Launching the Canadian Buy the Dips Portfolio: Identifying the Leading Energy Companies – Part 1

Summary

  • The Canadian Dollar is much weaker than the US Dollar from a year ago.
  • As a result, some Canadians may want to invest in Canadian stocks instead of US stocks for now.
  • The main strategy of this portfolio is to buy leading companies after some form of pullback.
  • 2 Canadian leading Energy companies can be bought with at least 31% and 38% potential gain in 2 to 3 years, not including dividends.

Why I’m Launching the Canadian Buy the Dips Portfolio

With more than $1.14 Canadian Dollar needed to convert to $1 U.S. Dollar (not to talk about added conversion fees), do-it-yourself Canadian investors may want to stay in their domestic currency and invest in Canadian companies instead of US ones. A reader asked me how to build a Canadian stock portfolio that is conservative and have the goal of income and steady growth. One strategy is to buy companies in a specific sector which has pulled back. A classic of buying low and possibly selling high. I say “possibly” because it might be wiser to buy low and sell high in certain sectors or companies more than others.

To remain conservative though, let’s first identify leaders in their respective sectors and industries. One way of doing this is finding the companies with the largest market capitalization in a particular sector. They are able to grow big (relative to their peers) because they are doing something right. These companies generally have more solid balance sheets and pay a growing dividend.

A Couple of Canadian Leaders in the Energy Sector

A stock portfolio can only be built one company at a time. The Energy companies have pulled back with the oil price decline. This fits the pull back criterion. Let’s take a look at some of the Canadian leaders in the Energy sector. They are Suncor Energy (TSX:SU), and Canadian Natural Resources (TSX:CNQ). They are the companies with the largest market capitalization in their respective industries.

Industry Leaders *Market Cap S&P Credit Rating *Yield
Integrated Oil and Gas Suncor Energy 52.4B A- 3.1%
Oil and Gas E&P Canadian Natural Resources 41.4B BBB+ 2.4%

* As of the close of Nov 28, 2014 on the TSX

Introducing Suncor Energy

Suncor logo

Suncor Energy is Canada’s largest integrated energy company, having a balanced portfolio of high quality assets. Its oil sands business is located in Alberta, Canada having 6.9B barrels of reserves and 23.5B barrels of contingent resources. Suncor estimates to have a compounded annual growth rate of 10 to 12% in oil sands and 7 to 8% overall until 2020. Suncor has been publicly traded since 1992. Since its high of $46 in June 2014, Suncor Energy has dropped to $36, a 21.7% decline.

SU Chart

SU data by YCharts

Even as the oil price dropped like a rock in the financial crisis, Suncor maintained its dividend. In fact, since 2011, it has increased it from $0.10 per share to its current $0.28 per share, a 180% increase. Its current yield is sitting around 3.1%, which is higher than the index’s (TSX:XIU) 2.34%.

Currently, this industry leader can be bought around $36. Rated 4-star by Morningstar, it is undervalued with a fair value estimate of $50, which is a potential 38% gain. Read More

Buying Vermilion Energy for Growth and Income

I recently discovered Vermilion Energy (TSX:VET), a Canadian oil and gas producer which is listed on both the TSX and NYSE exchanges. In the last decade, it returned 25% annually. Since it is a mid cap company, it’s more stable than a small cap, while has higher growth than a large cap. My research indicates that it provides a safe dividend with a current yield of 4%. With its low payout ratio, there’s also potential for future dividend growth. Enrolling in Vermilion Energy’s dividend reinvestment program allows dividends to be reinvested with a 3% discount.
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Canadian Dividend Reinvestment at a Discount – Companies List

Some Canadian companies offer dividend reinvestment at a discount. These dividend reinvestment plans (or DRIPs) allow you to reinvest dividends (or distributions) at a discount. So that you can buy shares (or units) of these companies (or REITs) for a cheaper price with the dividend (or distribution) that is paid to you without having to pay commission fees. Typically, the reinvestment price is some sort of weighted average of the market price in addition to incorporating the discount percentage.

