Dogs of the TSX Dividend Stock Picks (February 2023 Update)

Over the past number of years, I’ve been writing about the investing strategy known as Dogs of the TSX (taken from “Dogs of the Dow” in the USA) – also known as the Beating the TSX Dividend Stock Strategy (BTTSX). (Click here to skip directly to my 2023 picks).

The principle of this strategy is to systematically filter undervalued blue-chip stocks each year. The filter for our stock selection is mainly dividend yield. While this is an imprecise metric, what higher yields generally signify (at least amongst the large dividend-paying Canadian oligopolies) is that a company’s share price is lower than it should be relative to its free cash flow.

So what I like to do is take the 60 largest stocks on the Toronto Stock Exchange (aka the TSX60) and sort them by dividend yield. Then I remove income trusts and stocks that have cut dividends OR have crazy-high payout ratios (and consequently, are at risk of cutting their dividend).

You’ll notice that it has a lot in common with my Best Canadian Dividend Stocks 2023 list that I update monthly.

While 2022 turned to be an all-time doozy of a downturn for the world’s stock markets, our Dogs of the TSX investing strategy has held up far better than most portfolios. Canada’s energy companies, pipeline stocks, and utilities are keeping many portfolios above water – while tech-heavy investors are floundering.

Top Canadian Dogs of the TSX Pick for 2023: Telus (T)

Our top pick out of the 2023 Canadian Dogs of the TSX is Telus (T). It’s simply tough to beat the telecommunications oligopoly when it comes to reliable stability in overall returns. The company makes most of its money from wireless business – which has only three real operators in Canada.  

What separates Telus from fellow Dog of the TSX, Bell (BCE) is their ability to grow and spin off valuable secondary business verticals in addition to their core businesses. Telus International, Telus Health, and Telus Agriculture are quite interesting new fields to be a part of, and so far it appears that management has figured out how to create value there.

The company raises their dividend like clockwork each year, and has been a great mix of a growth plus yield. While the P/E ratio is a bit higher than I’d like to start 2023, I’m willing to pay a premium to own this stability.  

It’s also worth noting that as the Rogers/Shaw dance continues, Telus benefits in two major ways. To start, the fewer competitors in a market, the stronger the oligopoly pricing power becomes. Secondly, the longer this drags on, the more it distracts both companies from challenging Telus in areas of strength.

February 2023 Update: Telus has a solid-if-not-spectacular start to the year. As of writing, it’s up 6%, which basically tracks the broader S&P/TSX Composite Index’s 5%. BUT, keep in mind, that doesn’t include the juicy 5% dividend yield that Telus is spinning off this year.

The 4th quarter earnings report for the company showed a 3.8% operating revenue increase from the previous year. While adjusted earnings per share were basically flat, that bottom line number doesn’t reflect two key considerations:

1) The last few years have seen massive capital expenditures from Telus as they paid upfront to install fibre-optic cables to homes and businesses. They are nearly done with that huge undertaking, and it will free up nearly $3 billion in cash flow for 2023. Let’s just say there are no dividend cuts in the future.

2) In September, Telus acquired the US-health company LifeWorks for $2.2 billion. This represents another investment into Telus’ growing telehealth business. I really like this focus on healthcare as opposed to traditional media and sports teams that Bell and Rogers seem to favour (in addition to their core telecommunications business)

National Bank recently released their 2023 Dividend list, and highlighted Telus saying, “Telus has enjoyed a premium valuation to its peers. […] After the successful IPO of Telus International, we await future monetization opportunities related to Health and Agriculture which could happen over the next two or more years.”

Dogs of the TSX Dividend Stock Strategy Implementation

Here is the step by step procedure of how this strategy is implemented:

1. Sort the TSX60 by dividend yield.

2. Purchase the top 10 positions with equal dollar amounts but remove former income trusts (maybe some exceptions) and stocks that have a shaky dividend history (ie. dividend cuts, cyclical companies, pausing dividends etc).

