Dividends Are Still the Key

10/28/2011 8:30 am EST

Focus: STOCKS

Roger Conrad

Founder and Chief Editor, Capitalist Times

When a stock drops 30%, it takes three years for a 10% yield alone to make up the loss. That’s a depressing fact…until you realize there’s an obvious catalyst for a much faster recovery, observes Roger Conrad of Canadian Edge.

Mainly, when a dividend-paying stock drops that far and that fast, it’s because investors expect a dividend cut, and possibly a steep one. When those fears diminish, the stock will bounce back to recover its lost ground.

That’s what happened in the aftermath of the 2008 crash. And the only prerequisite for recovery was simply maintaining dividends.

To be sure, outside of a handful of power and pipeline companies and REITs, it’s been a tough couple of months to own Canadian stocks. And US investors’ losses were further extended by a 10% slide in the Canadian dollar.

Many of the companies tracked in the Canadian Edge coverage universe are down at least 20% year to date. Some two dozen stocks yield at least 10%, with another 20 dishing out between 8% and 10%, all clearly pricing in dividend cuts.

I call it the “Yellow” disease. Investors seem to be assuming that every high yielding company will go the way of Yellow Media Inc. (Toronto: YLO, OTC: YLWPF).

That’s understandable, given that Yellow suffered its final coup de grace last month. Management eliminated its dividend and all but admitted Yellow was at the mercy of creditors, with little hope for retaining any shareholder value.

Even in 2008, however, the vast majority of companies never cut dividends. Their stocks dropped during the crash. But they did recover all that lost ground and more, and a lot sooner than expected besides.

Unfortunately, some individual companies will falter in an environment like this one, Yellow Media being the latest and greatest example. The two biggest reasons are faltering revenues and debt. In a worst case, the two combined will not only cause dividend cuts but can literally wipe out shareholder value, as lenders basically subject the company to a giant margin call.

The good news is, most companies still stack up well on both counts. That’s why dividend increases in our coverage continue to vastly outnumber dividend cuts.

The timing of a share-price recovery is going to depend on macro factors outside individual companies’ control. In fact, company developments are likely to be virtually ignored, unless they do involve something disastrous like a dividend cut.

Good signs at companies from Atlantic Power Corp (AT) to Toronto-Dominion Bank (TD) hint the lift might be greater and longer-lasting.

Another is simply for the macro situation to beat expectations by being not the outright disaster so many expect. The US economy is still not in recession, and companies are still able to borrow at the lowest rates in 50-plus years. Few have the kind of near-term refinancing needs that would leave them exposed to a contagion from overseas.

Those are all stark contrasts with late 2008. Moreover, unlike that time, investors, companies, and governments are hunkered down for disaster. Historically, that’s not the point at which real sell-offs begin.

The key is to separate companies that will hold dividends from companies that can’t. To avoid another Yellow, I’m resolved to sell much faster when there are signs of weakness. But if any other Canadian Edge stocks do cut dividends, we’ll be cutting them loose.

Finally, there’s no better protection against dividend cuts than old-fashioned diversification. Unless you’re a long-distance mind-reader, you’re not going to catch every company’s stumbles before they become public.

But spreading your bets—coupled with careful selection—ensures one misstep won’t sink your portfolio. And your other positions will ensure you’ll share in what should be a powerful recovery in the coming months.

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