Purchasing Canadian Dividend Stocks: A Comprehensive Guide

Solely relying on stock appreciation for financial gain can sometimes be a source of stress. Unrealized gains can unexpectedly vanish during a market correction. However, incorporating dividend stocks into a stock portfolio can add a degree of stability.

To determine the sustainability of a dividend, it is advisable to evaluate the P/E ratio, payout ratio, and balance sheet of a potential dividend stock. Another option for diversifying dividend stocks is to consider investing in a dividend stock ETF.

This article will begin by exploring the fundamentals of dividend stocks and then delve into the process of purchasing dividend stocks on an investment platform. Below, you will find four steps to help you get started.

One of the appealing advantages of holding dividend stocks is the consistent income they provide. Given the frequent fluctuations in stock prices, receiving dividends offers a sense of stability in earning money from stocks.

Dividend stocks can also serve as motivation to continue investing. Even earning a modest sum from dividends can provide a sense of accomplishment.

Furthermore, weathering a stock market downturn can be easier when holding dividend stocks. A stock that experiences a 40% drop in value and doesn't pay dividends may seem tempting to sell. However, there is a greater incentive to hold onto a dividend stock due to its regular dividend payments.

• Established and Reputable Companies

The majority of dividend-paying stocks belong to well-established companies with large-scale operations and a loyal customer base. The trust and loyalty of consistent customers create a barrier to potential competition.

Dividends represent money paid out by a company, which reduces its available cash reserves. In order to distribute dividends, a company must generate sufficient profits. Failure to do so may result in the company taking on debt to meet its dividend obligations.

Growing companies often choose not to pay dividends so they can reinvest their profits for future expansion. These companies tend to focus on increasing revenue/sales each year, even if it means operating at a loss.

Dividend stocks typically have limited potential for significant growth, as they prioritize distributing dividends rather than reinvesting profits to expand the company. Dividends can be an indication that a company lacks other avenues for revenue or profit growth.

With the cash outflow from dividend payments, a company's cash reserves decrease, limiting opportunities for future growth.

During the stock market crashes of 2008 and 2020, many dividend stocks had to cut their dividends. Numerous companies were experiencing financial losses, and there was significant uncertainty regarding how long these losses would persist.

An example of a stock that eliminated its dividends in March 2020 is CCL. Due to the inability to operate its cruises, the company was sustaining losses and generating minimal revenue. Therefore, CCL decided to completely suspend its dividends.

Dividend stocks have the flexibility to cut or eliminate their dividends at any time. This is usually triggered when a company starts experiencing financial losses or its profits are insufficient to cover dividend payments. Additionally, dividend cuts may occur when a company faces the threat of bankruptcy.

During stock market and economic downturns, companies often experience reduced revenue as consumers decrease their spending. Many stocks choose to reduce or eliminate their dividends during these challenging times.

• Taxation of Dividends

Capital gains on stocks are only taxed in the year they are sold. For instance, if a stock is purchased in 2010 and sold in 2017, resulting in a $2,000 profit, there would be no taxes owed from 2010 to 2016. The $2,000 capital gains would be reported as income for the 2017 tax year.

Dividends, on the other hand, are subject to taxation in the year they are received. Dividend taxes cannot be deferred to future years, unless the dividends are held in a registered account such as a TFSA or RRSP.

High dividend stocks that have limited or no revenue growth often offer approximately 4% dividends. In order to earn $100 per month from a 4% dividend yield, one would need to invest around $30,000 in high dividend stocks.

Conversely, dividend growth stocks typically offer lower dividends to account for their potential for growth. Assuming a 1% dividend yield, an individual would need to invest approximately $120,000 in dividend growth stocks to receive $100 per month in dividends.

In order to generate a monthly income of $1,000 ($12,000 per year) from dividend stocks, an individual must invest approximately $300,000 with a 4% dividend yield. It is important to note that a dividend yield exceeding 7% is considered a warning sign, indicating the need for further research to ensure the sustainability of earnings in order to pay dividends of 7% or more.

