Friday, 29 April 2011

Which Canadian Stocks with Growing Dividends? - The High Yielders

Income-seeking investors are naturally keen on stocks that pay dividends, especially ones that combine a history of consistently rising dividend with high dividend yield (dividend as a percent of stock price). Such stocks are often termed dividend achievers or aristocrats. Some might think those stocks to be automatic winners. Today we look at Canadian stocks that currently fit that bill to see how true that might be.

Finding the Current Canadian Dividend Achievers
In doing our search we first came across blogger Passive Income Earner's list from January 2011. To find a current list at any time, a convenient source is the holdings of Claymore Canada's S&P TSX Canadian Dividend ETF (symbol CDZ , MER 0.66%) which selects only companies that have increased dividends for at least five consecutive years. Then we sorted the list to select the "high" dividend payers, which we define simply as anything more that the TSX Composite average yield of 2.4%, a figure obtained on the TMX Money Indices page. That left less than half the original number of stocks, whose yields were all 3.0% or more. (Next week, we'll look at and compare the remainder of the stocks in the list, whose yields fall below 3%.) The resulting list is below.

Lesson #1 - Dividend achievers exist in a variety of sectors, everything from the expected utilities and pipelines to retailers, oil companies, financial companies, telecoms, media and transportation.

Is the Dividend a) Safe and b) Likely to Continue Rising?
As we all should know, the future may not repeat the success of the past. Our table of comparison above shows that for several of the companies, various factors may threaten the dividend, such as:
  • large debt load and weak coverage of interest on that debt, which must be paid before dividends
  • dividend payouts that exceed the earnings of the company
  • falling earnings that may not generate enough cash to fund dividend increases
Lesson #2 - Some companies may not be able to sustain further dividend rises

Two companies look vulnerable to an end to dividend increases, if not outright dividend cuts - Enbridge Income Fund Holdings (symbol ENF, not to be confused with Enbridge Inc, symbol ENB, which looks quite solid) and Thomson Reuters Corp (TRI).

Based on the combinations of the factors (green numbers in the table), several companies look to be well capable of continued increases in their dividends:
  • Canadian Real Estate Investment Trust (REF.UN)
  • Corus Entertainment Inc B (CJR.B)
  • Canadian Utilities Inc (CU)
  • Rogers Communications Inc B (RCI.B)
  • Intact Financial Corporation (IFC)
  • Transcontinental A Subvtng (TCL.A)
  • Canadian National Railways (CNR)
  • Imperial Oil Ltd (IMO)
Are the Stocks Too High Priced?
The dividend may be safe and even likely to rise further, but perhaps the stock is over-priced and its price risks falling, leading to capital loss for the investor. This factor is the hardest to assess and could benefit from more detailed examination of the company than is done here but we can draw tentative indications.

Lesson # 3 - The price of some of these stocks appears attractive and others not at all.

Some of the indicators that suggest stocks which may be worth a detailed look include: stock price to earnings ratio that is lower than the TSX Composite average of 19.7; price to company cash flow that is low; healthy return on equity and on assets; and growing earnings per share. Stocks that look good on this preliminary basis of value include:
  • North West Company Inc (NWC as of May 2nd - before that NWF)
  • Telus Corp (T)
  • Canadian Real Estate Investment Trust (REF.UN)
  • Rogers Communications Inc B (RCI.B)
  • Corus Entertainment Inc B (CJR.B)
  • Shaw Communications Inc B (SJR.B)
  • Canadian Utilties Inc (CU)
  • Transcontinental A Subvtng (TCL.A)
  • Intact Financial Corporation (IFC)
The not-so-attractively priced stocks:
  • Enbridge Income Fund (ENF)
  • Thomson Reuters Corp (TRI)
Have the Same Companies been the Top Canadian Dividend Achievers Year After Year?
If there was any doubt of the need to be cautious in assuming that the current companies with consistent records of dividend increases will keep doing so, it is only necessary to see how past lists compare. We managed to find similar lists from 2007 (from the Globe and Mail here and here) and 2009 (from the Million Dollar Journey blog here)and only four companies have managed to qualify in all three years' lists. In the comparison table below, we highlight in green cells the stocks that appear in every list, in pale yellow the stocks in the 2009 and 2011 lists and in pale blue those in the 2007 and 2009 lists.

