This is a guest post by passionate investor Mike Heroux who authors The Dividend Guy Blog.
I must tell you, since Dale started this blog, I’ve been a fan. While we are very different in many ways; we share something in common: the urge of sharing our investment knowledge and to make sure investors don’t get the “usual crap” from big firms.
One of our common fights is against the “one size fits all” strategy some investors or advisors share. There are multiple ways to achieve your financial goals and the best person to know is yourself. Nobody cares more about your money than you do.
The creation of the first Exchange Traded Fund (ETF) over a decade ago was a radical change in the investing world. For the first time in the stock market history, the small investors could win. ETFs brought instant diversification and a professional investing approach at a very small cost. Over the years, specialized ETFs were created helping investors selected sub-sectors or tracking specific strategies to improve their returns. There are virtually new ETFs coming on the market on a daily basis.
Is it now time to get rid of your hand picked stocks and jump in the ETF train? Many will tell you can’t beat the market. Is it worth it to pick stocks and build your own portfolio? Why not let professionals do the hard job and follow a “couch potato” investing approach?
While I appreciate ETFs and I think it’s a great investing product for many investors; I still prefer picking stocks to build my own “ETF”. I even think you can find marvels within the Canadian stock market. And I’m not talking about banks and telecoms here.
The Canadian Stock Market Challenge : Finding Diversification
Most ETF lovers will tell you that the only way to achieve your financial goals is to invest in… surprise… ETFs. While ETFs investing will offer you a great way to diversify your portfolio, it may not be right when it comes down to finding diversification among Canadian stocks. If you follow large ETF index such as the XIU, you will end-up with 50% of your money invested in financial services, energy and basic materials. This is not exactly what I would call “being diversified”.
If you have been investing for a few years, you already know how the energy sector is volatile. For one reason or another, the oil price goes up or drop like a rock without indication. I remember reading very well detailed research telling us the oil barrel would hit $200 very soon. That was in 2007. Then, the same economists were writing it would stay at $35-$45 for a while. That was in 2009. Can you guess how much we will pay for oil next year? I can’t. This is why I stay away most energy companies. They make very bad dividend growers in general as their cash flow generation abilities isn’t stable.
How can you diversify you Canadian portfolio then? Here’s the methodology I followed to build my own portfolio.
Start with the “classics”
The Canadian economy is built on one of the world’s most solid banking systems. Such a stable environment will grant investors great opportunities in a few sectors.
Canadian Banks: I personally go with Royal Bank (RY.TO) and National Bank (NA.TO).
Over the past 5 years, Royal Bank did well because of its smaller divisions acting as growth vectors. The insurance, wealth management and capital markets push RY revenue. Those sectors combined now represent about 50% of its revenue. Royal Bank also made huge efforts into diversifying its activities outside Canada. Canadian banks are protected by federal regulations, but this limits their growth. Having a foot outside of the country helps RY to reduce risk and to improve growth potential.
One could definitely pick shares of TD bank (TD.TO) or ScotiaBank (BNS.TO) instead. But please keep in mind that buying 4-5 banks isn’t helping your sector allocation. This is called diworsification as all banks will be hurt by the same events.
Utilities: A stable economy will improve access to funds. Capital intensive businesses such as utilities (which are also known for their generous dividend) find a haven to build a financial structure that will support both their growth and dividend policy. In this category, I went with some “easy picks” as they were long-term dividend payers.
Fortis aggressively invested over the past few years resulting in strong and solid growth of its core business. You can expect FTS revenue to continue to grow as it is expanding. Strong from its Canadian base business, the company can generate sustainable cash flow. In the past it lead to 4 decades of dividend payments. The company has a five-year capital investment plan of approximately $14.5 billion for the period 2018 through 2022, up $1.5 billion from the prior year’s plan. Chances are most of its acquisitions will happen south of our border. FTS yield isn’t impressive for a utility (~3.50%), but there is a price to pay for such a high-quality dividend grower.
I also went for a small investment in a risky play: Polaris Infrastructures (PIF.TO)
There are other great opportunities in this field, you can find them here.
Real Estate Income Trusts: If utilities can enjoy a favorable lending market, so can REITs. Since I’m in my late 30’s and I’m not looking to generate income, I don’t have any in my portfolio. However, there are many great REITs to add to your holdings such as Allied Properties (AP.UN.TO), Granite REIT (GRT.UN.TO) or Interrent REIT (IIP.UN.TO).
Telecoms: Similar to banks, telecoms evolve in a protected environment where it’s almost impossible to enter if you are not part of the club. Telus (T.TO), BCE (BCE.TO) and Rogers Communications (RCI.B.TO) control about 90% of the wireless industry. You can also add Shaw Communications (SJR.B.TO) that is working hard as a late entry in this field. From this short list, I’ve picked Telus a long time ago.
