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For today’s soundbites, we speak with James Black, vice-president, Canadian equities, with Beutel Goodman Investment Counsel, about dividend-paying stocks. We talk about what dividends say to the market, when they’re appropriate and when they’re not… and we started by asking about the perennial attraction of dividend stocks.

James Black (JB): I would say that the appetite for dividends, particularly from retail investors, has been solid for quite some time, particularly in a lower interest rate environment where people who need income are seeking it. Dividends provide income, which many investors require as part of their investment strategy. You could look at several categories: retail investors, particularly retirees; charitable foundations which have spending requirements; or mature pension funds that have to make payments to beneficiaries. All of them, at particular points in time, would find stocks that pay dividends attractive. Our view would always be that there’s likely going to be an appetite for stocks that can pay ongoing dividends, particularly those that can grow through time.

What dividends say about a company

JB: I would say that dividends provide tangible evidence that a business can generate free cash flow that’s greater than what is required to invest in itself. And that very fact that the company can pay dividends should foster investor confidence. I would say that dividends are the gravy that results after a business has been really well run and well capitalized and appropriate amounts of sustaining and growth investments have been made. They are then the evidence that this business is truly a good one and a resilient one.

When dividends are not such a good thing

JB: The whole notion of what a good dividend-paying stock is really speaks to our investment process. We’re looking to buy great businesses that generate good returns and good free cash flow levels. When these great businesses generate excess cash, we’re really happy for them to return some of that to us. It can come in the form of dividends, or it can also come in the form of share buybacks. Share buybacks can be really good when the stocks are attractively valued. But dividends are welcomed particularly when they’re based on a reasonable pay-out ratio. We don’t want companies stretching their balance sheet or stretching their financial flexibility to return cash to us. We want the dividend level to be sustainable, providing them with flexibility over time. If we look at total returns in some of the names that we own, absolutely the dividend has been an important component of that. We want the dividend to be sustainable to ensure that the business can remain flexible. And absolutely there are circumstances when a company might be going through a period of heavier investment, or it might have a really attractive acquisition opportunity that has significant synergies, and we would absolutely not want a company to raise its dividend through that if it prevented it from being able to pursue either organic investment or a creative acquisition growth. Again to speak to the sustainability of the dividend, this is what comes back to us after the company has done everything it needs to do to create a resilient long-term business model.

The impact of interest rates on dividend players

JB: We’re looking to buy businesses that have competitive moats and sustainable free cash flow. If they’ve got those characteristics, then they should be able to increase prices when there is an inflationary environment. And that very fact should provide some protection to the real value of the dividend stream. Secondly, I would say that there are some businesses, like banks, that benefit when interest rates increase, because things like their net interest margins expand, creating greater levels of profitability. Rising rates and increasing inflation that is at reasonable levels, the business that we own should be able to sustain itself through that.

And finally, what’s the bottom line?

JB: Sustainable and growing dividends are indicators of a great business. And when valuations are attractive in stocks like that, you know, we want to be buyers of them.

Well, those are today’s Soundbites, brought to you by Investment Executive, and powered by Canada Life. Our thanks again to James Black of Beutel Goodman Investment Counsel.

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