An excellent dividend stock is characterized by having sufficient company profits to cover its dividend payments. After all, dividends are cash distributions made by a company, which depletes its cash reserves and can potentially place the company in a precarious financial position.

Determining whether a stock is a good or bad investment cannot be based on a single measure. The following factors, which can be easily found through a quick search on platforms like Yahoo Finance or Google, are important indicators specifically for dividend stocks:

- The payout ratio represents the portion of a company's earnings that is distributed to shareholders as dividends. The payout ratio is widely used and considered a crucial measure when assessing the sustainability of dividend payments.

For example, if a company earns $5 per share in a given year, a payout ratio of 50% would indicate that the company paid out $2.50 in dividends (50% of $5). If the company elected to distribute all $5 of its earnings as dividends, the payout ratio would be 100%.

Generally, a lower payout ratio is favorable for dividend stocks as it suggests that the company has not distributed all of its profits. A payout ratio exceeding 100% is not ideal since it indicates that the company's profits are insufficient to cover dividend payments. A payout ratio below 100% indicates that a company is generating enough profits to sustain its dividend payouts.

If a company's profits are inadequate to support dividend payments, it may be compelled to take on additional debt to meet its obligations. A payout ratio over 100% signifies a higher risk of potential dividend reductions or eliminations in the future due to the company's inability to generate enough profits to cover dividends.

A payout ratio ranging from 50% to 70% is generally considered optimal, as it allows a company to retain a portion of its profits for future use. Lower payout ratios are typically preferred.

A company's balance sheet provides insight into its equity, assets, and liabilities. While there are various ways to analyze a balance sheet, this article will focus on the fundamentals.

Companies listed on the NYSE, TSE, and NASDAQ are required to disclose their balance sheets and other pertinent information every three months through a 10-Q filing. Additionally, they must file an annual comprehensive report known as a 10-K. These reports are publicly available.

For a stock, particularly dividend stocks, to be financially sound, the "total current assets" should exceed the "total current liabilities," and the "total assets" should exceed the "total liabilities."

The greater the disparity between assets and liabilities, the more favorable the financial position of a company.

A company's balance sheet also reveals its ability to weather potential downturns in the future. Companies with minimal assets compared to their liabilities face a higher risk of bankruptcy, particularly during stock market crashes.

On the other hand, companies possessing robust balance sheets with significantly greater (at least double or triple) assets than liabilities can continue to pay dividends even during recessions.

Assessing a stock's dividend history over five or more years is advantageous in determining its reliability. A stock that consistently raises dividends over time is likely to continue doing so, provided it also maintains a strong balance sheet and a loyal customer base.

While it may be understandable for a dividend to be reduced or eliminated for a quarter or two during major stock market crashes such as those in 2000, 2008, and 2020 due to the overall economic climate, an extended dividend cut lasting three years or more indicates a higher likelihood of future reductions.

The ability of a dividend stock to sustain dividend payments during challenging times demonstrates the resilience of the company.

The beta of a stock simply measures the volatility of its price chart. A lower beta indicates a flatter stock price chart with less significant price movements, while a higher beta signifies greater price fluctuations, both in upward and downward directions.

For instance, a stock that remains relatively flat and trades within the $50 to range for five years would have a low beta. Alternatively, a stock that experiences substantial price swings, ranging from $10 to $100 and back to $50, with regular fluctuations of 30% or more, would have a high beta value.

To obtain the beta of a stock, one can refer to platforms like Yahoo Finance or similar websites.

In general, individuals tend to prefer stable prices for dividend stocks. An optimal beta for high dividend stocks is below 0.5, while a beta of approximately 1 suffices for dividend growth stocks. A beta lower than 1 is considered below average in the stock market.

Please note that a beta of 0.5 is merely an estimation. Primarily, beta solely considers the price movement of a stock and does not take into account its fundamental factors such as the balance sheet, company strengths, customer base, and so on.

