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Dividend All-Stars (Fall 2016)

The grim spectre of stagnation is reaching out from the grave of economics to drag down interest rates across the world. The yield on long-term Canadian government bonds has fallen to a mere 1.8%, but that's sky high compared to the negative yields seen in Japan and parts of Europe.

It's no wonder that investors are fleeing bonds and heading to the high seas of the stock market instead. They're prepared to ride the market swells, and weather its storms, in the hopes of earning more than a dram of income over the long term.

We're here to offer a steady hand on the tiller with this year's Dividend All-Stars, which steers investors to the best income-generating stocks in the land. It marks the tenth anniversary of the strategy, which has profitably navigated through some big storms along the way.

Our top stocks steamed ahead since last time. The A-graded stocks gained 14% on average over the last year while the A-and-B stocks climbed by an average of 13%. In comparison, the S&P/TSX Composite ETF (XIC), which tracks the broad Canadian stock market, advanced 11% and the dividend-oriented iShares Canadian Select Dividend ETF (XDV) gained 11% over the same period.

We're pleased to say that our efforts have also been highly profitable over the long term. If you had purchased an equal dollar amount of each A-graded stock in your RRSP and rolled the proceeds into the new ones each year, you'd have gained a total of 148% since we started way back in 2007. Similarly, a portfolio of A-and-B stocks would have climbed 88%. By way of comparison, the S&P/TSX Composite Index ETF (XIC) logged a return of 39% over the same period and the dividend-oriented iShares Canadian Select Dividend ETF (XDV) advanced 50%. (The returns above include periodically reinvested dividends.)

While our method provided an extra edge, we weren't surprised by the outperformance of Canadian dividend stocks because market studies have extolled their virtues for a long time. For instance, Dartmouth professor Kenneth French studied various stock picking strategies in markets across the world and found that dividend stocks fared particularly well in Canada.

In one study Professor French sorted Canadian stocks by dividend yield at the end of December and put them into three portfolios. The first portfolio held the 30% of stocks with the highest yields and the second contained the 30% of stocks with the lowest yields. The final portfolio tracked stocks that didn't pay dividends. The portfolios were followed for a year and then the process was repeated. As a result, it was possible to calculate their returns over several decades.

The accompanying figure shows the growth of each portfolio along with that of the Canadian stock market. You'll notice that the high-yield stocks handily outperformed the market by an average of 4.0 percentage points a year from 1977 through to the end of 2015. The low-yield group underperformed by 0.5 of a percentage point annually over the same period.

But take a gander at the miserable returns generated by the no-dividend group, which trailed the market by an average of 7.2 percentage points a year from 1977 through 2015. While it had a strong run in the late 1970s, the group peaked in 1981, and then crashed. Shockingly, the non-dividend payers failed to fully recover during the decades since then.

Aside from strong past performance, focusing on dividends can lead to behavioural benefits for many investors. Think of it this way. Stock market crashes cause a great deal of stress, but dividend yields rise when stock prices fall. That tends to make them more attractive to dividend aficionados. As a result, they're more likely to load up - or at least stay invested - when prices are low.

Hunting For Dividends

When looking for good dividend stocks we evaluate each candidate based on its yield, reliability, and value. You can read about the process on page TK, but we boil everything down to an easy to use letter-grade that sums up a stock's investment potential.

Firms with the best prospects are awarded As and solid candidates get Bs. We think both are worthy of your consideration. Middle of the road firms get Cs while those in need of improvement get Ds or even Fs.

A select group of seven of stocks managed to earn As this year while 11 picked up solid Bs.

The All-Star Leaders

Three big banks got top marks last year and did so again this year. They are the Bank of Nova Scotia (BNS), the Bank of Montreal (BMO), and TD Bank (TD), which offer yields of 4.2%, 4.0%, and 3.8% respectively. They are joined by CIBC (CM), which gained a grade level this year and provides a 4.7% yield.

All of the banks generate more income via their dividend yields than they offer on their 'high interest' savings accounts, albeit with more risk. After all, recent revelations of skulduggery in the nation's real estate sector should be of concern to bank shareholders. It's a big reason why wise investors diversify broadly.

Insurance firms Great-West Lifeco (GWO) and Sun Life Financial (SLF) made it to the top of the class again with yields of 4.4% and 3.9% respectively. The same is true of, Genworth MI Canada (MIC), which provides mortgage insurance and a hefty yield of 4.9%. Worries about the real estate market weigh on the stock, which trades at 9 times earnings and 88% of book value. A crash would put it to the test.

The B Team

Just a step behind, the B-list starts with Royal Bank (RY) and National Bank (NA) with yields of 4.1% and 4.7% respectively.

They're joined by insurance firms Industrial Alliance Insurance (IAG) and Manulife Financial (MFC). Both are returning B-graders as is asset manager IGM Financial (IGM), which offers the highest yield of the bunch at 6.2%.

Financial conglomerate Power Corporation of Canada (POW) rounds out the B-Team's list of financials. The firm slipped a grade point this year, but still provides a hefty 4.8% yield and trades near book value. It also owns stakes in highly-rated Great-West Lifeco, IGM Financial, and Power Financial.

The B-list continues with auto-parts firms Linamar (LNR) and Magna (MG), which offer relatively modest yields, strong dividend growth, and low price-to-earnings ratios of 7 and 8 respectively. Keeping with the transportation theme, WestJet (WJA) picked up a B and delivered top notch dividend growth over the last five years.

Electric utility Fortis (FTS) and Shaw Communications (SJR.B) round out the team. Fortis is a little expensive at 21 times earnings while Shaw is relatively cheap at just under 10 times earnings.

A Caveat

Use our grades as the starting point for your own research. Before buying any stock, make sure its situation hasn't changed in an important way and that it's right for your portfolio. Read the firm's latest press releases and regulatory filings. Scan newspaper stories to make sure you're aware of important developments and breaking news.

Look beyond the grades and think about the unique or intangible features of each company. Such factors can be beneficial, like a recent technological development. But they can also be detrimental, like the sudden arrival of new competition. Similarly, we're in an aging bull market, which means that you should be prepared for storm clouds on the horizon.

While we're pleased with our long-term track record, we can't guarantee that you'll make a fortune with every A- or B- rated stock. The market is just too wild and woolly for that. Nonetheless, we do think they deserve your attention and further research.

Dividend All-Stars
A Grade Stocks
Bank of Montreal (BMO)
Bank of Nova Scotia (BNS)
Genworth MI Canada (MIC)
Great-West Lifeco (GWO)
Sun Life Financial (SLF)
TD Bank (TD)
B Grade Stocks
Fortis (FTS)
IGM Financial (IGM)
Industrial Alliance Insurance (IAG)
Linamar (LNR)
Magna International (MG)
Manulife Financial (MFC)
National Bank of Canada (NA)
Power Corp of Canada (POW)
Royal Bank of Canada (RY)
Shaw Communications (SJR.B)
WestJet Airlines (WJA)
As of September 1, 2016

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Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...