If you’re reinvesting for more shares (or units) through a transfer agent, you’ll be able to reinvest for partial shares. If you enrolled for the DRIP in a brokerage account such as ScotiaOnline, then, you’ll only be able to reinvest full shares. That means, you need to buy enough shares (or units) initially to receive a dividend (or distribution) that is enough to buy at least 1 full share. For example, I held 364 units of TSX:PLZ.UN, a retail REIT. On October 22, 2014, its distribution was reinvested at $3.78 at a 3% discount, and I received the rest of the distributions ($3.50) as cash. Now, I hold 365 shares.

Learn more about buying shares through a transfer agent.

Dividend or Distribution must be Safe

As a dividend investor, the dividend is an essential ingredient to my total return. So, I decided to add another criterion for a company to make this list. The dividend or distribution hasn’t been cut for the past 5 years (since 2009). This criterion eliminated some Energy companies. This criterion is especially important if you’re planning to reinvest dividends into the company. Think about it; you’re adding more money to the investment!

Additionally, companies with a BBB+ S&P credit rating or better indicates that they are investment grade, and have safer balance sheets. This means, I will purchase a BBB+ company over a BB- company for example, given the companies are at proper valuations and future earnings expectations are positive.

Dividend Reinvestment at a Discount – The Canadian Companies List

Below is a list of companies or REITs whose dividends (or distributions) haven’t been cut for 5 years. For ones which have only paid dividends (or distributions) for less than 5 years, they’re marked as such. This list is not a recommendation to buy these companies. It simply serves as a reference to look for safer companies with a DRIP discount. Just because they offer a DRIP discount, doesn’t mean you should buy them at any price. Check their valuations and future prospects first! For instance, do you have a positive outlook on their future?

Safe dividend reinvestment at a discount with Enbridge, Fortis, and Sun Life Financials.

3 companies I want to highlight are Enbridge, Fortis, and Sun Life Financial. They have the most solid balance sheets of the group.

In the list, there are 11 REITs. Investors invest in Real Estate Investment Trusts for their tendency to pay out a higher starting yield. So, they are nice income vehicles. However, most offer little growth for that payout. Additionally, their distributions aren’t eligible dividends. Further, a portion of an REIT’s distribution maybe return of capital. Wrap your head around REIT taxation from Globe and Mail. To simplify things for yourself, you can choose to buy REITs in the TFSA or RRSP instead of in the taxable, non-registered account. Then, you don’t have to worry about their tax situation. Read More

Invest in Real Estate Investment Trusts or REITs for Income

Investors can passively invest in real estate by buying units of REITs or real estate investment trusts (just like buying shares of a company). So that they don’t have to deal with tenants. Investors buy REITs mainly for their income. So, REITs are suitable for income investors, and retirees. Some REITs pay out distributions monthly, while others pay quarterly.

Types of REITs

  1. Equity REITs are the safer kind as they invest in and own properties. They receive rents from those properties and by law, and they pay out a high portion of that as distributions. (Distributions are like dividends.) That’s why, generally, REITs pay out higher distributions than a typical stock.
  2. Mortgage REITs owns property mortgages. They earn interest from mortgage loans. So, mortgage REITs are the riskier type. That’s also why they sport higher distributions than the equity REITs, sometimes in double digits!

Because I’m primarily a conservative investor, I have only bought equity REITs.

Equity REIT Categories

eREITs can be categorized into retail REITs, office REITs, residential REITs, Healthcare REITs, etc. Some eREITs are categorized by diversified for example if they own properties in retail, office, and industrial.

REIT Distributions act like Dividends but aren’t exactly Dividends

One thing to note is that the distributions from REITs aren’t entirely considered as eligible dividends. If you want to avoid the tax hassle, then, as a Canadian, you would want to buy REITs in the Tax-Free Savings Account (TFSA) or the Registered Retirement Savings Plan (RRSP).

Personally though, I like to buy Canadian eREITs in the TFSA, since I can withdraw from it anytime without any tax consequences. If you plan to reinvest the monthly distributions via DRIP (dividend reinvestment plan), then, it doesn’t matter if you buy the units in the TFSA or RRSP. However, note that Canadians can only DRIP full shares/units (cannot DRIP partial shares/units).

