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Monday, December 8, 2014

A basic Dividend Growth oriented Canadian Investment Portfolio

I've recently been analyzing the performance of several, mature Canadian companies with a huge presence in the Canadian economy and therefore in people lives up here. I chose companies from different sectors for some diversification. I wanted to only analyze large caps, dividend payers and growers. I also didn't want to make this a never ending series about an overwhelming collection of companies. I wanted to keep it simple and illustrate the power of reinvested dividends, dividends that grow above inflation every year combined with capital gains. So, only nine companies in the end, which in my opinion could make up a simple long term investment portfolio with some degree of diversification with the goal of cash flow generation in mind. The companies analyzed were, in this order:

The Bank of Nova Scotia (BNS)
Emera Inc (EMA)
RioCan Real Estate (REI.UN)
Potash Corp. of Saskatchewan (POT)
Enbridge (ENB)
TransCanada Corporation (TRP)
Suncor Energy (SU)
Toronto-Dominion Bank (TD)
Telus Corporation (T)

In today's article I want to analyze a hypothetical portfolio made up of these 9 companies. I want to see how the portfolio performed in the last 20 years; calculate its draw-down for the year 2008 and make some basic future projections on how your capital could growth if similar returns are achieved.

The table below shows the Average yearly returns and the Dividend yields of the companies as of October 17, 2014, which was the common point in time I used in all the analysis:

(Click on image to enlarge)

The portfolio is overweight in Financials and Energy. That's typical on a 100% Canadian portfolio as those are the most representative sectors of the Canadian markets. But there is some degree of diversification inside each sector, for example in the Financials sector we have banks and a Real Estate Investment Trust. The Energy sector with not only a producer but also distributors (pipelines) who suffer commodities' prices fluctuations a lot less. Apart from that there is exposure to the Telecommunications sector, Materials and Utilities. Unfortunately Canada is not very strong in the Technology sector, so I didn't add anything in that area.

Assuming you invested the same amount of money on each company, the Average Yearly Return of the portfolio was +14.18% (That's for almost two decades, from April 1, 1995 to October 17, 2014). This obviously assumes that all the dividends received over time were re-invested. This is a spectacular yearly return for a period that includes the 2000 dot com bubble burst, 9-11 terrorist attacks, Wars, the 2008 market correction, the 2011 debt ceiling issues in the US and the European debt debacle.

The portfolio had a -24.36% year in 2008, considered by many the second worst recession in history. Can you stomach a -24% loss in your portfolio? That's a valuable statistic, because you know how bad it can get if you decide to go with this portfolio. The reason why the portfolio didn't correct as much as the major market indices (30% - 40%) was because of the presence of defensive stocks, like Emera (Utility) and Energy distributors such as Enbridge and TransCanada.

Dividend Yield
The dividend yield of this hypothetical portfolio was +3.91% on October 17, 2014. Prices are a little over extended right now compared to historical valuations. This portfolio should typically pay above 4% yearly in the form of dividends. Dividends that are favorably taxed in respect with normal income a.k.a salary. Dividends that provide you with cash flow without selling your shares, without giving away your ownership on the company.

At 4% yield, a $600,000 dollar portfolio would spit out $24,000 in the form of dividends every year, which would be enough to sustain my current life-style. Of course my current life-style will need more that $24,000 in the future due to inflation. But fortunately these companies have a history of rewarding shareholders via dividend increases every year, typically above inflation.

In terms of taxation, if those dividends are the only income you receive in an entire year, you pay absolutely no taxes on that income. I think you can earn up to $56,000 in dividends per year in Canada, and as long as that is your only income you pay no taxes. But I'm not a tax specialist so don't quote me on that. Of course, if you have that money in tax sheltered accounts like an RRSP and/or a TFSA you would pay no taxes at all regardless of how much money you make.

Why not other companies?
Why these companies in particular? Why these nine? As you know, I'm invested in 15 Canadian companies and 7 American ones as of this writing. However, for the Invest and retire before you die series, I wanted to keep it short, simple and sweet. I expect those nine companies covered in the series to be my main focus every year, and I believe they represent a solid core for a Canadian portfolio. But you can certainly go beyond those nine and invest in other companies:

In the banking sector for example, I could have chosen the Royal Bank of Canada (RY.TO), which has posted a 16.40% average yearly return (reinvested dividends included) in the last two decades. Similar to what both TD and BNS have delivered. And that is paying 3.73% a year in dividends as of right now.