3. Hold your positions until the new year at which point you check the list of top 10 yielding blue chips on the TSX again. If there are any differences, you swap out positions until they match.

4. Repeat annually going forward.

While it may sound like a lot of portfolio churn, since the TSX is fairly small, the top 10 list doesn’t vary much from year to year.

It also turns out that a number of the largest dividend stocks in Canada are also dividend growth stocks. While the traditional method of picking these positions is to buy the top 10 while removing former income trust and companies that have cut their dividends in the past, I prefer to pick stocks that also have a history of dividend increases (most of them do).

Performance of the BTTSX Strategy

As magical as it may seem, this strategy has been outperforming the TSX over the long term. Mind you, the strategy does not outperform every single year, but it has outperformed over the long term (however, note that past results do not guarantee future returns).

According to the Beating the TSX Wiki page, between 1987 and 2017, the BTTSX had an average return of 12.4% vs the TSX which has returned about 9.6%.

As you know, small improvements in portfolio performance can lead to a significant difference in portfolio size over the long term.  Note my article on improving your portfolio performance by 1.7% through reducing your portfolio MER can lead to a 60% difference in portfolio size over 30 years. It also helps to use a low-cost online broker.

I like this strategy in that investors are getting the highest possible yield out of the largest blue-chip stocks in Canada with the possibility of dividend increases.

The downsides are that there is annual turnover (usually minimal) which can result in a tax hit in non-registered accounts and potential lack of diversification depending on the year.  For example, one year, it could be a high concentration of financial stocks in the portfolio, and the next could be utilities.

BTTSX Dividend Stock Picks For 2023

Now, for what you’ve been waiting for, the 2023 BTTSX stock picks.

1. Algonquin Power and Utilities Corp (AQN)
2. Enbridge (ENB)
3. TC Energy Corp (TRP)
4. Bank of Nova Scotia (BNS)
5. BCE (BCE)
6. CIBC (CM)
7. Power Corp (POW)
8. Pembina Pipeline (PPL)
9. Manulife (MFC)
10. Telus (T)

For further context, here’s the old the MDJ 2022 BTTSX picks:

1. Enbridge (ENB)
2. Pembina Pipeline (PPL)
3. BCE (BCE)
4. TC Energy Corp (TRP)
5. Manulife (MFC)
6. Algonquin Power and Utilities Corp (AQN)
7. Power Corp (POW)
8. Suncor (SU)
9. Bank of Nova Scotia (BNS)
10. Telus (T)

1. Telus (T)

The 2023 Dogs of the TSX group contains 2 telcos, 3 financials, 1 pure utility, 1 utility + renewable hybrid, and 3 pipeline utilities (or “mid-stream” energy companies).  For a complete portfolio, we would also need materials/resources, real estate, technology, and consumer stocks. If you want to round out your dividend portfolio, check our top dividend stocks for 2023.

If you are considering this strategy, I would recommend using it as part of your Canadian exposure and using index ETFs for global diversification.

My top 10 holdings after several years of doing the BTTSX are:

1. Enbridge (ENB)
2. CIBC (CM)
3. Scotia Bank (BNS)
4. Manulife (MFC)
5. BCE (BCE)
6. TC Energy Corp (TRP)
7. Power Corp (POW)
8. Telus (T)
9. Pembina Pipeline (PPL)
10. Algonquin (AQN)

My Own Implementation of BTTSX

I mentioned in an earlier financial freedom update that my spouse had some cash saved up, and we were looking to deploy into dividend stocks using the Dogs of the TSX strategy. We ended up opening yet another account at Qtrade.

Our “non-registered” dividends shown in a recent update are from our “BTTSX” dividend portfolio. Here’s my end of 2022 update.

• Total Dividends: $73,800/year 

Being a dividend growth investor, we decided to utilize a hybrid approach to this strategy. We essentially sorted the TSX60 by yield, but only picked stocks with a history of dividend increases. We also added a couple of positions for diversification. So it’s not a pure Dogs of the TSX investing strategy.

