Long-term dividend investing stocks Canada: building a dividend portfolio

Long-term dividend investing in Canada is commonly used by investors who seek to build wealth gradually, while receiving regular income from their investments. Investing in dividends often involves buying stocks in companies that pay dividends and holding these investments over time to gain income and long-term price growth.

Dividend investing is a structured investment approach, but it doesn't come without risks. The guide outlines how dividend stocks work, how dividend stocks are evaluated, and more.

What is dividend investing?

Investing in dividends is a strategy where investors focus on stocks that make regular cash payments to shareholders, also known as dividends. These payouts usually derive from Canadian company profits or cash flow, which can vary over time.

Key concepts associated with dividend investing include:

• Dividend yield: This measures annual dividend income compared to the share price. Payout ratio: This indicates how much of a company's earnings are distributed to shareholders as dividend payouts.

• Dividend reinvestment plans (DRIPs): When dividends are automatically used to purchase additional company shares, which contributes to compounding over time.

• Total return: Includes both dividend income and changes to share price.

Why Canadians may consider long-term dividend investing

Many Canadian investors tend to favour dividend investing because it focuses on well-established Canadian companies in the banking, utilities, and telecommunications sectors that pay regular cash dividends to shareholders. These payments can provide investors with a steady source of income that feels predictable, while still allowing for long-term growth. This income stream may make it easier for some investors to remain invested through market fluctuations.

In non-registered accounts, Canadian dividends are typically taxed more favourably by the CRA (opens in a new tab) compared to interest income and foreign dividends, as the federal dividend gross-up and tax credit systems adjust how dividends are taxed, so corporate and personal taxes reduce double taxation. But the exact amount of tax will depend on the investor's overall income and tax situation.

One thing to remember is that while dividend investments are used by many Canadian investors, the dividends themselves are not guaranteed, and companies can increase, reduce, or stop payments depending on financial performance at any time.

Long-term dividend stocks

Long-term dividend investing often focuses less on dividend yield and more on the underlying business itself and the dividend's sustainability.

Sustainable payout ratio

A lower payout ratio may suggest that dividends come from a company's earnings. In contrast, a high payout ratio may suggest a company pays its dividends through other financial resources that may not be as sustainable.

Consistent cash flow

Consistent cash flow means a company regularly generates money from their operations. This, in turn, helps the company pay dividends to their shareholders even when overall economic conditions fluctuate.

Dividend growth history

Companies with a history of maintaining or increasing dividend payments may appear more stable than others, but it's important to remember that past performance does not guarantee future results.

Strong balance sheet

Balance sheet strength refers to how financially stable a company is, including its debts and how costly that debt is to pay back. If debt levels are high, the company may have less ability to keep paying dividends, should the company's conditions become worse.

Reasonable valuation

Valuation is how expensive a stock is compared to what the company earns. Even if a company pays stable dividends, shares bought at a high price may reduce future returns or increase risk if the price falls.

Dividend yield traps

A higher dividend yield may look favourable to investors, but it doesn't necessarily indicate a strong investment opportunity. In some cases, a dividend yield may be higher because the share price dropped, which could suggest that the company is going through challenges or facing uncertainty.

This may serve as a warning sign that the dividend is not sustainable. For example, if a company is having trouble earning enough profits or cash flow, it may need to reduce or completely eliminate its dividends in the future. Because of this, dividend yield is often only one part of the larger picture, and is rarely used as the sole reason to make an investment decision.

Canadian sectors commonly used for dividend investing

Dividend-paying companies in Canada frequently function in the following key sectors of the Canadian market:

• Finance

• Utilities

• Telecommunications

• Energy

• Insurance

• Real Estate

• Consumer staples

All sectors mentioned will respond differently to economic changes, interest rates, and other factors. For example, when interest rates increase or decrease, some sectors may be more affected than others. The Canadian stock market is often concentrated in a few sectors, so spreading investments across various industries may aid in reducing the reliance on a single market area.

Building a dividend portfolio in Canada

Oftentimes, dividend portfolios consist of a mix of individual stocks and other diversified funds:

Diversification across companies and sectors

Diversification across economic sectors and companies may be used to reduce investment concentration.

Portfolio inclusions

Portfolios may include dividend stocks or exchange-traded funds (ETFs) that contain numerous companies.

How dividend reinvestment works

Reinvesting dividend payments can lead to compounding over time, where funds are used to purchase additional shares.

Reviewing holdings

Canadian investors often review their portfolio holdings regularly to monitor trends, payout ratios, and possible dividend announcements.

Account type considerations

Account type is also a part of the process. Dividend investments can be held in registered and non-registered accounts. Common registered accounts include the tax-free savings account (TFSA) and registered retirement savings plan (RRSP), both of which have their own contribution limits and tax treatments.

Dividend stocks vs. dividend ETFs

Dividend stocks provide exposure to certain companies and are often associated with greater investment control. However, these types of investments can require more research and ongoing monitoring.

In contrast, dividend exchange-traded funds (ETFs) offer diversified exposure to a group of dividend-paying companies. This may reduce concentration risk and may be simpler to manage. Each investment has pros and cons, and choice will depend on investor preference, time commitment, risk tolerance, and market familiarity.

Tax and account considerations for Canadian dividend investors

Tax treatment of dividends in Canada will vary based on the type of dividend purchased and the account it is held in. In non-registered accounts, dividends may qualify for tax credits. In registered accounts, on the other hand, tax treatment will differ. For example, in RRSPs, tax is deferred until withdrawn later in retirement.

Example: evaluating a Canadian dividend stock

Investors can typically evaluate dividend stocks using several factors.. These can include dividend yield, payout ratio, earnings, cash flow trends, debt levels, and more.

For example, a company with lower yields, stable growth, and consistent earnings may be viewed differently compared to a company with a higher dividend yield but declining profits.

Factors investors often weigh 

Before reinvesting dividends, here's what an investor might consider:

• Do I understand how the company makes money?

• Is the dividend supported by earnings or cash flow?

• Is the yield unusually high compared with peers?

• Has the company maintained or grown its dividend over time?

• Is the company carrying too much debt?

• Am I diversified across sectors?

• Does this investment fit my account type and goals?

• Am I comfortable holding through market volatility?

Building a long-term dividend investing strategy

Long-term dividend investing strategies are often associated with gradual income growth, compounding through reinvestments, and diversified investment exposure. That said, it's important to remember that dividend payments and share prices may change based on business operations and market conditions.

Considerations investors may prioritize include dividend sustainability, diversification, tax treatment, and alignment with long-term goals.

Conclusion

Investing in dividends is often associated with gaining exposure to income-generating companies. While dividends may provide regular income, they are not guaranteed, and results will depend on sustainability, market conditions, and diversification. Canadians can invest in dividends through both registered and non-registered accounts.