Dividend investing continues to grow in popularity among investors. Not only are dividends treated favorably for taxation purposes, but they allow investors to enhance returns and mitigate risk. But the secret to dividend investing is selecting those companies with a relatively stable stock price, paying a sustainable dividend with a reasonable yield.
As such, when picking dividend paying stocks I prefer to focus on large-cap stocks with a low degree of leverage, a dividend payout ratio of less than 50% and a dividend yield of at least 3%. The reason is that I want a dividend yield that is higher than the rate of inflation as well as the yield on 10-year Canadian government bonds. I also only invest in those companies that pay eligible dividends, thus making this dividend income tax-effective.
While investors should be seeking companies with relatively stable stock prices, they should not ignore the opportunity for capital growth. As a result I have focused on those companies which fit the above criteria and have a price-to-earnings ratio of 14 or less. So let’s take a closer look at my top three dividend picks for 2014.
Buy into this impressive history of dividend growth
One company that stands out for all the right reasons is Agrium (TSX:AGU) (NYSE:AGU). It is a defensive stock — meaning it remains relatively stable during all phases of the business cycle or in times of uncertainty in the market — and has relatively low level of leverage with a debt-to-equity ratio of under 0.6.
Agrium pays an impressive dividend yield of just over 3% and with a payout ratio of under 10%, it is clear the dividend is under no threat at this time. Even more impressive is that Agrium has consistently grown its dividend since 2002, giving it a compound annual growth rate of almost 30%.
Agrium’s share price fell by 7% over the last year, leaving it to now be trading with an attractive price-to-earnings ratio of just over 11 indicating that the company is moderately undervalued by the market.
I also expect to see Agrium generate consistent earnings through 2014 with continuing strong demand for its retail products. The company is also well positioned to leverage the synergies from the acquisition of Viterra, which made Agrium Canada’s biggest agricultural retailer.
Emerging market exposure without leaving Canada
My next pick is Canada’s second largest mortgage lender by market share, the Bank of Nova Scotia (TSX:BNS) (NYSE:BNS). Like its peers, the Bank of Nova Scotia reported solid 2013 full year results on the back of Canadians’ ongoing passionate love affair with housing and credit.
With a dividend yield of 3.8%, it is not the highest yielding of Canada’s banks — that honor goes to CIBC yielding 4.3% — but I believe it possesses the greatest growth potential of the big five. This is because it has a diverse international portfolio with significant operations in some of Latin America’s most under-banked and fastest growing economies.
It is also clear that with a debt-to-equity ratio of 0.14 and a payout ratio of 45%, the dividend is sustainable and not under threat. But unlike Agrium, the Bank of Nova Scotia’s dividend has only grown modestly over the last 10 years with a compound annual growth rate of under 4%. But this consistent dividend growth exceeds Canada’s average annual inflation rate over the same period.
Over the last year, the Bank of Nova Scotia’s share price has remained relatively flat. Based on its price-to-earnings ratio of 12 coupled with a price-to-book ratio of 1.8 it appears to be good value, particularly when its solid growth prospects are considered.
Invest in this attractively priced real estate company for growth and yield
I have never been a fan of property investment companies for a variety of reasons including their high levels of leverage and the illiquidity of their assets. But there is very little about Brookfield Office Properties (TSX:BPO) (NYSE:BPO) not to like.
Not only does it pay a dividend with an attractive yield of 3%, with a low payout ratio of 22% — indicating the dividend is sustainable — but its dividend has a 10-year compound annual growth rate of almost 9%. On the basis of its price-to-earnings ratio of eight and a price-to-book ratio under one Brookfield also clearly appears undervalued by the market.
The company also has strong growth prospects for 2014, having spent 2013 consolidating its business and becoming a pure play asset manager. This move will certainly pay off for investors over the long term. Brookfield will be able to benefit from its ownership stakes in the underlying real estate platforms while earning growing fee revenue through managing those assets.
Foolish bottom line
All three companies’ dividend payments tick all the right boxes, being classified as eligible dividend payments that are growing in value and with yields greater than the current 10-year government bond yield. Finally with all three having payout ratios of less than 50% the dividend payments appear sustainable.
But what makes these three dividend stocks standout is the considerable growth potential they offer investors. Each company is well positioned in its industry to continue growing its underlying business. Providing investors not only with a regular tax effective income stream but also the opportunity for sustained capital growth.
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Fool contributor Matt Smith does not own shares in any of the companies mentioned.