Canadians who buy US REITs will find that they need to pay the marginal tax rate on the distributions if bought in the taxable / non-registered account. I heard that Canadian investors who hold some US REITs in the RRSP won’t have withholding tax on the distributions, that is, they’ll receive the full distribution. However, I can’t be certain that that is the case for all US REITs.

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Foreign Dividends with No Withholding Tax – Companies List

Usually there’s a non-resident withholding tax on dividends paid by foreign companies. For example, as a Canadian, the US dividends I receive in my non-registered (taxable) account will automatically get 15% deducted. However, I can recover that by filing for a foreign tax credit. Still, I must pay the marginal income tax rate on those foreign dividends.

So, to save the tax on the foreign dividends, Canadians would buy US dividend stocks in the RRSP instead. However, the point of this article is to record the list of companies which don’t have a withholding tax on the dividends for non-residence. As I’m continuing on my dividend growth investing journey, I’ve collected a list of companies which do not have withholding tax on the dividends for Canadians. That means, if you’re holding these dividend companies in the RRSP or TFSA, you receive the full dividend. If you’re holding them in the non-registered (taxable) account, then, it’s true that there’s no withholding tax on the foreign dividends, but you still need to pay the marginal income tax rate on the dividends.

Buy these companies in your TFSA, and receive their full dividend.

  • BP plc (NYSE: BP) – *yield: 5.39% – an Energy company
  • Royal Dutch Shell plc or simply, Shell (NYSE: RDS.B) – *yield: 5.04% – an Energy company
  • Unilever plc (NYSE: UL) – *yield: 3.78% – a Consumer Staple
  • Westpac Banking Corporation (NYSE: WBK) – *yield: 5.23% – an Australian bank
  • BHP Billiton plc (NYSE: BBL) – *yield: 4.55% – a Basic Materials company
  • GlaxoSmithKline (NYSE: GSK) – *yield: 5.88% – a pharmaceutical company
  • HSBC Holdings plc (NYSE: HSBC) – *yield: 4.83% – a London-based bank doing business in 80 countries
  • Vodafone Group plc (NASDAQ: VOD) – *yield: 7.13% – a Telecom

*yield as of October 28, 2014 closing ; Note that I collected this list from the web, so there could be inaccuracies. Please let me know if any correction is needed. I will also add to this list as I come across such companies.

Of course, buying the above companies in the RRSP will yield the same result — that there’s no withholding tax on their dividends. However, you get deducted 15% on US dividends in the TFSA, but get the full dividend in the RRSP. So, you probably want to leave the room in your RRSP for US dividend companies instead.

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Invest US Stocks in the Non-Registered Account at Scotiabank – Currency Exchange Fee Tips

My observations in the last year lead me to believe that I should buy US securities under USD/CAD 1.12 at Scotiabank, preferably <= 1.10. Right now, around 1.08 – 1.09 is certainly favorable to buy some US securities which are undervalued though discounted excellent businesses are hard to come by in this fully valued market.

In my self-directed non-registered account, Scotiabank separates the Canadian positions and US positions. Specifically, in the Canadian Account Positions section, all positions remain in the Canadian currency, while in the U.S. Account Positions portion, all positions remain in the USD currency.

US Stocks in the Canadian Account Positions

Each time I buy a US stock here, Canadian dollars is converted to US dollars. Likewise, each time I sell a US stock here, the proceeds is converted back to Canadian currency. And if I want to buy again, I need to convert to USD again. In between each currency exchange, Scotiabank takes a haircut of 2%.

For example, on July 3, 2014, USD/CAD is 1.0627 (shown on Google Finance), while Scotiabank charges 1.0845 (that is a 2.18% difference). In addition to paying the 1.0845 currency exchange fee, I need to pay $9.99 per trade in the currency of the stock purchased. If I buy $1000 worth of shares, that is 1% fee. In total, the fee I would have paid for a trade on July 3, would have been 8.45% + 1%, that is 9.45%. Of course, I buy US stocks, expecting that the currency exchange rate to stay about the same if not US dollars eventually reverting back to the norm of $0.86USD to $1CAN.

To minimize paying for currency exchange (which would trigger the 2% fee by Scotiabank), I only buy non-dividend paying US stocks in the Canadian Account Positions section of my non-registered account.