While going through this process for 5 years now, I’ve noticed that I’m good at picking and buying the stocks, but terrible at selling! I’d much prefer to add to existing or new positions with new money rather than selling to gain capital. As of this post, I have not sold any of my original positions.

Since inception in September 2017 to January 2022, using XIRR the portfolio has returned about 12% while the index (XIC.TO) has returned about 8%. Not a bad result, but in reality, I’m more focused on the dividends that the portfolio produces.

My Overall Top 2023 Dividend Picks After Adjusting for Dividend Growth

How Did Our Canadian Dogs of the TSX Perform in 2021 and 2022?

Our 2021 Dogs of the TSX list resulted in Enbridge being the top pick – and it came through big time for us. With a capital gain of over 21%, and a dividend yield that was over 8% when we wrote the article last year, we realized a total gain of almost 30% for this Canadian dividend king.

I say that only to properly frame the context for my “Dog of the TSX” 2022 stock pick: Algonquin Power and Utilities Corp (AQN). 

This one stings! But I feel it’s important to be brutally honest with readers when things don’t go as predicted. Hopefully it lends credibility to when we get things right – and by the way, I still honestly feel that we’re going to be right on AQN in the long term!

Here’s a few pieces of information to chew on as we consider what to do going forward:

1) The dividend (even after the recent cut to start 2023) is now 6.51%. This is insane value, and I have purchased more of the stock already.

2) When EPS comes down 9%, there is some reason for a 5%-ish fall in share price. The massive fall is completely disproportionate and reveals a lot of investors that are not confident in their investing thesis.

3) Algonquin is NOT dramatically affected by the rising interest rates. The company doesn’t carry a ton of debt relative to other utility companies AND much of that debt isn’t due for 3+ years. It’s locked in at the very low rates we saw the past couple of years. 

Even if interest rates go up another 1-2% (doubtful it will be higher than 1.5% after the US CPI numbers last week), we’re only talking 15-30M in annual increased interest costs for Algonquin. This is a company that is set to make over $400M this year. That means the interest rate increase will sting a bit, but we’re not talking panic by any stretch here.

4) AQN managed to negotiate a better purchase price on their big acquisition of Kentucky Power. The substantial purchase will add to free cash flow going forward.

Algonquin has a great track record of being able to manage utility companies and add value in the renewable energy space. While its stock dilution has been irritating at times, it has allowed the company to grow without adding crushing debt loads (which looks like a pretty smart move at the movement). 

Until they prove that they have lost their touch when it comes to bringing value to new projects I will continue to give them the benefit of the doubt. Plus, at this entry point, the downside is incredibly miniscule. Even just their attractiveness as a takeover target puts the fair market value WAY higher than the current price point. 

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Dogs of the TSX FAQ

Final Thoughts

As you can see, the BTTSX strategy has been outperforming the TSX over the long term. Mind you, the strategy does not outperform every single year, but it has outperformed over the long term (however, note that past results do not guarantee future returns).

Perhaps it’s the fact that large-cap stocks on the TSX tend to beat Canadian small caps, which at times can act as a drag on the overall index (Canadians love their oligopolies with large barriers to entry after all). Another reason may be that as yields rise for blue chips, it may mean that their stock price is relatively low which can equate to a form of value investing.

If you are considering the Dogs of the TSX strategy, I would recommend using it as part of your Canadian exposure and using all-in-one ETFs for added diversification.

Using an all-in-one ETF can give you instant international exposure, and is especially key for getting some of your money into areas like tech and healthcare where Canada doesn’t have many champions.

Canadian dividend stocks have historically been an excellent value (and I honestly believe they represent one of the best places to build your nest egg) but a responsible investor knows that diversifying risk is essential to long-term success. See my Canadian dividend stocks list for more information on what I’m putting new money into these days.