What makes a dividend stock safe? There are multiple perspectives — dividend safety, safety of principal, and ensuring you’re at least keeping pace with inflation. Some investors may even add “stock resilience” as a requirement for safety.
I’ll introduce three of the safest dividend stocks in Canada below.
Dividend safety
What makes a stock’s dividend safe? A sustainable payout ratio is a good criterion. Normally, Royal Bank of Canada’s (TSX:RY) payout ratio is around 50% of its earnings. Sure enough, its trailing 12-month payout ratio is 49% of its net income available to common shareholders. At times, such as during recessions, it has higher provision of credit losses (to prepare for higher levels of bad loans), which leads to its payout ratio being temporarily higher.
Because Fortis (TSX:FTS) is a regulated utility, it’s able to earn predictable returns on its assets. Since it provides essential electricity and gas services to its customers, its earnings tend to be stable throughout the economic cycle. Stocks that have predictable earnings can afford a higher payout ratio. The utility stock’s payout ratio is estimated to be about 77% of earnings this year.
Global alternative asset manager Brookfield Asset Management (TSX:BAM) has a track record of delivering solid long-term returns for its institutional and retail clients. So far, it has attracted US$800 billion of assets under management. It also earns predictable asset management fees. It’s a capital-light business so that it’s able to target a higher payout ratio of about 90%.
Safety of principal
Much like shopping for deals when you go to the grocery store or clothing store, stock investors should also shop for good deals on the stock market. Investors should aim to buy stocks at a discount, even if they’re shopping for the safest dividend stocks that tend to trade at a premium for their quality.
You can compare current stock valuations to their historical levels. You can also compare current stock valuations to the industry average. The lower the valuation you can pay versus the company’s normal earnings power (earnings it can earn in a normal economic environment), the safer your principal is.
Are you keeping pace with inflation?
You need sufficient returns to keep pace with inflation and maintain your purchasing power. Of course, the goal is to increase your purchasing power. To do that, your returns must beat inflation. Statistic Canada revealed that the latest inflation in February was 5.2%. So, in the current environment, investors would need to target returns of north of 5.2% to increase their purchasing power. Keep in mind, though, that the Bank of Canada targets the long-term inflation rate at about 2%, which is easy to beat.
All the stocks discussed trade at reasonable valuations and can grow their earnings at a good pace in the long run. So, they should increase your purchasing power for the long haul.
Stock resilience
Generally speaking, stocks that pay decent yields from their safe dividends are more resilient than the average stock that don’t pay dividends. That’s because investors are able to earn stable returns from the dividends alone.
RY data by YCharts
You can also look for stocks that have greater resilience versus their peers. For example, Royal Bank of Canada stock tends to have greater resilience than its peers. The above is an illustration, showing the price action of RY versus the ZEB ETF, which provides exposure to the Big Six Canadian banks.
