Dividends: Financial Gazelles
I like to watch nature shows on TV. One of the more interesting episodes I saw featured the behaviour of gazelles when attacked by predators. Now, you would think that the obvious choice of any creature, when confronted with a charging lion, would be to immediately put all other activities aside for the time being, and run like the blazes. Don't waste energy making noise, don't grab that last mouthful of grass, and don't tap your hooves for an indecisive moment trying to decide what to do - just head for the hills! It's a decision that we in the investment community might call a ' no brainer'.

Strangely enough, however, the gazelles waste a lot of energy leaping as high as possible into the air as they flee. These leaps slow them down, and one could easily imagine that in some cases it could mean the difference between life and death, so why do they do it?

Researchers have an explanation. The leaps demonstrate the health, fitness and strength of the gazelle. In effect, the gazelles say to the lion, "Look how strong I am. You are chasing me, but I am still able to leap this high in the air. Give up, because I am so fit you'll never get me." And it works! The strongest gazelles jump the highest, and are ignored. The leaps give the lions a reliable signal of how successful their attack is likely to be. So it's good for the lions, and good for the gazelles. At least, for some of them…

What if there was such a signal to us investors that demonstrated the strength of companies? Something to identify which companies are in good shape, earning substantial profits, and worthy of investment consideration? How useful that would be.

Well, there is such a signal: dividends. In effect, dividend-paying companies are communicating the message that they have made enough profit to give some of it back to shareholders. They can afford to do it. Regular and growing dividends indicate that there is enough financial health to allow shareholders to be rewarded - in cold hard cash.

Quite often, dividend-paying companies are in very boring, yet reliable industries, the kind that we all frequent on a regular basis; banks and insurance companies, consumer products, utilities, telecommunications, and food companies. These have been called the 'inevitable' businesses, because we inevitably have to use them all the time. They tend to be businesses that have been around awhile, have built up strong brands, and are in industries where it would be very hard for a new competitor to move in.

In addition, these companies tend to be strong financially and managerially. They can't survive if they don't demonstrate that they will be there, year in and year out. Because they are big companies, with, in most cases, global brands, they have lots of resources. Financially, they attract strong credit ratings, which implies limits to the amount of debt they take on. And in terms of management, the need to regularly pay dividends imposes a certain amount of control and discipline on management.

What is not boring is the performance. Studies have shown that dividend-payers outperform the underlying market over the long haul. In down markets they don't fall as much, because the dividends tend to help support the stock price, whereas in rising markets the stocks tend to do as well or better than the rest of the market. Volatility is reduced, and investor satisfaction is increased.

Of course, dividends can also play an important part in generating stable and growing income for your retirement needs. While there are a lot of income-producing assets out there, over the long haul, it is often best to accept a slightly lower initial income stream, as long as that income grows. These dividend-paying stocks do just that.

Interestingly, foreign dividend-paying companies have significantly higher dividend payouts than in North America. Here, yields have averaged 1.5% - 2.0% over the last decade, whereas the U.K. benchmark index (the FTSE 100) has seen dividend yields averaging 3.5% to 4.0% over the last 3 years. (Source: TD Economics). Investing solely in Canada limits your opportunities; of the top10 global consumer durables companies, none is North American. In many other sectors, the best companies are overseas as well.

Nevertheless, no method is infallible, and there's a lot more information to analyze when making investments than just dividends. It can be particularly difficult to examine foreign companies, let alone buy them on foreign stock exchanges, when you are not familiar with the local market. Furthermore, it's important to determine whether the dividends are likely to be cut at some point in the future due to adverse business conditions. Either you or someone else needs to do the homework required.

Here's a clear need for a good mutual fund: to do the analysis, and make the investments for us. Take a look at the AIC Global Premium Dividend Income Fund. This fund invests in precisely the types of companies I have been discussing. I have met with the fund managers, and have complete confidence in recommending this fund to clients for whom it is appropriate. These guys know how to separate the strong gazelles from the weak.

If you'd like more information on this fund, or just a review of your investments, feel free to give me a call at any time, with no obligation. Our team is devoted to providing you with superior service and advice, protect your capital, while beating inflation and taxes. It would be well worth your time to get a second opinion and hear what we can offer.

Sincerely,

Scott Swallow, HBA, MBA, CIM