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Dividend Stocks at a Value: April 2014 Watchlist

I like dividend stocks because they pay out dividends from a part of the earnings. The dividend adds to my total return on top of capital gains that I take if any. As long as I keep my shares, I’m entitled to the dividends that they pay. Using these dividends, I can purchase more shares without adding in new money. On the other hand, as someone in the early stage of accumulation, it might make sense to add in new money along with the incoming dividends to grow my portfolio of stocks faster. This is exactly what I’m doing.

For this month, I looked over my current holdings to see which dividend payers are good values to buy now.

Classic Dividend Companies

  • Coca-cola (NYSE:KO) – yield: 2.99%
  • Procter & Gamble (NYSE:PG) – yield: 3.16%
  • Chevron (NYSE:CVX) – yield: 3.22% (dividend raise expected Q2 2014)
  • Cisco Systems (NASDAQ:CSCO) – yield: 3.25%

Since I’ve written about Coca-cola, Procter & Gamble, and Chevron in my February Dividend Watchlist, I will only write about Cisco this time.

Cisco Systems

Cisco logoCisco Systems designs, manufactures, and sells internet protocol-based networking products, and other products related to the communications and IT industry. Cisco also provides services related to these products and their use. Some of Cisco’s products and services include: Application Networking Services, Networking Software, Routers, Servers, Switches, and Unified Communications. It has an attractive yield of 3.25% right now after raising its dividend by north of 11% this month. Since initiating its dividend in 2011, it has grew at a compounded annual growth rate of 47%. However, that’s largely because its payout ratio expanded from 10% in 2011 to its present 45%. Going forward, Cisco should raise its dividend by around 9% to align with its estimated earnings growth (next 5 years) of north of 9%.

Turnaround Dividend Stocks?

Sometimes there are dividend stocks on sale which aren’t your typical dividend companies. Here are two:

  • BP p.l.c. (NYSE:BP) – yield: 4.53%
  • General Motors (NYSE:GM) – yield: 3.53%

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Look for Safe Dividends for your Income Portfolio

Summary

  • low payout ratio does not suggest lots of room for dividend growth
  • companies with wide economic moats are more likely to continue to grow dividends
  • companies with strong balance sheet strength are more likely to continue to grow dividends

Low Payout Ratio does not suggest there’s plenty of room for Dividend Growth

The payout ratio is the amount of earnings paid out in dividends to shareholders. Just because a company has a low payout ratio does not imply that it will continue growing its dividends. Businesses in stable industries tend to have higher payout ratios. For example, it is normal for industries like consumer staples, tobacco, and utilities to have relatively higher payout ratios of 60-70%. Companies such as Coca-cola (NYSE:KO), Philip Morris (NYSE:PM), and Wisconsin Energy Corporation (NYSE:WEC) come to my mind. On the other hand, if a company had higher earnings variability, it would need a higher cushion for the dividend in periods when the company’s profitability is challenged. That is, such a company would have a lower payout ratio. Thus, the payout ratio is just one of the metrics which help determine if the dividend is safe and has potential to grow.

A good way to tell if a company is meant to have a low payout ratio or not is to simply compare its payout ratio to its peers’ payout ratio. Since they’re in the same industry, they’d want to have a similar amount of cushion for their dividends. For instance, Ross Stores (NASDAQ:ROST) and TJX Companies (NYSE:TJX) are both in the cyclical business of apparel retails. Ross has a payout ratio of 16.5, while TJX’s is 13.7. If both companies decide to keep the payout ratio in the teens, the only way they can grow the dividend is to rely on earnings growth. So, estimating the earnings growth of a company becomes a good exercise to help determine the safety of a company’s dividend and its growth.

Of course, a company can choose to grow its dividend at a faster rate than its earnings growth. In this respect, other than with the “help” of earnings growth, the company must raise its payout ratio. An example that I noticed is Qualcomm (NASDAQ:QCOM). It recently grew its dividend by 20% from an annual payout of $1.40 to $1.68, while this year its earnings growth estimation is around 15%.