Telus has been showing a very strong dividend triangle over the past decade. The company can grow its revenues, earnings and dividend payouts on a very consistent basis. Telus is very strong in the wireless industry and now can attack other growth vectors such as the internet and television services. The company shows the best customer service (read lower churn) in the wireless industry. It uses its core business to cross-sell its wireline services. The company is particularly strong in Western Canada. Telus is well-positioned to surf on the 5G technology tailwind.
As you can see, you can easily build a strong core portfolio by selecting well-known dividend growers. This is a great start, but you can surely do better by digging a little further, right?
Where I Start All My Stock Research
When I open my stock screener, I like to keep as many options open as possible while limiting at the same time. I know… it’s not an easy task! The key here is nobody has the time to review thoroughly 1,500 companies per year, but we all want to hold winners.
Since past metrics only tell me a part of the story, I decided to select a handful of metrics that would give me a basket of great companies to look at. I called it the “dividend triangle”:
Revenue growth positive over the past 5 years: Without revenues, there is nothing, right? Then, those revenues must grow year after year to ensure the company’s sustainability.
EPS growth positive over the past 5 years: Then again, if you are looking for dividend payment growth in the future, you need to see rising earnings as well.
Dividend growth positive over the past 5 years: The company must pay an increasing dividend. If management is not on board with this policy, I quickly lose interest in the stock.
You can’t obviously go and blindly pick any names coming out of this search. Some will then pay more attention to cash flow metrics, debts, payout ratios, etc. But it’s a good starting place that will tell you if a business is making money and will continue to increase your dividend in the future.
Once I pull out this search, I usually add metrics such as payout ratio, cash payout ratio, free cash flow and debt to equity metrics. The fun begins where I then open quarterly and annual financial statements to read more about each company and understand how it works.
In 2017, I quit my job and received over $100,000 coming from the commuted value of my pension plan. I decided to use the tools I’ve developed at Dividend Stocks Rock (my membership website) to find those pearls:
Andrew Peller (ADW.A.TO)
Andrew Peller is known to grow its revenues through acquisitions. Since 1995, management invested over $200M to purchase 17 vineyards. The company built a solid relationship with provincial liquor stores, but also maintained company-owned retail stores in Ontario. Andrew Peller is a dominant player managing a strong brand portfolio. Management made major investments in acquisitions, developing new brands and marketing. We expect those investments in branding systems planning and production efficiency will translate into stronger earnings in the upcoming years.
CAE has developed a close relationship with many of its clients. The switching cost for them is relatively high as CAE clearly understands their needs and can improve/modify its training/simulation solutions to evolve with its customers. This creates a high recurring volume of business. With over 160 locations across 35 countries, CAE can meet any international clients’ demands. The company has shown steady growth over the past 5 years, and finished 2018 with a record backlog. As the economy continues to grow, demand for commercial and business aviation will remain strong. Therefore, more training will be required.
Intertape Polymers (ITP.TO)
With the rise of online shopping, the packaging industry should benefit from this tailwind. ITP expects to reach $1.5 billion in sales by 2022. Intertape is #1 and #2 in its main market in North America and shows international expansion opportunities. Management also expects to grow by acquisition to expand its current line of products, consolidate its activities, and open additional doors in international markets. In August 2018, the company completed the acquisition of Polyair Inter Pack for $146M. This was a strategic move to expand the ITP product offering while opening doors to cross-selling opportunities to PIP’s clients.
Alimentation Couche-Tard (ATD.B.TO)
An investment in ATD is definitely not for an income producing stock. However, if you are looking at the long-term horizon, your dividend payouts will grow in the double digits for a while and you will enjoy strong stock price growth. ATD potential is directly linked to its capacity to swallow and integrate more convenience stores. Management has often proven its ability to pay the right price and generate synergies for each deal. ATD shows a perfect combination of the dividend triangle: revenue, EPS and dividend strong growth.
I couldn’t list all the great Canadian stocks I found for my portfolio here, but you can get a complete look at what my portfolio looks like below.
What my Canadian Portfolio Looks Like Today
The portfolio I’m about to show you doesn’t represent all my invested money. What I like about this account is that I can’t add more money to it (it’s a LIRA). Therefore, the returns showing are coming solely from the performance of my initial investment. I started managing this account in September 2017 with 50% in the Canadian market and the other 50% in US investments. I keep cash at minimum and show no other holdings but stocks.
Here are some stats:
Initial value as of September 2017: $108,362.19
Present value (USD converted at 1.3080) as of July 16th 2019: $150,053.94
Total return during this period: +38.13% (total return)
Current dividend yield (as of June 2019): 2.40%
I believe the Canadian stock market presents plenty of great opportunities. However, I had to invest half of my portfolio into US holdings to make sure my sector allocation was optimal. Unfortunately, it is very difficult to find international companies or tech dividend stocks on Canadian soil (besides Open Text (OTEX.TO) obviously). With a 50-50 combination, I think Canadians can sleep well at night and smile when they look at their statement.
ETF investing does work, but as long as I get better results from dividend growth investing, I’ll stick to my strategy. What about you? What do you like best?
Disclaimer: I hold shares of all stocks mentioned in this article besides OTEX.