As many of you know, I use the dividend investing strategy for the Canadian portion of my portfolio. To summarize the strategy, I essentially own the largest dividend paying companies that have a history of annually increasing their dividend.
I started building my dividend portfolio many moons ago (around 2008), and it has grown to the point where it can support our annual recurring expenses. We have achieved financial independence.
In my financial freedom updates, I list my top 10 dividend holdings and I also point out that I add to my positions when they appear cheap.
The most recent update had the following top 10 positions:
- TD Bank (TD)
- CIBC (CM)
- Canadian National Railway (CNR)
- Royal Bank (RY)
- Scotia Bank (BNS)
- Bank of Montreal (BMO)
- Fortis (FTS)
- Enbridge (ENB)
- Emera (EMA)
- TransCanada Corp (TRP)
These top 10 positions vary quite a bit over time as their values go up and down. However, while their value goes up and down, these top 10 tend to pay dependable dividends that tend to increase over time. As I plan on living off dividends in the near future, income dependability is a high priority.
If you are just starting out, check out my post on how to build a dividend portfolio. The post shows that I tend to pick the leaders in each sector that pays a dividend and own them forever.
Here are some market leaders and a starting point for your research:
- Telecom – BCE (BCE), Telus (T), Rogers (RCI.B)
- Pipelines – Enbridge (ENB), TransCanada Corp (TRP).
- Financials – Any of the big banks: Royal Bank (RY), Toronto Dominion Bank (TD), Scotia Bank (BNS), Bank of Montreal (BMO), CIBC (CM); Insurance: Manulife (MFC), Great-West Life (GWO), Sunlife (SLF).
- Resources and Materials – Suncor (SU), Canadian Natural (CNQ), Teck Resources (Teck.b)
- Utilities – Fortis (FTS), Canadian Utilities (CU), Emera (EMA), Brookfield Infrastructure Partners (BIP.UN/BIPC), Algonquin (AQN).
- Health Care – Canada is weak in this sector in terms of dividend stocks.
- Consumer – Empire (EMP.A), Loblaws (L), Canadian Tire (CTC), Dollarama (DOL)
- Industrials – Canadian Pacific Railway (CP), Canadian National Railway (CNR), Finning International (FTT), Waste Connections (WCN)
- Technology – Enghouse (ENGH), CSU
- Real Estate – Riocan (REI.UN), CHP.UN, CAR.UN
When building a dividend portfolio, I believe that it’s important to simply initiate a position and keep adding to it as it becomes undervalued and/or when new savings become available to invest.
How do I determine Canadian undervalued stocks?
Ok onto why you are here, how do I determine when Canadian dividend stocks are undervalued? I tend to use a combination of methods and here are the three that I use most often.
Relative P/E Ratios
A common metric for determining when stocks are undervalued is the Price to Earnings ratio, otherwise known as the P/E ratio. In this ratio, the stock price is divided by its annual earnings to come up with a number. The lower the number, the “cheaper” the stock.
The one thing about this ratio is that it can be deceiving in that “earnings” can be manipulated with creative accounting. As well, some industries often report relatively low “earnings” but have strong cash flow (like real estate investment trusts). Another variable, sometimes the market rewards growth companies with a higher P/E.
As you can see, P/E ratio can be subjective and not a great single measure of value, but I often use the P/E ratio as a comparison and starting point when researching strong companies within the same sector.
For example, BCE and Telus are head to head competitors. Both are dividend growth stocks (I own them both), have a strong mobile footprint, and have a history of growing their dividend on an annual basis.
Right now, BCE is trading at a P/E ratio of 22.61 while Telus is trading at P/E ratio of 26.85. I will say that historically, the P/E ratios for both companies right now are on the high side (ie. appear expensive), and in this case, BCE appears “cheaper” than Telus. While strictly from a P/E ratio valuation perspective, you could pick BCE as your choice, but if you look at the growth prospects of Telus Health and other ventures, along with people cutting their BCE cable TV at an increasing rate, which is the better choice? It’s hard to choose from a P/E ratio perspective.
Average 5-year Yield
Another way that you can see if a company is trading at below their historic levels is to compare its current yield to its 5-year average yield. Remember that dividend yields go up as the stock price goes down.
So if the current yield is higher than the 5-year average (ie. attractive), then it may be a good starting point for your research on why it’s trading lower, and if you expect the fundamental business to continue growing going forward. If everything appears normal and it seems that the market is just being temperamental, then it may be time to start/add to that position.
For example, as of this post, TRP is trading with a yield of 5.93% and according to ca.dividendinvestor.com, their 5-year average yield is 4.8%. This indicates that it may be a good time to add to (or initiate) your TRP position depending on if you like their business prospects going forward.
Technical Analysis – Using Moving Averages
A third factor that I consider before adding to a position is the use of basic technical analysis, more specifically, using the long-term moving average.
Personally, I tend to add to positions when they are on an uptrend but have pulled back to their long-term moving average, like the 200 day simple moving average (SMA).
In the example below, I had a position in BIPC but noticed after a strong uptrend (first arrow) that it was selling off and it pulled back (second arrow) close to the 200 day moving average. I like the future prospects of BIPC and added to my position in the circle area.
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Undervalued banks stocks in Canada
Now it’s time to put some of the strategies stated above into practice so let’s start with some of the largest companies in Canada – the big banks.
I like to compare the big banks to each other, and from my experience, a P/E comparison is a quick and effective way to determine if one bank is relatively undervalued compared to another.
Here is a table comparing all the big banks:
|Company||P/E||Yield||5yr Avg Yield|
|Royal Bank (RY)||14.36||3.72%||3.9%|
|TD Bank (TD)||12.53||3.83%||3.9%|
|Scotia Bank (BNS)||14.86||4.56%||4.8%|
|Bank of Montreal (BMO)||13.78||3.75%||4.2%|
As you can see across the board, using the 5-year average yield valuation method, all of the big banks are a little overpriced (their current yields are below the 5yr avg yield).
However, if I had to add to a big bank today, it would probably be TD Bank. In terms of P/E it’s lower than the rest, and in the top 2 in terms of market cap (size). You can read more about that in my investing in Canadian banks guide.
Undervalued oil and energy stocks in Canada
For those of you still interested in energy stocks, there are a few left in Canada that are investable. In my mind, here are the top energy dividend stocks in Canada:
|Company||P/E||Yield||5yr Avg Yield|
|Canadian Natural Resources (CNQ)||n/a||4.75%||4.3%|
For this table, to keep things fair, I would compare ENB vs TRP and CNQ vs SU. From a yield perspective, it looks as though both ENB and TRP could be undervalued here. CNQ must have negative earnings, which results in P/E showing as n/a. However, from a yield perspective, it looks as though CNQ may be undervalued and SU slightly overvalued.
When building a dividend portfolio, it’s mostly about owning the strongest companies – this is the foundation of your portfolio. Over the decades, these strong slow and steady companies will continue to grow their earnings and their values will slowly go up – essentially, relative to the future, they are “undervalued”. However, if you are looking to add a little “alpha” to your portfolio, then buying the dip (using some of the strategies outlined above) on strong dividend stocks may add to your returns.
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