With the S&P 500 yielding a measly 2.1%, where’s an income investor supposed to look these days?
I’ll tell you where. A place where the dividends flow like maple syrup, and the companies raise their payouts not once but twice a year. I’m talking about a little place called Canada.
Investors loved the Looney and everything else Canadian when crude oil was trading hands for triple-digits. It wasn’t too long ago (January 2013) that the Canadian dollar was more valuable than its U.S. counterpart. It’s shed 25% against the greenback since.
Canadian stocks peaked 18 months later than its currency (about this time last year). They’re down 15% since. Our neighbors to the north have a commodity-driven economy, and resource prices – most notably that of oil – are usually the leading indicator when it comes to asset valuations.
As we discussed last week, I don’t believe oil has bottomed yet. Money managers are still net long 130,000 contracts per the latest Commitment of Traders (COT) report, and the U.S. crude oil inventories haven’t been this high at this time of year than 80 years. The goo will continue its slide while these two bearish factors are in place.
But the cure for low prices is low prices, and oil will eventually find a foothold and rise again when the supply/demand imbalance overshoots the other way. Canadian stocks will follow suit and bounce in tandem. Which means if you’re searching for income, you’re going to have some great options above the border in the near future.
Canadian banks in particular should be at the top of your watch list. Here are three candidates that are down double-digits over the last twelve months. Thanks to this northern downdraft, they’re all yielding 4% or better. And they’re increasing their payouts not once but twice per year to compete in a Canadian yield race that quietly began a few years back.
Royal Bank of Canada (RY) pays 4.4% today. Management has increased the dividend twice per year since 2012 (including this year). It’s grown the dividend 10.9% annualized over the past decade, and it has room for more double-raises in 2016 with a sub-50% payout ratio.
RY trades for just 11-times earnings and 1.9-times book value, a 20% and 17% discount to its five-year averages. The company grew earnings by 9% last year. Investors are pricing in slow growth – anything better could send the share price 20% higher towards previous valuations.
Toronto Dominion (TD) is a 4.1% payer that’s given investors two raises a year since 2011. It does need a December boost to follow its 8.5% bump in April to keep the streak alive, but that’s a possibility given that TD also has a sub-50% payout ratio. TD increased earnings by 6% year-over-year in its most recent quarter, driven by large growth in its U.S. retail banking business.
Like RY, TD is cheap in absolute and relative terms. It’s trading for 12-times earnings and 1.6-times book value, which are 9% and 11% discounts to its five-year averages. Its share price has double-digit upside, and not much downside thanks to its secure payouts.
The Bank of Montreal (BMO) is the longest-running dividend payer in Canada, and its stock is even cheaper than our first two banks. BMO trades for less than 11-times earnings and just 1.2-times book value – the latter is a 25% discount to its five-year average. Book value is a popular valuation measure for banks because most of their assets and liabilities are marked to market. It’s often thought of as the bank’s approximate liquidation value – which means BMO’s actual business isn’t getting much credit.
Why is BMO so cheap? Its U.S. operations have struggled to gain traction and the company’s earnings are slightly below their 2012 peak. But the company pays a 5% yield today that’s comfortably with management’s target 40-50% payout ratio. In the Canadian banking tradition, BMO has raised its dividend twice per year since 2013, including this year.
All three of these banks are fine dividend-payers to consider in 2016, with Royal Bank and Toronto Dominion being the top two I’m keeping my eye on thanks to their earnings growth and potential. But I wouldn’t buy any just yet. Instead, I prefer this healthcare company that’s yielding 7% (and is likely to double that payout within a decade).