Here are the current dividend longevity champions:
  • AGF Management Ltd B (AGF.B)
  • Enbridge Inc (ENB)
  • Canadian National Railways (CNR)
  • Imperial Oil Ltd (IMO)
CNR and IMO both have modest dividend yields, though the accumulated increases over the decade or so (the total time straddled by all the lists) that they have been raising dividends would have produced a handsome income for shareholders of long duration.

Perhaps the most interesting feature of the 2007 to 2011 evolution is the falling away of the banks and insurance companies after the financial crisis. The big question - will any or all come back to qualify again for the dividend achiever list? A few banks have announced dividend increases recently. Perhaps the future won't be like the recent past, only the distant past?

Lesson # 4 - The present is very little like the past and the future may be quite unlike the present as well. Such lists as Canadian Dividend Achievers can be a good starting point to find promising dividend-generating income stocks but are not a foolproof method of picking them.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Tuesday, 26 April 2011

Borrowing to Invest (Leverage) - Choosing Amongst Loan, Margin, Leveraged Fund, Capital Split Shares

Interest rates are low these days so some investors might be considering borrowing money to invest. The first step is to carefully consider the rewards and risks of borrowing money to invest, also referred to as using leverage. Doing a Google search for the words "borrowing to invest" along with "leverage" will bring up many articles. It's highly advisable to read several before jumping in.

Once the decision has been taken, the next step is choosing a method. Let's explore the pros and cons of three common ways to use leverage for buying stocks in Canada - 1) Bank loan, secured or unsecured, 2) Broker Margin, 3) Leveraged ETFs - and one less known method - 4) Capital Split Shares.

