The Bank of Canada continued with a 0.25% interest rate hike this month, raising the policy interest rate to 4.75%. Some experts are calling the current interest rate the norm. Perhaps we were too comfortable with an extended period of low interest rates from about 2010 to early 2022.
What can Canadians do in a higher interest rate environment when the cost of borrowing is increasing and everything else from electricity to gas to groceries — you name it — is becoming more expensive or at least have a higher price tag?
One thing that can help is for you to make passive income from dividend stocks. Here are some top must-own dividend stocks that pay big dividends.
Want big current income?
If you need income now, Enbridge (TSX:ENB) stock is a good start. At $50.62 per share at writing, it offers a whopping dividend yield of 7%, which is hard to beat for a Canadian Dividend Aristocrat that has a long history of paying dividends.
The large North American energy infrastructure company has not missed a dividend payment for about 70 years. And it has paid an increasing dividend for roughly 27 consecutive years. Its attractive dividend yield and long history of safe dividend payments are why the stock doesn’t trade at a big discount most of the time.
At the recent quotation, analysts believe it trades at a discount of about 14%. Let’s say it took the company five years to fill that valuation gap. The total return of this blue-chip stock would be roughly 10% per year over a five-year period.
Passive-income stock on sale
Big Canadian banks are increasing their loan loss provisions in this higher-risk macro environment where there will be a higher percentage of bad loans. In other words, the banks are setting aside a greater reserve in anticipation of a potential recession. Bank of Nova Scotia (TSX:BNS), in particular, appears to be the riskiest of the big Canadian bank stocks, as it currently offers the highest dividend yield of approximately 6.4% at $66.13 per share.
Higher loan loss provisions reduce the banks’ earnings. A release of those provisions, when the economy improves, will result in a bump in the earnings and likely dividend increases. A reversion to the mean could result in meaningful long-term price appreciation for BNS shareholders. Meanwhile, you get to pocket its large dividend for passive income. A return to its normal valuation could result in potential price appreciation of about 40% over the next few years.
The bank’s expanded payout ratio remains sustainable at about 58% this year. (The ideal payout ratio is 40-50%.) And Bank of Nova Scotia continues to increase its retained earnings reserve that it could use as a buffer for its dividend (if needed), as it remains profitable through the economic cycle.
Investor takeaway
Between the two stocks, Canadians can get a high average yield of 6.7%, which is taxed at lower rates than interest income. For reference, the best one-year GIC rate is about 5.2%. However, stocks are meant for long-term investment.
Don’t just buy one or two stocks for passive income. Instead, diversify your portfolio to spread your risk. A diversified portfolio might include a diversified basket of quality stocks, bonds (or stock and bond exchange-traded funds), real estate, business, crypto, etc.
