Dividend investing is one of the most popular ways Canadians build passive income. There’s something satisfying about receiving regular cash payments from companies you own, especially when those payments increase over time. But before building a dividend portfolio, I’d ask yourself one question: Do you actually need the income right now?
If you’re investing for retirement decades away, I wouldn’t necessarily screen companies based on whether they pay dividends. Total return, which includes both capital appreciation and distributions, is what ultimately matters. A company that reinvests its profits at attractive rates can create just as much shareholder wealth as one that regularly distributes cash.
On the other hand, if your goal is to generate passive income, dividend stocks can be an excellent fit. They’re particularly appealing inside a Tax-Free Savings Account (TFSA), where dividends and capital gains are generally tax free. So, if I were building my first Canadian dividend portfolio today, here’s how I’d approach it.
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How I’d screen for dividend stocks
First, I’d start with sector representation. Canada’s stock market is heavily concentrated in financials and energy, so any dividend portfolio built around domestic companies will probably have substantial exposure to banks, insurers, pipelines, and oil and gas producers. But I wouldn’t overlook other sectors simply because their yields are lower.
Next, I’d look beyond the headline dividend yield. A stock yielding 8% might seem more attractive than one yielding 3%, but an unusually high yield can signal that the market expects trouble. Remember, dividend yield rises when a company’s share price falls, even if its underlying financial position is deteriorating.
That’s why I would examine the payout ratio. For most companies, this means comparing dividends paid with earnings. For capital-intensive businesses such as utilities, pipelines, telecommunications companies, and REITs, I’d pay particular attention to free cash flow or the relevant industry-specific cash flow measure.
Third, I’d examine dividend growth. A company with 20 consecutive years of dividend increases certainly deserves consideration. But I’d also want to know how quickly those payments have grown. If management has raised the dividend by only 2% annually for the past decade, shareholders are barely keeping pace with inflation, if at all.
Finally, I’d consider payment frequency. Most Canadian dividend-paying corporations distribute cash quarterly. Some companies pay monthly, while REITs and certain royalty trusts are particularly well known for monthly distributions. Monthly payments can be convenient if you’re using dividends to cover living expenses. But I wouldn’t sacrifice other factors just to receive cash more frequently.
Want to automate everything? Consider XDIV
If researching payout ratios, monitoring dividend increases, and rebalancing individual stocks sounds like too much work, there’s a simpler alternative. The iShares Core MSCI Canadian Quality Dividend Index ETF (TSX: XDIV) packages much of that process into a single exchange-traded fund (ETF).
XDIV tracks the MSCI Canada High Dividend Yield 10% Security Capped Index, which focuses on Canadian dividend-paying companies with characteristics such as relatively strong balance sheets and less volatile earnings.
The ETF currently offers a 3.1% trailing 12-month distribution yield, paid monthly. However, diversification is a limitation. XDIV holds just 20 stocks, with approximately 45% of its portfolio invested in financials and another 31% in energy.
For investors seeking broad diversification across the Canadian economy, that’s a meaningful trade-off. But if you’re deliberately looking for a focused portfolio of established Canadian dividend payers, I think the methodology makes sense.
The cost is another advantage. XDIV charges an expense ratio of just 0.11%, Historically, performance has also been impressive. Over the trailing five-year period, XDIV delivered an annualized total return of 19%, assuming distributions were reinvested.
