By Tom Bradley
In the Report on Business last week, John Heinzl, fondly known as the ‘Yield Hog’, dedicated his column (How a Focus on Dividends Can Transform Your Investing Approach) to a dividend-oriented portfolio managed by a real investor, Rob. It looks like a pretty good portfolio and there’s lots to like about what Rob is doing. He has specific criteria for approving stocks. The portfolio is limited to 20 holdings and is ultra low cost. And the companies have a history of growing their dividends.
But what does not come out in the article is any notion of valuation or risk management. Rob buys stocks that have a yield between 3% (“I didn’t want anything below 3% because it’s not much of a return”) and 6% (“... if it was higher than 6% I wasn’t sure how sustainable it would be ...”), but there’s no mention of how he determines what the companies are worth.
I raise this, because stocks are not like bonds - yield is not a valuation tool. Dividends come as a result of making a profit, and dividend growth is a consequence of profit growth. So while Rob’s portfolio is positioned as a conservative one, a key element in measuring risk, the price of an asset, does not appear to be front and center.
Also on the topic of risk, too often dividend investors run with relatively undiversified portfolios (a generalization of course). In Rob’s case, the portfolio (listed below) has exposure to five sectors of the economy – financial services, energy/utilities, REITs, pipelines and telecommunications – which means it’s narrowly focused and highly interest-rate sensitive. There’s no technology, healthcare, consumer products, retail or resources.
As I talk to investors and people throughout the industry, yield, steady income and dividends continue to be the dominant theme in the market. It’s off the scale really. And as a result, funds with the highest yields garner the biggest in-flows, lower quality bonds sell out in minutes and almost every new retail product has yield, income or dividend in the name.
Certainly there is plenty of demand for income from the baby boomers who are starting to retire, but there’s more to this trend than that. There are other forces at work, the prime one being past performance. Rob’s strategy has done well over the last five years ... really well ... and as a result, we see all kinds of investors running with income portfolios, even younger investors who have 20 plus years until retirement.
As I said at the beginning, there’s lots to like about a portfolio of companies that are growing their dividends, but it needs to be done in a balanced way that gives full consideration to risk and valuation.
Bank of Montreal
Bank of Nova Scotia
Sun Life Financial
Algonquin Power and Utilities
Canadian Apt. Properties REIT
Pembina Pipeline Corp.