The surge in interest rates over the past 18 months has triggered a sharp pullback in the share prices of some great Canadian dividend stocks. Competition from fixed-income options and the impact of higher debt expenses are likely to blame.
Contrarian investors seeking high yields and attractive potential capital gains are wondering which top TSX stocks are now undervalued and good to buy before interest rates begin to fall.
When will interest rates decline?
The Bank of Canada is raising interest rates as part of its effort to get inflation under control by cooling off the economy.
Rising borrowing costs normally force consumers to reduce spending as they allocate more cash flow to cover increased debt costs. Businesses also get hit by rising rates and might decide to shelve investment decisions due to the elevated borrowing expenses.
At this point, the economy appears to be slowing down as a result of the rate hikes that occurred over the past year and a half. Inflation is slightly above 3% compared to 8% in June 2022. As soon as the Bank of Canada is confident inflation is headed to its 2% target, the rate hikes should end. In fact, rates will likely begin to drop to avoid a severe recession.
Economists have varied opinions on when the Bank of Canada will start to cut rates. Some estimates see the first reduction occurring in the first quarter (Q1) of 2024.
Investors might want to get ahead of the rate cuts and start buying top dividend-growth stocks while they are out of favour. As soon as the rates offered on Guaranteed Investment Certificates (GICs) begin to fall, there could be a flood of funds back to high-yield stocks.
TC Energy (TSX:TRP) trades near $50 per share at the time of writing compared to more than $70 last summer.
The drop appears overdone, considering TC Energy expects its $34 billion capital program to drive enough cash flow to support planned annual dividend increases of 3-5%. TC Energy has increased the dividend annually for more than two decades. Investors who buy the stock at the current price can get a 7.4% yield.
BCE (TSX:BCE) raised its dividend by at least 5% annually for the past 15 years. The stock currently trades below $55 compared to $65 a few months ago.
BCE cut staff this year to adjust to a slowdown in advertising spending in its media business, but management still expects total revenue and free cash flow to be higher in 2023 than in 2022. Ongoing strength in the mobile and internet subscription businesses should offset the media woes.
At the time of writing, BCE stock provides a 7% dividend yield.
Bank of Nova Scotia
Bank of Nova Scotia (TSX:BNS) has underperformed its peers in recent years. The stock trades for about $65 at the time of writing compared to more than $90 in early 2022.
Investors are concerned that the Bank of Canada might keep interest rates too high for too long and cause an economic downturn that is more severe than anticipated. The result would likely be a surge in loan defaults as businesses run out of savings to cover higher loan expenses and households default on car payments, mortgages, and credit card loans. A jump in unemployment could lead to a sharp decline in the housing market.
Where things will end up is anyone’s guess, but Bank of Nova Scotia stock already appears priced for an ugly economic scenario that might not materialize. The bank has a solid capital cushion to ride out some tough times and remains very profitable, even in the current economic situation.
Bank of Nova Scotia raised its dividend when the bank reported the fiscal Q2 2023 results, so there doesn’t appear to be much concern about the profit outlook. Investors who buy BNS stock at the current level can get a 6.5% dividend yield.
The bottom line
TC Energy, BCE, and Bank of Nova Scotia pay attractive dividends that should continue to grow. If you have some cash to put to work, these stocks look cheap and deserve to be on your radar.