1) Bank Loan / Line of Credit
  • Loan interest must be paid regularly on a fixed schedule, and perhaps principal payments too, unless the loan is interest-only
  • Payments do not vary with value of the investments, whether they go up or down, unlike margin with its possible margin calls. Close monitoring of the investments is not required.
  • Full amount of the investment can be covered by the loan
  • Loan collateral may be none, if unsecured, provided by the securities, or by other assets, like a home. That can have drastic consequences if the investments go bad and you cannot pay the loan. A key pre-requisite to choosing this method of leverage would have to be the investor's capacity to keep paying the loan despite stock market dips.
  • Investment choices are unlimited.
  • Current unsecured loan interest rates are in the 5-6% range according to Fiscal Agents. One should then net out the tax deduction of interest in a taxable account - at 46% top marginal rate in Ontario, that works out to 5% - 0.46*5% = 2.7%. Secured (against a home or the investments) rates would be about 1% less, around 4%. These are floating rates that will rise when interest rates do. Fixed rate term loans are available but the cost will be much higher. One major bank is quoting 8.55% for a two-year term loan.
2) Broker Margin
  • Interest rate fluctuates up or down with prime rate. Borrowing cost is not fixed or predictable
  • Investor must put in some equity money, calculated as a percentage of the total investment e.g. 30%. That percentage must be maintained at all times. If the market goes up, there's no problem but a market decline may push the value of the investments too low compared to the loan and the investor will then receive a margin call to add cash to the account or be forced to sell some of the securities
  • Loan collateral is provided by the securities
  • Amount of margin or equity that the investor must provide varies by stock price e.g. for stocks priced at $5 or more, the investor must put up a stake of 30% of the total investment while it is 50% for stocks $2 to $5 and under $2, it is not possible to buy on margin at all. Beyond that, investment choices are unlimited.
  • Margin accounts are normally only available for taxable accounts, not TFSAs, RRSPs or other registered accounts. In any case, losing the tax deductability of the interest expense, which happens when funds are borrowed for investment within registered accounts, knocks off a big part of the value of borrowing to invest.
  • Interest is paid through monthly posting by the broker of the charge in the account (see BMO's FAQ). If the account has a cash balance, the interest will be deducted against the cash, otherwise it is cumulated and compounded monthly with the rest of the margin loan and figures into the margin maintenance calculation.
  • Cost of borrowing - A typical current broker margin rate is 4.25% such as at BMO Investorline, though it may be less for larger accounts One should then net out the tax deduction of interest in a taxable account - at 46% top marginal rate in Ontario, that works out to 4.25 - 0.46*4.25 = 2.38%.
3) Leveraged ETFs (see primers such as ETFdb's and GetSmarterAboutMoney's)
  • Fund applies the leverage, not the investor. The ETF determines the amount of leveraging, not the investor. Most ETFs are 2x leveraged to get double the underlying stock return though some US ETFs apply 3x leverage.
  • Due to leveraging techniques used, such as options and futures, the investor gets no tax deductible interest charge. Investors will generally experience only capital gains or losses from buying or selling the ETF shares.
  • Daily performance tracking of such ETFs - it is the daily return only that the ETF enhances - means that they are suitable only for short term trading and not for long term investing.
  • Broad range of index and sector tracking funds is available.
  • Eligible to be bought in any type of account
  • Costs are difficult to determine or predict due to the mix of management fees (the only Canadian leveraged ETF provider Horizons BetaPro funds charge 1.15%) and on-going leveraging costs. Price performance of the ETF shares will almost always overwhelm such costs in determining investment returns.
4) Capital Split Shares (see our recent post looking at their overall investment potential)
  • Borrowing is carried out by the split share corporation, not the investor. Thus, amount of leverage is not controlled by the investor. Most split shares employ less than 2x leverage, many much less than that. To find out exactly how much, one must go to the split share's website and either get it from the corporation's profile or from the annual report. For instance, Newgrowth Corp (TSX symbol: NEW.A) sports leverage of 1.52x (52 cents of debt for each equity dollar invested)
  • Investor faces no loan repayments or margin calls. The collective "loan" consisting of the preferred shares in the split share corporation is only paid back at its wind-up maturity date (June 26, 2014 for NEW.A). As an investor, you merely hold the shares and experience up or down movements in stocks as paper gains or losses until they are realized upon sale. The Capital share will merely(!) decline a lot faster than the market but you won't be required to come up with extra cash.
  • No tax-deductible interest arises from owning split shares. Distributions are in the form of dividends or return of capital.
  • A limited range of investment opportunities through split shares exists in Canada - mainly large banks, insurance companies, utilities, REITs, telecomms, pipelines. The majority have multiple holdings, a few are fairly diversified and some hold the shares of only one company. The 50 or so Canadian split share corporations are listed within the GlobeInvestor Closed-End Fund report.
  • Total cost of borrowing is the sum of the preferred share interest rate plus other corporate expenses. For example, for NEW.A, we estimate costs at 6.45% - the sum of preferred dividends receiving 6.0% plus other fund costs 0.45%. The cost remains quite static. The main component, the preferred share dividends, remains fixed through out the life of split share corporation and the other expenses should not vary a great deal. Interest rates these days are quite low but if, or should we say when, they start to rise the fixed borrowing rate costs of existing Split Shares will become increasingly beneficial to Capital shareholders.

This quick review of the options for leveraged investing suggests that the best method might vary amongst investors depending on many factors, such as type of account, tax situation, financial flexibility, target securities, time horizon and risk capacity. Hopefully, this post helps you to be aware of the alternatives and some of their key characteristics.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.

Thursday, 14 April 2011

Five Last Minute Tax Reducers for Investors

2010 is long gone and the April 30th income tax filing deadline looms close, so investors might ask themselves what last minute tax actions they might be able to take to reduce taxes or get a larger refund on this year's return. Here are some suggestions.

