I saw a headline recently that caught my attention; it wasn’t so much because of the words themselves, but the content that followed.
The headline: “This 5-Stock Portfolio Crushes the S&P 500.”
I’m a big fan of easy-to-assemble portfolios, so I eagerly read the entire article from start to finish; I came away with several points dividend investors need to keep in mind when selecting dividend stocks for their portfolios.
Forget about dividend yield
Don’t fixate on an arbitrary number such as the average dividend yield of the S&P/TSX Composite Index, or, if you’re investing in U.S. stocks, the S&P 500. If you do, you’ll potentially miss out on some significant capital appreciation.
Take Visa Inc. (NYSE:V) for example. Its current dividend yield is 0.74%; that’s not good enough for income investors who are relying on this cash flow to pay the bills.
However, over the past five years, while Visa’s dividend yield has stayed in a tight range between 0.63% and 0.78%, its dividend has actually grown by 200%, providing Visa shareholders who’d held the entire period a total return of 215%. In addition, the yield on their original investment would now be 2.3% — not the original 0.69%.
So, forget about dividend yield. Total return is what counts.
What to look for
Three things are critical to successful dividend investing.
- Earnings growth: Without growing earnings, it’s virtually impossible (except by borrowing) for companies to meet the next two points.
- Payout ratio: Generally, you want to invest in companies that aren’t paying out more than 50% of their dividends because that leaves room for my third point.
- Dividend growth: Two things drive share prices higher — earnings growth and dividend growth. While the former is the more important of the two, the latter is essential to dividend investors.
Easy criteria for finding good dividend stocks
I went ahead and did a stock screen that looked for Canadian stocks with market caps of $500 million or more, five-year earnings growth of 10%, a payout ratio of less than 50%, and dividend growth of 10% or more.
While I’m not a mathematician, I came up with the following formula to weed out the imposters:
Five-year earnings growth rate + dividend-growth rate ÷ payout ratio
My stock screen came up with 22 stocks that met the three criteria from above. Only those stocks with a quotient of two or more make the list.
Here are my five dividend stocks to own for the next five years.
While the Waterloo company has only paid a dividend since June 2013, it’s grown steadily since then. Open Text Corp. (TSX:OTC)(NASDAQ:OTEX) helps companies share content both in the cloud and in the office. Fool.ca contributor Joey Frenette wrote about the tech company in January, calling is a “rare” technology gem.
Yes, I know its dividend yield is only 0.4%, but Dollarama Inc. (TSX:DOL) is, hands down, the best discounter in this country that’s actually based in Canada. Some wonder about its ability to continue to grow, but should earnings and revenues slow, its 11.1% payout ratio leaves it with lots of room to grow dividend.
The maker of railway ties and hydro poles has seen a slowdown in revenue after five years of steady growth; it’s to be expected that business would experience a hiccup or two along the way. Stella-Jones Inc. (TSX:SJ) is a well-run company; in January, I recommended that investors look to buy its stock after hitting a 52-week low.
The steady-as-she-goes Winnipeg packaging company is benefiting from a surge in Canadian exports — January 2017 was third straight month with trade surplus — and as the Canadian dollar continues to weaken, Winpak Ltd. (TSX:WPK) is only going to get stronger.
If there’s a better stock to have owned the last five-years — with a total return of 52.8% — I’d sure like to know about it. CCL Industries Inc. (TSX:CCL.B) continues to make all the right moves when it comes to acquisitions and expanding into new markets. It’s one of my favourite Canadian stocks and a proven money maker.
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Fool contributor Will Ashworth has no position in any stocks mentioned. The Motley Fool owns shares of Open Text and Visa. Open Text is a recommendation of Stock Advisor Canada.