In the Materials sector I could have chosen Agrium (AGU.TO) instead of Potash (POT.TO), or both.

In the Telecommunications sector, where I chose Telus, I could have chosen competitors such as Bell (BCE.TO), or Rogers (RCI.B.TO) or all three of them. Solid dividend payers with long track records of rewarding shareholders.

So, it is up to you. You decide how many companies you want to be invested in. How much more you want to diversify your portfolio etc. It really depends on your goals, time availability, risk tolerance etc.

But even in the simple core portfolio of 9 companies covered in the series, if only 2 or 3 of them repeat what they did in the past two decades, that exponential capital growth can easily absorb the entire bankruptcy of 3 or 4 of the other companies, which to me is an unlikely event.

The future
Unfortunately, it is always unknown. We can only speculate and dream.

If we invest $1,000 every year in each one of these 9 companies names ($9,000 in total per year), and we obtain the same 14.18% yearly return with reinvested dividends, you end up with a $955,445 portfolio in 20 years that spits out a nice $37,358 sum in dividends. A 14.18% yearly return is pretty optimistic, so let's analyze other scenarios:

13% yearly return (dividends of around 4% included) -> $823,229
12% yearly return (dividends of around 4% included) -> $726,289
11% yearly return (dividends of around 4% included) -> $641,386
10% yearly return (dividends of around 4% included) -> $567,022
9% yearly return (dividends of around 4% included) -> $501,881
8% yearly return (dividends of around 4% included) -> $444,806

Will this portfolio return 14% a year going forward (with dividends reinvested)? 
Probably not.

Will it grow your capital and contribute to a growing passive cash flow via dividends? 
Paraphrasing a prominent blogger I follow: Beats me. But if we have more terrorism, wars, governments' debt issues and two major corrections in the next few years, then our chances are pretty good.

Talk to your beautiful wife and get her on board. If your wife is not beautiful, get her on board anyways. The market gives the right to every one, beautiful or not. The market doesn't discriminate. The market is just. Have her cooperate. $375 from you every month, $375 from her every month. $9,000 a year consistently for a couple of decades and you can be set for life. Invested in solid companies that provide vital services to society and who periodically share those gains with their investors via dividends. Gains that are taxed much more favorably than standard income. Dividends that are increased every year, automatically keeping your passive income in pace with inflation. Do it, and at the end, a couple of surgeries here and there with part of the proceeds will make her hot again and you'll thank your pal The Lazy Trader for it.

Related Articles:
Chapter 1 - Invest and retire before you die - The Bank of Nova Scotia (BNS)
Chapter 2 - Invest and retire before you die - Emera Inc (EMA)
Chapter 3 - Invest and retire before you die - RioCan Real Estate (REI.UN)
Chapter 4 - Invest and retire before you die - Potash Corp. of Saskatchewan (POT)
Chapter 5 - Invest and retire before you die - Enbridge (ENB)
Chapter 6 - Invest and retire before you die - TransCanada Corporation (TRP)
Chapter 7 - Invest and retire before you die - Suncor Energy (SU)
Chapter 8 - Invest and retire before you die - Toronto-Dominion Bank (TD)
Chapter 9 - Invest and retire before you die - Telus Corporation (T)
Chapter 10 - A basic Dividend Growth oriented Canadian Investment Portfolio

ETF Rotation Systems to beat the Market

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  1. Hey LT,

    I've been meaning to get back around to looking at this for a while and I finally did. Those returns are impressive and that drawdown isn't that bad either. It's making me want to do some research on U.S. companies with the same characteristics. In the past year I decided to take a small position in BRK.B for similar reasons with a long term holding period in mind. At any rate, good stuff and thanks for sharing.


    1. Thanks Dan,

      Doing my best to shine some light over here. Yes, there are some remarkable performances on individual stocks but after intense study, I believe the use of ETF rotation strategies is superior and less risky. But, this is something else in our tool box, and it's pretty passive. The key would be to fine those that pay dividend and grow the dividend and who have been doing it for a number of years.