Dividend investing started gathering momentum after the tech bubble burst in the first half of 2022. The way the stock market works, growth stocks rise when the economy grows, and dividend stocks are in demand when the economy is weak.
The trend of dividend investing in Canada
Rising interest rates slowed economic growth. A 5% interest rate shifted investors’ focus to low-risk bank deposits. When you can get a guaranteed return of 5% on fixed deposits, dividend stocks have to offer higher returns for the risk that comes with the stock market.
This risk-return trade-off puts downward pressure on dividend stocks. When the dividend stock price falls, the yield rises. The yield is the annual dividend per share as a percentage of stock price. Let’s take the example of Enbridge (TSX: ENB). It is an evergreen stock with a 7.6% yield ($3.55/$46.22). Its fundamentals have also been good as oil and gas demand recovered to the pre-pandemic level. After surging 37% between January 2021 and June 2022 in the pandemic recovery, the stock fell to its pandemic level of $44–$46.
One of the reasons behind this dip was the need for a yield above 5%. If you notice the trend, the stock fell between June 2022 and July 2023, when the interest rate surged from 0.25% to 5%. Many economists believe the interest rate has peaked, and the Bank of Canada will start cutting the rates from 2024 onwards. As interest rates fall, Enbridge’s stock could rise. Now is a good time to shift from bank deposits to dividend aristocrats like Enbridge, as they could give you a 7% yield and 10–12% capital growth.
I believe dividend investing could surge through interest rate cuts.
Recession and dividend investing in Canada
However, the above trends of interest rates and dividend stocks might not work if the economy enters a recession. Canada stalled a recession in 2020 by giving generous stimulus packages. However, pulling back the stimulus package could take a toll and a recession could occur in 2024.
A recession impacts the lives of people. Daily essentials become expensive, and there is no job security. Households cash in on investments when income is low and expenses high. In a recession, the economy falls, and everything from growth to dividend stocks falls. At times like these, companies with ample liquidity and lower expenses survive the downturn and revive during recovery.
Enbridge has survived many recessions in its over 68-year dividend history. It can survive a recession without a dividend cut as it only pays out 60–70% of its distributable cash flow (DCF). The remaining 30% gives it flexibility to sustain its payouts in tough times.
The future of dividend investing
Enbridge has served its investors well with dividend growth for a long time. The energy industry is transitioning towards greener alternatives, and Enbridge is transitioning towards liquified natural gas pipelines. This transition could help it grow dividends for years, but the growth rate will slow from the previous 10%.
The next growing dividend sectors are real estate and telecom. These sectors are currently going through some capital inefficiencies. But they could give long-term dividends as they mature and become more efficient. BCE and CT REIT (TSX: CRT.UN) are good alternatives within these sectors. CT REIT is among the few REITs growing its dividends at an average annual rate of over 3%.
CT REIT is buying stores from its parent Canadian Tire and third-party owners. It is developing these stores and collecting rent. Unlike other REITs, CT REIT has maintained lower debt and is using 72.5% of its distributable cash flow to pay distributions. A lower payout ratio gives the REIT flexibility to maintain and grow dividends in tough times.
Investor takeaway
You can boost your dividend portfolio when the economy is weak or interest rates are at their peak. The risk premium these stocks will give in the form of higher yields can compound your passive income in the long term.