1) Swap between spouses to offset unrealized capital gains of one against losses of the other
This operation could save taxes of the current year or of the past three years for couples with investments in non-registered taxable accounts. A person with unrealized capital gains makes a swap with his/her spouse who has unrealized capital losses. The somewhat tricky procedure requires several steps to effect the gain-loss transfer. Two good step-by-step descriptions can be found in financial planner and author Alexandra Macqueen's Canada:Transfer Capital Losses and in accountant Tim Cestnick's Globe and Mail article Share with your spouse and erase a cash drain.

2) Carryback 2010 (or older) realized capital losses to offset previously reported realized capital gains and recover past taxes paid
If you have capital losses from 2010, they can be used to offset gains in the three previous tax years (2007, 2008 and 2009). That is allowed after 2010 losses have been applied to any 2010 gains and there is still a loss. The form to use is the Canada Revenue Agency's T1A Request for Loss Carryback, which is included/filed with the 2010 return.

3) Apply net realized capital losses of prior years to reduce realized 2010 capital gains or past capital gains
The same idea of offsetting capital losses in one year against gains in another year can work as well by bringing forward past losses to the present. You will see on your 2009 Notice of Assessment from the CRA the total of past capital losses you have claimed. The claim is made on line 253 of your income tax return.

If you messed up and missed doing this before, there is still some chance to do the offsetting of gains and losses further back. First, note that there is a time limit on changes to past returns. The CRA's How to change your return page says that you may only change returns of up to ten years ago, i.e. 2001 or later. If you neglected to report losses in 2002 (remember that year of big market declines?), you can do so now but cannot claim against any gains in 2000 (perhaps tech boom year profits?). The ten year limitation is a good reason to report capital losses promptly each year, even if there are no present gains to offset. Losses can be carried forward indefinitely against future gains. It is too easy to forget or lose documents needed to make a future claim, and the process is more cumbersome.

4) Make a declaration of deemed capital loss for companies gone bust
When a company like Nortel goes bankrupt or becomes insolvent and its shares become worthless with no hope of recovery, it is possible even without selling the shares to make a declaration to the CRA claiming a total capital loss under subsection 50(1) of the Income Tax Act. The claim is made through a letter to CRA (no form is available) stating: name of the company, number and class of shares, date shares were bought, adjusted cost base, proceeds of disposition (usually zero), any expenses for disposition, and amount of the loss. Accountant Robert Smith's Tax Deduction for Shares You Can't Sell and Million Dollar Journey's Claiming Capital Loss from a De-listed Stock provide more background.

Two important points are:
  • The declaration must be made in the return for the tax year the bankruptcy happens e.g. for a 2010 bankruptcy, it must be made this year.
  • De-listing of the stock is not enough - some companies may carry on doing business after de-listing. However, de-listing is a strong sign to pay attention (check the TSX Reviews and Suspensions list on TMX Money) if the drop to zero in your account hasn't caught your attention! The Office of the Superintendent of Bankruptcy Canada has a database that can be searched to provide a key detail required in the claim letter - the date of insolvency, bankruptcy or wind-up.
5) File a return and pay taxes owing on time
The easiest way for an investor to save money is to avoid paying a penalty for late filing, paying interest on any taxes owing or interest on the penalty! The CRA Interest and penalties page tells us exactly how much interest and penalties CRA will apply. Should it be necessary to report imprecise or incomplete data, it is still better to file a return, and estimate the amount owed. Even when that means over-paying taxes, there may be a silver lining since CRA's current rate of interest paid back to individuals on overpayments is a rather attractive, compared to that of bank accounts and term deposits, 3%.

Disclaimer: this post is my opinion only and should not be construed as investment or tax advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor or an accountant.

Tuesday, 5 April 2011

How Your Province, Income Level and Investment Choices Affect Your Income Tax

Taxes matter to the investor. What is left to spend after paying income tax is what interests us as investors, not the nominal pre-tax return. There are key elements that an investor should be aware of in order to guide plans and shape investing strategy. As we show below the differences can be very large indeed.

