Investment warning — you can be too safe for your own good
Even when interest rates go up, you’ll be safest with good quality dividend stocks, says a Canadian analyst who has four to recommend.
If you’re getting fed up with the stock market these days, you could opt for safe returns.
Try some Government of Canada treasury bills and GICs. They’re as stable and safe as you can get.
And at today’s rates you’ll double your money in ... let’s see, about sixty years.
Not interested? Neither is Mr. David Baskin.
Mr. Baskin is the owner of a sailboat called Safe Returns, he writes in The MoneyLetter. And as head of his own wealth management firm, he certainly works to keep investments out of harm’s way.
But that’s not enough. He wants a lot more wind in his sails when he sets his investment course.
He doesn’t propose that otherwise conservative investors throw caution to the winds and jump into small caps or penny stocks. He does recommend four solid dividend-paying stocks.
But above all, he says, be aware that safe can be sorry.
Striking dividend yields
Mr. Baskin has done the math for the past 10 years. Even in a tax-protected account, an RRSP or an RRIF, after-inflation returns for 90-day Treasury bills and five-year GICs were “an anemic 1.2 per cent.”
Suppose instead that an investor had put his or her money into equal quantities of the largest Canadian bank, telecommunications, pipelines and utility stocks and simply held the shares for the past decade.
The four stocks that filled the bill were Royal Bank of Canada (TSX-RY), Bell Canada (TSX-BCE), TransCanada Corp. (TSX-TRP) and Fortis Inc. (TSX-FTS).
Mr. Baskin supplies a table that shows the difference in graphic detail. The average annual real return of these stocks after tax was 9.24 per cent.
But the most striking number in this analyst’s mind is the average annual dividend yield. For these four stocks taken together it was 7.58 per cent. “All of these companies raised their dividends considerably over the ten year period,” he adds.
Even Bell, which of course dropped its dividend altogether during its failed privatization attempt.
The analyst drives the point home. “The long term holder of shares in these blue chip companies got paid more and more each year, whether the market went up or down, whether interest rates increased or decreased.”
More than a nickel
There are many advantages to this strategy, says Mr. Baskin. Taxes, for one. Dividends are taxed at about 23 per cent, half the rate of interest.
“The after-tax value of the dividend yield is more than 5.5 per cent a year — equal to a bond paying more than 10 per cent a year.”
So even if these stocks had not increased in value by a nickel, he says, “the return on the dividends alone would have been much better than the so-called safe investments.”
But the stocks did increase in value, and by a lot more than a nickel. If you had cashed out these “four boring blue chip high dividend stocks” at the end of the decade, you would have had a post-tax return of over five per cent to add to the high dividend yield.
The analyst concedes that interest rates have been uncommonly low over the past 10 years. Yet in the same decade stocks fell hard, twice. The tech stock crash of 2000 and 2001 brought them down. Seven years later, the worst bear market in 70 years did even greater damage.
All in all, then, the past 10 years are a pretty fair test of the comparative returns between good quality stocks and the safest investments, says the analyst. Note he said “good quality stocks.”
Four to recommend
Interest rates will go up, concedes Mr. Baskin. This will send many investors flocking to safe returns, in order to lock in the new higher rates.
“If history is any guide, this will be the wrong move,” the analyst insists. “During times of increasing inflation, bonds will do even worse, falling further and further behind the cost of living.”
The best strategy over time, he repeats, is to buy high quality companies that raise their dividends regularly.
He has four to recommend. He has kept two of the four he used for his 10-year survey, but changed the bank and the telecommunications stock.
TransCanada Corp. is still this analyst’s favoured pipeline company. Last week, TransCanada announced solid but unexciting results (as usual), and it has already raised the dividend this year (as usual).
It trades at $35.92 and yields 4.4 per cent on the dividend of $1.60. Its 10-year average annual yield was 8.8 per cent.
Fortis has raised its dividend 37 years in a row, most recently in January. “Like TransCanada, Fortis is insulated from economic vagaries in its utility operations,” the analyst tells his readers in The MoneyLetter.
It is trading at $26.91 and yielding 4.2 per cent on the $1.12 dividend. Over 10 years, its annual average yield hit 9.54 per cent.
Among the banks, Mr. Baskin has turned to Bank of Nova Scotia (TSX-BNS). He likes its growth prospects thanks to its operations in Latin America and southeast Asia. This will offer capital gains as well as yield.
Scotiabank trades at $50.77 and yields 3.8 per cent on a dividend of $1.96. None of the big banks has raised its dividend yet this year.
Telus Corp. (TSX-T) is the analyst’s telecom choice, despite some tough sledding in the past year. As if to reward Mr. Baskin’s confidence, the company yesterday released surprising results that beat analysts’ expectations — and came wrapped with a dividend increase.
Telus trades at $38.65 and yields 4.9 per cent on the $1.90 dividend, which rises to $2.00 in July for shareholders of record as of June 10.
In the end, this analyst concludes, the only truly safe return is one that involves some risk. Otherwise, you’d just sit in the harbour all day, go nowhere and get nothing in return.
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