Canadian shareholders have always been handsomely rewarded. The most valuable companies in the country are in relatively stable industries like finance, utilities, or oil. These industries tend to generate tremendous cash flow, which makes its way back to shareholders in the form of dividends or share buybacks.
In 2023, investors looking to generate passive income need to consider the rate of inflation and looming recession before picking their favourite dividend stock. Here’s a closer look.
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Economic uncertainty
A few years ago, dividend stocks were an attractive alternative for investors who didn’t want to leave their cash in a zero-interest-rate account. Now, the economic outlook is completely different. A government-backed guaranteed investment certificate (GIC) offers rates as high as 5%. Compared to that, a stock’s 3% or 4% dividend yield simply isn’t attractive.
Investors also need to consider inflation. Headline inflation is running at 5.1% right now, which is far higher than the average dividend yield on Canadian stocks.
Finally, investors need to steer clear of volatile sectors. The oil and gas sector had a cash windfall last year as energy prices surged. Now, oil prices have dropped substantially, which means net earnings in this sector are likely to be significantly lower. This will, eventually, impact dividends and buybacks for these cyclical stocks.
With all this in mind, investors should seek out a robust dividend stock with a stable business model.
The best dividend stock
I believe insurance and financial services could be the best sector for dividends right now. Power Corporation of Canada (TSX:POW) is one of the best examples. The company owns life insurance and financial planning services across three continents. This business model is far less volatile and much more lucrative than producing energy or issuing mortgages.
Power Corp currently offers a 5.6% dividend yield, substantially higher than the industry average. In fact, the dividend yield is better than a typical GIC and higher than inflation, too.
Power Corp is also actively repurchasing its shares. Earlier this year, the company’s management team declared a new buyback program. This new program would allow the team to buyback up to 5.4% of the company’s outstanding shares between March 1, 2023 and Feb. 29, 2024. This should enhance the total shareholder rewards for this year.
The stock is up 8.8% year to date. Despite this, it’s still trading at just 11.6 times earnings per share, which implies an earnings yield of 8.6%. Put simply, Power Corp is an undervalued dividend stock that has plenty of room to enhance shareholder rewards in the months ahead. Keep an eye on this opportunity.