The major tax differences arise from:
  • Type of income - employment, pension (including age 65+ RRIF withdrawals), interest (including RRSP withdrawals), capital gains, dividends, TFSA withdrawals
  • Province - each province has its own tax scale for each type of income, in addition to that of the federal government. Some Provinces have high taxes, some are low and some are in the middle (see the Ernst & Young 2011 Personal Tax Calculator to find where each Province falls in the spectrum). We've chosen three to do our comparisons - middle level Ontario, low tax BC and high tax Nova Scotia.
  • Income level - each type of income in each Province has its own tax scale according to income level (yes, it is reminiscent of the child's song "there's a hole in the bottom of the sea")
Tax Comparisons:
The Canadian 2010/2011 Tax Calculator from provides a quite sophisticated free tool (it includes exemptions, deductions, tax credits, adjustments for dependents, age and spouse income splitting) that we have used to gain insight into the bottom line effect of various combinations of the above factors. Our comparison tables are organized by income level. We've chosen three - a modest pre-tax income of $40,000, a middle income of $60,000 and a high income of $100,000. Then we try out different breakdowns of types of income sources to see total tax payable results.

Middle Income - $60k Table

High Income - $120k Table

Modest Income - $40k Table

What the numbers tell us:
  • Interest income always attracts the highest tax and by a lot, no matter what the Province or income level.
  • Healthy doses of capital gain and dividend income can significantly reduce an investor's total tax / average tax rate, especially for high income earners.
  • The mixture of income types makes the most tax difference. The mix of interest, capital gains, dividends etc has a huge impact that is far greater than any difference amongst Provinces. For example, a $60k income could have $10,000 to $11,000 less income tax to pay if instead of being all interest income, it is an even combination of interest, capital gains, dividends and TFSA withdrawals (which are tax-free).
  • The highest tax Province of Nova Scotia shows the most sensitivity to type of income. It has the greatest dollar difference between highest and lowest combination no matter what the income level.
  • The lower the income level, the more the type of income matters ie. the greater the relative difference between highest and lowest tax. In our tables, that shows up in the column "Within Province, Highest to Lowest Multiple". For example, in Ontario, someone with $40k income only in interest would have almost 11 times (10.9 is the exact figure) more tax to pay than if they had only dividend income. At $60k income the multiple is only 4.7 times and at $100k, only 2.9 times.
  • The difference between the Provinces matters less for modest income. At $40k the percent difference in between the highest and lowest Province varies from 1.5 to 4.7% while at $60k and and $120k the difference is generally 5+%.
Practical Implications and Considerations:
  • Use the Tax Calculator to examine how your individual situation works out in detail, then compare against alternatives. Keep in mind that registered accounts (like RRSPs, RRIFs, etc) allow tax deferral of any income, so if you do not need the money now to spend, it is likely better to contribute and keep the funds within such accounts (see our previous post RRSP vs TFSA vs RESP vs Non-Registered Taxable Account?). In any given year, when you have a choice of which combination of accounts and sources to use to withdraw funds, such as in retirement, the calculator may save you hundreds or thousands of dollars. Investors may also want to look at the long term planning software package RRIFMetic, which asserts it can optimize such withdrawal strategies over many future years.
  • Lower income investors should try to shape their income towards dividends and capital gains.
  • TFSAs could, down the road when they have grown enough to contain substantial assets, be a valuable source of supplementary tax-free income that keep total taxes down. During retirement, the TFSA has another nice feature in that withdrawals do not reduce eligibility for OAS and GIS.
  • Within taxable accounts, investors should acquire investments that generate dividends and capital gains. (Dividends and capital gains within registered accounts such as RRSPs, LIRAs RRIFs etc do not matter as there is no immediate tax to pay and the money when withdrawn will be either ordinary income or pension income.)
  • Some people might even wish to consider Provincial tax differences in deciding where to live, though that is quite a drastic measure!

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.