A few weeks ago I was busy re-formatting the blog and going back through my old blog posts. It's always fun to take a peek back in time and see what I discussed. One post that caught my eye was my Dividend Investing post back in May 2017. It interested me because I'm not a big fan of dividend investing and the results were quite revealing: don't focus on dividends, especially when they no longer offer a value proposition.
Dividend investing is huge in Canada! Just about every bigger financial blog written by Canadians for Canadians has a overwhelming positive view on dividend-focused investment strategies. Fortunately some are slowly turning towards index investing and other strategies, but that allure of cash payments dropping into your account on a monthly or quarterly basis is just too much for many to resist.
Maybe dividend investing made a lot of sense at one point in time. Mutual funds in Canada used to the chief comparison for the dividend crowd and we know Canadian mutual funds are generally a rip-off. Then there's the whole value argument that once was linked to dividend investing.
Further, dividends get very nice tax treatment, especially for lower-income Canadians such as retirees. Back when the capital gains inclusion rate was higher than it currently is, dividends were a clear winner in non-registered accounts. In RRSP accounts there are some tax advantages for investing in U.S. dividend stocks.
Dividend Investing Isn't What It Seems
The strategy behind dividend investing (when done correctly, of course) was actually not a terrible one at first glance. However, contrary to what you might have been led to believe by the dividend crowd, it was not good because of the dividend income stream.
Dividend investing was actually a pseudo-value strategy with a buy-and-hold tendency because of the focus on income rather than investment price. Companies that paid investors a healthy portion of their profits and increased their dividends over time were historically cheaper than the broad market. It's never a bad strategy to invest in a basket of companies that are cheaper than the overall market, be that on a price-to-book, price-to-earnings, or price-to-sales basis.
Meb Faber recently completed a white paper that further demonstrates what I am talking about. He also shows investors are better off using proper value metrics and staying away from attraction to those dividends.
It's important to always understand what you are really investing in and why your strategy gives you an edge in the markets. If you were investing in a strategy that turns out to actually be a value-driven strategy, it no longer makes sense to invest in that strategy if the valuations of those companies have gone totally crazy while the growth prospects remain muted.
There are so many viable investment strategies out there, it hardly makes sense to chase any one strategy with blinders on. Dividend investing, like any active individual stock strategy, takes a fair amount of work. When the prospect of outsized returns has disappeared--even if it's just temporary--why not focus your investing on indexing instead and save yourself the time and trouble of analyzing individual stocks. If you still want to put in the work, then invest in something more sound on a risk-reward basis like trend following.
Dividend Investing vs. Trend Following
The biggest problem with Canadian-listed dividend companies in general is that they got ridiculously expensive. I would say the blame for this lies squarely on massive government intervention in the financial markets, particularly since 2009. People used to be able to dump a big chunk of their portfolio in government bonds and earn 5% interest income; those days seem to be gone for now.
The only place left where you can get decent income is dividend stocks and REITs. Since 2009, the rush into these categories has been phenomenal. This wave of money made prices ridiculously high given the real growth prospects of these old-guard industries. That underlying value premium which historically benefited investing in dividend stocks is gone.
In my May post, I talked about the insane valuations of some of these Canadian dividend favourites. I specifically mentioned Loblaws (L.TO), Emera (EMA.TO), and Enbridge (ENB.TO) as being very expensive. Turns out I wasn't wrong in my belief that these companies had poor prospects going forward. If you had invested in these companies, you would be down around 15% since last May.
I am not a predictor and I had no clue that the prices of these stocks would begin to collapse, but at the appropriate time the trend lines would have quickly told you something wasn't right and that it was time to get out.
Let's have a look at their 1 year charts:
May 2017 was the clear peak price for both Enbridge and Loblaws. Emera ran up a bit more until December before turning negative. If you follow the long moving average line (purple one), you can see the price trends clearly flattening out and turning down. Selling when the price moved below the moving average would have significantly reduced your losses.
These are some great examples of why trend following works and why I prefer it to dividend investing. The system makes sense and doesn't depend on any fundamental evaluation or crowd promotion. Everything is baked into that price and I'll stay in the trend until it bends.
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