MP Market Review – January 13, 2023

Last updated by BM on January 16, 2023

Summary

• This article is part of our weekly series (MP Market Review) highlighting the performance and activity from the previous week related to the financial markets and Canadian dividend growth companies we follow on ‘The List’.
• Last week, ‘The List’ was up sharply with a positive +3.8% YTD price return (capital). Dividend growth took a step back with the dividend cut announced by (AQN-N). ‘The List’ is at +3.5% YTD, demonstrating the rise in income over the last year.
• Last week, there were no dividend increases from companies on ‘The List’, but there was a dividend cut.
• Last week, there were no earnings reports from companies on ‘The List’.
• No companies on ‘The List’ are due to report earnings this week.
• Are you looking to build an income portfolio of your own? When you become a premium subscriber, you get exclusive access to the MP Wealth-Builder Model Portfolio (CDN) and subscriber-only content. Start building real wealth today!  Learn More

“Having a framework that objectively improves the probability of being directionally accurate is more important than having the most intellectually compelling narrative. Some of the smartest people out there are just as likely to be dead wrong, no matter how compelling their narratives sound. Investing success is a game of having a probabilistic advantage that enables returns to compound over time.”

– Josh Steiner, Hedgeye

One of the reasons we publish ‘The List’ is so that we can ‘coach’ others on how to select and monitor dividend growth stocks for their portfolios. Its purpose is to provide investment ideas and a real-time illustration of dividend growth investing in action. It is not a ‘Buy List,’ nor a portfolio that reflects the composition or returns of our Magic Pants Wealth-Builder (CDN) Portfolios. It is only a starting point for our analysis and discussion of dividend growth investing concepts.

Last week one of the companies on ‘The List’, Algonquin Power & Utilities (AQN-N) announced a 40% dividend cut. Although dividend cuts are rare for dividend growth companies, they do happen.

As part of our process audit, we will take a few paragraphs to review the signs leading up to the dividend cut by (AQN) to see if we need to change anything or if an investor following our process could have seen this one coming. A good process means you review your decisions when they fall outside your expectations.

Here is an excerpt from the article we published on our blog titled ‘Our Dividend Growth Investing Process’.

“By standing on the shoulders of giants, those great investors who came before us, we have come up with a process that is simple to understand with only three basic rules:

1. Quality; only buy large-cap companies that have a long dividend growth streak and good financial safety metrics in an industry that is stable and growing.
2. Valuation; look to buy a company that is sensibly priced or undervalued by looking at a company’s track record. Undervaluation introduces a margin of safety. You are in essence tilting the odds in your favor that future price movements will be upwards.
3. Monitor; keep an eye on your dividend growers; especially the current yield; fluctuations in yields send signals. The consistency of a firm’s dividend growth is the best measure of management’s confidence in the long-term growth outlook for a company.”

“We will also review our outcomes regardless of if they were good or bad. Having a good process means you go back and review your decisions when they fall outside your expectations. We can then make tweaks based on our findings and enhance our process. Only then will we know if we were good or just lucky.”

This week we see the importance of Rule # 3. By monitoring our quality dividend growers, we can see signs of possible dividend cuts and mitigate the damage they can do to our portfolios.

In the case of Algonquin Power & Utilities (AQN-N), the fluctuation in yield and slowing dividend growth in 2022 were definitely ‘red flags’. While many investors would have been attracted to a higher yield, we see yield fluctuations as a warning sign. This, combined with a lower dividend growth rate announcement in July 2022, should have alerted the dividend growth investor to do a deeper dive into company fundamentals. In doing so, the dividend growth investor would have seen that the company had issues servicing its debt due to higher interest rates. This was noticeable when looking at the dividend payout ratio, which climbed to over 100%. Paying out more than you take in eventually leads to financial trouble. A high payout ratio often precedes a dividend cut.

Fortunately, we have never owned a position in (AQN-N) in any of our Wealth-Builder Portfolios, but if we did, it is reassuring to know that our process would have signalled us to do more research and then it would have been up to us to take action and decide what to do next.

Here is an excerpt from an article on the blog dated March 2021 that may help when you have this type of decision to make. Selling Dividend Growth Stocks

“When we make an investment, we take a patient, long-term investment horizon and expect to hold the stock for decades, keeping portfolio turnover low. Generally speaking, we will only sell a stock if the safety of the dividend payment has come into question, the company’s long-term earnings power appears to have become impaired, the stock’s valuation reaches seemingly excessive levels, or we find a more attractive idea.”

As dividend growth investors, a dividend cut means the wealth-building stops, so, we know what to do. Deep-value investors may need more of a push. Research shows us that the probability of a successful outcome is greatly reduced after the dividend is cut or eliminated.