price. This combination of growing income and capital appreciation is the secret sauce in our strategy, with annualized long-term total returns in the 10%-12% range.

Key Differences Between Growth and Dividend Growth Investing

Growth stock investors juggle multiple factors: selecting the right stocks, assessing current prices, evaluating company products, and timing the perfect sale to make a profit. This process must be repeated continually with different companies.

On the other hand, dividend growth investors focus on ensuring that their chosen companies will continue to pay and increase dividends annually. Lists of companies that have increased dividends for over ten years, even during tough times, are readily available. We follow one such list on this blog every week.

While growth stock investors sell their stocks to realize profits, dividend growth investors rarely sell because doing so would reduce their growing income. This income can also be reinvested in sensibly priced dividend growth companies to increase our returns.

Wrap Up

I plan to attend the investment club’s next meeting to learn more. Life has taught me that personal growth comes from stepping out of your comfort zone occasionally. At the very least, I will meet some interesting people passionate about investing.

Last week, we shared our latest quarterly and second-year financial results for the MP Wealth Builder Model Portfolio (CDN). PAID Subscribers can access the full document in our ‘Premium Content’ section and receive DGI alerts whenever we buy or sell within the portfolio. Here are some highlights:

In the quarterly review, I reiterated our approach as DIY dividend growth investors:

This is about buying businesses, not just stocks.

Trusting Canada’s top companies, led by exceptional management teams and supported by thousands of dedicated employees, is key to achieving financial freedom.

We consider our portfolio an asset management business, with our assets being the many dividend growth companies we own. Our plan is to shift from working for our investments to managing our assets and growing our ownership in the investments that work for us.

Finding companies with a historical alignment between dividend growth and price growth and purchasing them when their current yields exceed historical averages is a straightforward strategy for successful dividend growth investing.

Metro Inc. serves as a prime example within our ‘Core’ category stocks. Let’s examine two crucial charts: dividend growth (DG) versus price growth (PG) alignment and the 10-year yield chart for this quality dividend grower.

Dividend Growth vs. Price Growth Alignment

Over the past decade, Metro Inc.’s stock price has closely mirrored its dividend growth. The price rarely stays out of alignment for long. Dividend growth stocks that behave this way are some of the highest-quality companies in your portfolio. In addition, recognizing and acting on this short-lived misalignment can lead to outperformance in your portfolio returns.