Companies With Wide Economic Moats are Likely to Continue to Grow Dividends

Companies with economic moats have one or more competitive advantages over peers, and that a wider economic moat protects dividends over long periods of time. Matthew Coffina, from Morningstar, talks about Building a Moat in your Portfolio (pdf link to his slides) from March’s Individual Investor Conference. He lists the 5 sources of a moat:

  • Network Effect – the value of a company’s service increases as more people use it
  • Intangible Assets – patents, brands or regulatory licenses which protect excess returns
  • Cost Advantage – economies of scale, access to a unique asset
  • Switching Costs – it’s too expensive for customers to stop using a product
  • Efficient Scale – a niche market is effectively served by one or a small handful of firms

A company with a wide moat has multiple competitive advantages over its competitors. For example, I think that Coca-Cola’s moat comes from having intangible assets, cost advantage, and possibly efficient scale, as Coca-Cola is a world-renowned brand, and selling its products in more than 200 countries through its distribution system, and the only other big player is Pepsi (NYSE:PEP).

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Oversold or Overbought? Relative Strength Indicator Examples

When to Use the Relative Strength Indicator?

In my book, fundamental analysis always trumps over technical analysis. That said, using both hand-in-hand is useful. After deciding that I like a company’s fundamentals, and that it can be bought at proper valuations, I like using technical analysis to help determine whether it is a good time to buy. Looking at the relative strength indicator or the RSI is a simple way to tell whether a stock is currently overbought or oversold. Investopedia defines RSI as “A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.” When the RSI reaches 30 or under, the stock is considered oversold. When the RSI reaches 70, the stock is considered overbought.

RSI Example with Bed, Bath & Beyond

Just because the stock price reaches RSI 30, it could still keep going down. At the top of the Bed, Bath & Beyond (NYSE:BBBY) daily chart below, we see the RSI, indicating oversold for as long as month!

Bed, Bath & Beyond Daily Chart

Source: Stockcharts.com

RSI Example with Union Pacific

On the contrary, a fundamentally strong company might seldom hit the RSI 30 area. Even when Union Pacific (NYSE:UNP) hit RSI 70 (became overbought), the price didn’t go down much, and only traded sideways for awhile. The sideways trading led the RSI to get back to 50, before the price went higher again.

Union Pacific Weekly Chart

Source: Stockcharts.com


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Dividend Stocks to Buy: February 2014 Watchlist

With the recent dip in the market, it is time to shop for some blue chip companies for good yields and growing income.

For this month, I came up with these dividend payers.

Blue Chip Dividend Stocks

These are companies which have grown their dividends for over 15 years. Most generate revenue from different parts of the world.

  • Chevron (NYSE:CVX) – yield: 3.57% (next expected dividend raise: Q2 2014)
  • Coca-Cola (NYSE:KO) – yield: 2.95% (next expected dividend raise: Q1 2014)
  • International Business Machines (NYSE:IBM) – yield: 2.14% (next expected dividend raise: Q2 2014)
  • Procter & Gamble (NYSE:PG) – yield: 3.11% (next expected dividend raise: Q2 2014)

Chevron

Chevron logoChevron is a big oil company, which pays an attractive dividend of over 3.5%, higher than its 5-year average of 3.3%. It’s paying out 31% of its earnings for its dividends, indicating there’s room for it to grow. Furthermore, Morningstar gives it 4-stars, meaning the shares are currently undervalued. I usually try to get some Chevron starting at the 3.5% yield, and that’s what I did recently. Furthermore, if history is telling, then, having raised dividends for 26 years in a row, CVX will be increasing its dividend in Q2 of 2014, which is very soon!

Coca-cola

Coca-cola logoCoca-cola should be a familiar brand name for all who lives in a first world country. It sells non-alcoholic beverages via its wide-reaching global distribution system to over 200 countries. Its recent 10% acquisition of Green Mountain Coffee Roasters, and long-term relationship with the company will help add a kicker to Coca-cola’s growth. It is now selling at 18% discount according to Morningstar. Value Line projects KO’s price to be in the range of $50 to $60 by 2016-18. That is an upside of 31.8% to 58%, while starting with a yield over 3%, as Coca-cola is expected to raise its dividends in Q1 2014. See Value Line’s full report on KO (pdf).
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