If you’re buying your first Canadian dividend stock and want one that’ll hold up in any market, you’ll want a business that keeps paying investors steadily whether the economy is booming, sluggish, or in a full-blown downturn. That means thinking more about reliability than excitement. So before you dive into the first dividend stock with a high yield, let’s look at what investors want to consider, and one perfect option on the TSX today.
Source: Getty Images
Considerations
Start by looking at the source of the dividend. A healthy dividend comes from consistent free cash flow. Investors want companies that make money every quarter from products or services people always need: electricity, internet, groceries, banking, transportation, or energy. Then, check the track record. Any dividend stock can start paying a dividend when times are good, but only the strongest maintain or increase it through rate hikes, recessions, and inflation spikes. Look for at least 10 years of uninterrupted payments.
The payout ratio is another must-check. This tells you how much of the company’s earnings go to dividends. Anything above 80% can be risky, especially if profits dip during a downturn. A payout ratio under 70% leaves room for error, as well as for dividend growth. Then look at debt and interest coverage. High debt levels aren’t automatically bad, but become dangerous when borrowing costs rise. A quick check: if a company’s interest coverage ratio is well above three, it’s in safe territory.
Valuation also matters more than most people think. Even a great dividend stock can disappoint if you overpay. Look at the stock’s price-to-earnings or price-to-cash-flow ratios versus its own 10-year average. Buying below that long-term average gives you a built-in cushion. And don’t ignore dividend growth potential either. A 4% yield today that grows 5% annually is better than a 6% yield that stays flat. Over time, rising dividends mean rising income and usually rising stock prices, too.
Why RY works
Royal Bank of Canada (TSX:RY) is Canada’s largest bank by market value and one of the major players in North American banking. It offers personal and commercial banking, wealth management, capital markets, and insurance. Because it is diversified across geographies and business lines, it’s less exposed to the ups and downs of one narrow niche.
Royal Bank declares its quarterly common-share dividend reliably, most recently $1.54 per share for the next payout. The forward dividend yield is in the ballpark of 2.8% according to recent data, with the payout ratio at a moderate 45% of earnings. This leaves room for stability and growth rather than the company living hand-to-mouth just to keep paying the dividend. Plus, the bank has a history of increasing its dividend at a compound annual growth rate of about 6%.
There are a number of reasons the dividend stock works in any market. Banking is a fundamental part of the economy. Whether the market is up, down, or sideways, people still need banking services, and that gives a baseline of stability. With that diversification as well, if one segment slows, others may pick up the slack. That reduces the risk of major disruption. All this allows the dividend stock to keep growing, and keep paying investors.
Now, no stock is perfect, so there are a few items to watch. For instance, banking is cyclical. Therefore, credit losses, economic downturns, regulatory changes, and interest-rate swings can hurt earnings and thus the bank’s ability to raise dividends. Even large, diversified banks aren’t immune to global economic shocks or domestic crises.
Foolish takeaway
If I were picking a Canadian dividend stock to hold through different market regimes, RY would be high on the list of “core holdings.” It checks many of the boxes of stability, moderate payout, growth potential, diversification, and a proven track record. It may not deliver the highest yield in the universe, but for a dividend stock you can hold without worrying too much about a payout cut during rough patches, it works.
