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Investors should look beyond headline dividend yields and focus on companies with durable cash flows and disciplined capital allocation, says Tim Johal, senior vice-president and portfolio manager at Mackenzie Investments.
Speaking on the Soundbites podcast, Johal said today’s environment of trade and geopolitical uncertainty, shifting interest rates and AI disruption is rewarding businesses that can consistently generate cash, return capital to shareholders and continue investing for future growth.
Johal said those characteristics can support strong equity returns with less volatility.
“Dividend-paying companies provide real cash flow generation, and they also have a resilient asset base and strong capital allocation discipline. We think that is important in today’s market,” he said. “Dividend investing allows for strong equity returns with less volatility. And we believe that that is particularly attractive in today’s market environment.”
While many investors are drawn to high yields, those yields can signal that the company is, in fact, a value trap — a stock that appears inexpensive but whose underlying fundamentals are weak.
“These stocks tend to underperform over time and should really be avoided,” he said. “To distinguish between a good high-yield investment opportunity and a good dividend opportunity, investors should really focus on fundamentals.”
Johal said a rigorous investment process should assess free cash flow generation, balance-sheet strength, payout ratios and a company’s ability to grow its dividend sustainably.
“We continue to like the pipelines within the energy sector,” he said. “Global energy demand is growing, and disruptions in the market caused by the wars in Iran and Ukraine have really exposed the need for companies to diversify their energy supply.”
Johal said North American oil and gas producers should benefit from the push to diversify global energy supplies, with Canadian pipeline companies playing an important role in moving energy to export markets.
In particular, he likes TC Energy, which was yielding approximately 3.8% in early July and has increased its dividend annually for the past 25 years. He said the company has also been a strong free cash flow generator.
“The current management team has proven itself to be a strong capital allocator. They’ve made great allocation decisions, even in some really tough times as they’ve continued to build out their pipeline network.”
He also likes select stocks in the utility sector, particularly within the power generation and infrastructure areas.
“We believe these companies will be beneficiaries of the continued AI and data centre buildout. For the first time in decades, we’re seeing significant electricity demand growth in North America, and really the data centre buildout has been the main source of this new demand. We see these trends continuing and expect that our power generation and infrastructure companies will benefit.”
In other sectors, he likes Manulife, which he described as a well-managed company with a strong management team.
“We believe that their global insurance and global wealth and asset management platforms will continue to drive outsized growth on a very capital-light basis,” he said. “That stock has a yield of about 3.6% right now. We find that very attractive.”
While he is increasingly selective about Canadian banks given current valuations, he likes Royal Bank.
“It has a low-cost funding advantage,” he said. “And Royal has really been a leader in this transformation of banks to offer more digital capabilities to its customers and allow for AI integration into its businesses and its operations.”
He sees headwinds for dividend investors in some sectors, particularly consumer discretionary given the effect of upcoming mortgage resets on household spending, and in multi-family real-estate investment trusts where new supply is still coming on the market even as the government has slowed immigration.
“We think the combination of lessened demand due to immigration and a buildout of supply is still going to play out,” he said. “And these cycles in real estate play out over a long time, so we’re cautious generally on the REITs, but more particularly on the multifamily REITs.”
Johal said dividend stocks should remain part of a diversified portfolio, but investors should not select them on yield alone.
Companies that consistently grow their dividends, supported by strong cash generation and disciplined reinvestment, represent the more compelling long-term opportunity, he said.
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