Welcome to Soundbites, weekly insights on market trends and investment strategies, brought to you by Investment Executive and powered by Canada Life. For today’s Soundbites, we’re talking about North American dividend opportunities with Tim Johal of Mackenzie Investments. We talked about areas of opportunities, risks on the horizon and we started by asking why dividend-paying companies are particularly attractive in the current moment.
Tim Johal (TJ): Dividend-paying companies provide real cash flow generation. They also have a resilient asset base and strong capital allocation discipline. We think that is important in today’s market. The market has increased uncertainty around global trade, and around interest rates. And geopolitics has obviously been a driver of risk. The market is rewarding companies with strong cash generation, a return of capital to shareholders and then a reinvestment into modest but consistent growth. Dividend investing allows for strong equity returns with less volatility. We believe that is particularly attractive in today’s market environment.
Identifying good dividend opportunities
TJ: Many investors are drawn to highest yields, but that can oftentimes be a warning sign. To distinguish between a good high-yield investment opportunity and a good dividend opportunity, investors should really focus on fundamentals. A high-yielding stock may be a value trap — a stock that appears inexpensive and has a high yield, but the underlying fundamentals are weak, and there’s really no catalyst to re-rate the stock higher. These stocks tend to underperform over time and should really be avoided. Many of these high-yielding companies are highly indebted, and the market has spoken to the sustainability of their dividend. And oftentimes, these high-dividend-yield companies are candidates for a dividend cut, which also drives underperformance of a stock. We think that focusing on the fundamentals of a strong free cash flow generation, focusing on that balance sheet, focusing on the payout ratio of a company, strong and growing dividends over time is really what is going to determine outperformance.
Where he’s finding attractive opportunities
TJ: The best opportunities have a combination of income, dividend growth, attractive valuations and strong cash flow durability. We continue to like the pipelines within the energy sector. 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. North American oil and gas producers are going to benefit from this trend. And our pipeline companies in Canada will play a strong role in transporting energy molecules where they need to go. We also like 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. And then finally, I’d say in financials, we do prefer life insurance and property and casualty insurance. We see resilient earnings growth in select companies in those sectors, which will continue to drive strong dividend growth going forward.
Biggest risks facing dividend investors
TJ: There are some areas of the market that are concerning. We are not big investors in the REITs right now — the real estate investment trusts — particularly the multifamily REITs. There’s been a stark policy change by the government, particularly around immigration. We think the combination of lessened demand and a buildout of supply is still going to play out so we’re cautious generally on the REITs, but more particularly on the multifamily REITs. Another area of concern for us would be the Canadian consumer. We are generally not favourable on the consumer outlook. You still have a large swath of mortgage term resets coming due through 2026. We think that those mortgage resets will create some burden on consumer spending going forward. And some of the consumer staple stocks appear to be expensive to us as well. We prefer the discount retailers. We think there’ll be a continued trade down by the consumer into discount. So that’s where we’re focused in consumer. And then, finally, I would say the banks, from a valuation perspective, are quite expensive and we’re more selective right now.
Names he likes
TJ: TC Energy is one of our large pipeline holdings. It’s been a strong free cash flow generator over time. The current management team has proven itself to be a strong capital allocator. It’s grown its dividend each year for the last 25 years. We see that continuing, considering the growth profile. The yield on TC Energy is 3.8%, and a growing dividend should allow for pretty attractive dividend going forward. We currently like Manulife within insurance. Manulife is a well-managed company, very 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. In addition, the payout ratio at Manulife is still relatively low. We think that payout ratio can increase over time. That stock has a yield of about 3.6% right now. We find that very attractive. Last, I would have to touch on Canadian banks. I know I said we were a bit more cautious on Canadian banks, but Royal Bank is our top bank holding for a number of reasons. It has scale, it has a low-cost funding advantage, 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. The stock has done well. Valuations have expanded. And with the stock rising, the dividend yield has come in.
And finally, what’s the bottom line on investing in dividend-payers in the current moment?
TJ: In this market environment where AI disruption and increased capital spending is a risk to many business models, a portfolio of strong dividend companies with free cash flow generation, resilient assets and consistent growth profiles will continue to be rewarded by the market.
Well, those are today’s Soundbites, brought to you by Investment Executive and powered by Canada Life. Our thanks again to Tim Johal of Mackenzie Investments. Visit us at investmentexecutive.com, where you can sign up for our a.m. newsletter and never miss another Soundbite. Thanks for listening.
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