Show discernment with dividends

If you’re like most investors, dividend growth puts a smile on your face and a spring in your step.

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“Investors love dividend growth, as it typically signals the business is robust enough and profits are healthy enough to increase returns,” says Craig Jerusalim, portfolio manager at CIBC Asset Management.

Investors could find research to support this view. Previous empirical evidence shows “companies that grow their dividends consistently outperform non-payers, cutters and non-growers,” he points out. “But there are lots of holes in that analysis.”

Read: Can a board be legally forced to cut dividends?

For instance, a myopic focus on dividend growth can lead to suboptimal outcomes, “especially when companies sacrifice investing in their ongoing operations, overextend their leverage or manipulate payout ratios just to deliver dividend growth,” says Jerusalim.

In fact, many solid companies that could pay dividends choose not to, he explains, naming Spin Master, Berkshire Hathaway and Shopify. Instead, they pursue growth opportunities or invest retained earnings on investors’ behalf.

For these reasons, Jerusalim focuses on the more holistic metric of total shareholder yield, which incorporates dividends and dividend growth potential, as well as net share repurchases and net debt reductions — “all the asset allocation options available to a management team,” he says, adding that these are divided by market capitalization to calculate total shareholder yield.

“A higher number suggests higher shareholder value, [which] should result in higher stock prices over time.”

Jerusalim lists the key characteristics of such companies:

• defensible and sustainable competitive moods;
• strong business models;
• prudent balance sheets; and
• disciplined management teams.

For example, management should exhibit “an unwavering focus on optimizing returns on invested capital, such that they mak[e] the best asset allocation decision,” he says.

Sometimes that means increasing dividends, but it can also mean buying back shares or investing in growth or making other creative acquisitions.

Says Jerusalim: “Occasionally, we find great companies like CN Rail, Magna or Intact Financial that are able to successfully do all the above.”

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