Dividend payers looking good as value starts to outshine growth stocks

The percentage of returns that equity investors reap from dividends could jump significantly if the current economic malaise continues, says Adam Rivers, assistant vice-president and portfolio manager with Mackenzie Investments.

Rivers said equities have been hard hit since central banks began fighting inflation, which “plays to the benefit” of dividend investors.

“Dividends generally represent, over longer periods, 40% to 50% of investors’ total return,” he said. “But if we have more moderate equity returns, that number can increase to 70% to 100%.”

He said the current rising-rate cycle has been good for dividend investors, capturing more of the upside earlier on in recovery and less of the downside this year.

One concern about relying on dividends, however, is that to the extent that a dividend-paying company has debt outstanding, high interest rates will reduce earnings and hinder the company’s ability to maintain that dividend.

Rivers said rising interest rates rising could be “dilutive” to a company’s dividend growth. That’s why he suggested savvy investors do some digging to see how a company might respond to higher rates.

“It’s actually something we’re spending a lot of time on right now, going through our holdings our watch lists, assessing balance sheets,” he said. “Debt maturity schedules become quite important now in terms of how the debt is rolling over and what the refinance risk is.”

He said the reason high-growth companies tended to do well during the low- to no-interest days is because they are longer-duration assets, with high future cash flows leading to greater current discounts.

“This resulted in growth stocks, and, in particular, technology stocks, significantly outperforming the more value-oriented, dividend-oriented companies,” he said. “When rates started to rise off the bottom, you saw value and dividend-oriented companies do quite well, and tech start to underperform.”

Rivers said sustained high interest rates can make fixed income assets look more attractive and reduce interest in bond-like sectors where the underlying assets have benefited from large institutional flows chasing yield.

“Think utilities, think real estate, think infrastructure,” he said. “These are areas that would be most exposed to that concept of yield competition.”

He is particularly interested in REITs because the market has discounted them for their perceived sensitivity to interest rates.

For example, Toronto-based Canadian Apartment Properties REIT is “the largest apartment landlord in the country,” Rivers said. “It’s down 34% from its 52-week high. We think there’s pretty attractive upside in a name like that.”

He also likes Edmonton-based Capital Power, which benefits from current elevated power prices and holds “merchant power exposure” to Alberta. The company also boasts low leverage, so a reduced risk on cash flows from higher rates.

“They have a pretty good tailwind there,” he said.

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This article is part of the Soundbites program, sponsored by Canada Life. The article was written without sponsor input.