The price to earnings ratio (P/E ratio) stands as one of the most prevalent indicators for stocks. The P/E ratio reveals how much an investor must pay for each dollar of earnings at the current price. For instance, let's assume a stock is being traded at $100 and the company has reported earnings per share of $5.

In this example, the P/E ratio would amount to 20 (100 divided by 5). As a result, an investor would need to pay $20 for every dollar of earnings per year on this stock.

For the purpose of evaluating dividend stocks, it is worth noting that the P/E ratio serves a similar function to the payout ratio. By employing the P/E ratio, one can determine if a company's profits are sufficient to cover its dividends. Thus, it serves a comparable role to the payout ratio.

However, it should be emphasized that the P/E ratio remains the primary measure for stocks. This section pertaining to the P/E ratio is more discretionary in nature and may be considered optional in this article.

A high P/E ratio (50 or higher) indicates that investors are willing to pay elevated prices for each dollar of earnings, as they anticipate robust future growth for the stock. On the other hand, a low P/E ratio (10 or lower) signifies that the stock is inexpensive and investors anticipate either stagnant or decreased revenue and profits in the coming years.

In general, a good dividend stock is one in which profits are sufficient to cover the dividends. Therefore, a lower P/E ratio (low price, high earnings) is desirable for a dividend stock. A P/E ratio of approximately 15 to 25 is adequate to support a dividend yield of around 4%.

As the earnings (E) are employed in calculating the P/E ratio, one can determine the dividend yield a company can afford solely based on its earnings.

Using the same example of $5 earnings and a stock price of $100, the maximum dividend a stock can afford based solely on its profits is $5. If this stock were to pay out $5 in dividends, it would have exhausted all of its earnings ($5 earnings).

Thus, a P/E ratio of 20 (100/5) can accommodate a dividend yield of 5% (5/100). By inversing the P/E ratio, one can ascertain the maximum dividend a stock can afford based solely on its profits without incurring additional debt.

P/E Ratio Maximum Dividend Yield

520.00%

1010.00%

156.67%

205.00%

254.00%

402.50%

502.00%

Formula Used: 1 divided by P/E ratio. It is important to note that the earnings of a company fluctuate on an annual basis. The P/E ratio and payout ratio exclusively consider earnings from a single year. In reality, no one can predict the future profits of a company with certainty.

If a company fails to generate sufficient profits to cover its dividends in one year, it is highly probable that dividends may be reduced or eliminated in the future.

A P/E ratio of 10 or lower suggests that a stock is very inexpensive. However, this can also serve as a warning sign, as it implies that investors anticipate a decline in earnings in the future, justifying the low valuation of the stock.

For stocks with extremely low P/E ratios, it is helpful to examine the earnings and revenue history of the past five years as well as analysts' estimates for the next five years. If the projections indicate a decrease in earnings or negative earnings (loss) for the future years, then the low P/E ratio is warranted and serves as a red flag.

Please be aware that there are numerous additional factors that can be used to assess a dividend stock. The ones mentioned here are merely the most fundamental ones to consider. It is important to note that this information does not constitute financial advice, and it is recommended to seek professional advice from a financial expert.

There are two methods to diversify dividend stocks: purchasing five or more individual dividend stocks or investing in dividend stock ETFs.

Dividend stock ETFs are funds that mirror the returns of 50 or more dividend stocks within their portfolio. This means that if one of the dividend stocks in the ETF reduces their dividends or goes bankrupt, it will have a limited impact on the overall returns.

By diversifying through ETFs, you can spread out your investment risk. Here are a few dividend stock ETFs available in Canadian dollars. It is worth mentioning that investing platforms typically charge a 1-2% exchange rate fee when converting to US dollars. However, these ETFs can help you avoid those fees.

For US dividend ETFs, Vanguard ETFs are highly popular and well-regarded.

Dividend ETF (CAD)

CDZ

XEI

XDV

Dividend Yield: 3.26%, 3.77%, 3.83%

P/E Ratio: 19.4, 18.5, 16.1

Number of Stocks: 867, 429

Management Fees: 0.66%, 0.22%, 0.55%

Dividend Payment: Monthly, Monthly, Monthly

Note: The above data is accurate as of June 8, 2021.

ETFs typically consist of a group of stocks within their portfolio. For instance, XEI is comprised of 74 dividend stocks. On the "holdings" section of the XEI information page, you can find a selection of stocks such as RBC, TD Bank, TC Energy, and Suncor Energy.

These 74 stocks within XEI directly impact the returns and dividends of XEI. If some of the stocks within XEI reduce or eliminate their dividend payments, the dividends paid by XEI will also decrease. Conversely, when the stocks within XEI increase their dividends, the dividends paid by XEI will also rise.

Dividend yields and interest rates are expressed on an annual basis. This is applicable to credit card rates, car loan rates, savings account rates, and dividend rates.

For example, let's assume an investment of $10,000 with a dividend yield of 4%. In this case, we would expect an annual payout of $400, equivalent to a monthly dividend payment of $33.33.

Since dividend ETFs consist of 20 or more stocks, the dividend yield fluctuates when these individual stocks increase or decrease their dividend payments.

ETFs charge a fee, which is automatically deducted from the ETF's price. Common funds like S&P 500 ETFs have the lowest fees, usually around 0.10% per year or less. However, dividend ETFs generally have fees of around 0.50% per year. Typically, more diversified ETFs have higher fees.

Let's consider an ETF with 100 stocks in its portfolio. Assuming these stocks increase by 10% in a year and the ETF charges a 0.50% management fee, the actual ETF performance would be approximately 9.50% higher compared to the previous year, taking into account the 0.50% fee.

In Canada, there are several popular investment platforms where one can find dividend stocks and ETFs. These include Questrade, Wealthsimple Trade, as well as major banks like TD and RBC Direct Investing.

Similarly, in the United States, there are online brokerages such as Webull and Robinhood, along with big banks like Charles Schwab, Fidelity, and TD Ameritrade.

Here are some details about the commission fees for buying or selling trades:

- The minimum commission fee ranges from $4.95 to .95, with a maximum of 1 cent per share. For example, if you buy 2 shares, the fee would be $0.02, but it will not go below $4.95.

- ETF buys are free of charge.

- The fee for selling ETFs is also between $4.95 and .95, with a maximum of 1 cent per share.

- Option trades incur a fee of .95, plus an additional $1 per contract.

- There is a 2% exchange rate fee when converting to US dollars.

- The platform was established in 1999.

Now, let's look at the details for US investment platforms:

- Typically, there is a flat commission fee of .95 for every buy or sell trade. For US stocks, the fee is in USD, while for Canadian stocks, it is in CAD.

- There is an exchange rate fee of 1-2% when converting to US dollars, although this may vary depending on the bank.

- If an account holder does not make at least 3 trades in a quarter, they may be charged a $100 annual inactivity fee. However, this fee can be waived under certain conditions, such as maintaining a portfolio worth $15,000 or more (specific conditions may vary by bank).

- Opening an account can take a few days. The initial online application takes approximately an hour, but additional physical documents may be required, such as printing and mailing them to the bank's main branch (specific requirements may vary by bank).

- Option trades on this platform have a fee of .95, plus an additional $1.25.

In order to avoid the exchange rate fee, I opted for Wealthsimple Trade and ETFs in Canadian dollars.

Here are some recent investment updates from April and May 2021:

- In April 2021, I invested $500 in XEI (a Dividend ETF in CAD) and $500 in VSP (S&P 500 ETF in CAD).

- In May 2021, I purchased an additional $200 worth of VSP (S&P 500).

Now, let's move on to the latest update in May 2021.