There’s more to dividends than the current yield. While current yield tells you what you will receive this quarter, a closer look at the company’s dividend history and its business tells you what you might expect well into the future.

Dividends show respect for shareholders by returning cash to them. If the payments go back far enough, they tell you which market corrections, recessions and other financial crises the company has weathered. When these economic events forces share prices down, the companies that fall least, and rebound first, are the ones you want to own. You can wait for the rebound, while still collecting a payment. The best of the best increase their dividends in bad times.

These companies are the focus of Harvest Portfolios Group’s philosophy which aims for conservative growth and income, enhanced by a covered call strategy.

An example of the strategy at work is the Harvest Brand Leaders Plus Income ETF (TSX: HBF, HBF.U) which was launched in 2014.

As of Oct. 31, 2019, the actively-managed ETF held 20 global brand leaders who are the dividend elite, with an average portfolio dividend yield of 2.00% and a current distribution yield of 6.93%. The current distribution yield is enhanced by a covered call option strategy. The distributions are paid monthly and are payable as cash or through a Distribution Reinvestment Plan (DRIP). The ETF’s management fee is 0.75%.

Harvest CEO Michael Kovacs says the ETF offers income and capital appreciation through its holdings of diversified, large cap established businesses.

“With this ETF, you get a growth vehicle and capture more growth through the compounding power of the dividends. That’s our focus – longer term positions in really exceptional companies.”

In a low interest rate world, where a third of global bonds carry a negative yield, investors have turned to high quality dividend paying companies like those in the Harvest Brand Leaders Plus Income ETF. But the Harvest analysis looks beyond current yield.

Although a high yield is usually a good sign, if the yield is too high, it can sometimes be a warning. It may be high because a company’s share price has fallen, which pushes up the yield.  (Dividend yield is calculated by dividing a company’s annual dividend payment by its share price.) The decline in share price may be due to a change in business conditions and be a sign that investors believe the dividend will be cut.

So, you want to dig a little deeper. What portion of profits does the company pay out?  This is known as the payout ratio. How often is the dividend is increased and by how much on average? How sustainable is the payment if conditions change?

The selection process for stocks in the Harvest Brand Leaders Plus Income ETF covers these bases. The companies have a minimum market capitalization of US $10 billion, pay dividends which tend to increase, have a track record of growth, good management teams and all the key attributes you look for in a great business. They are true global leaders, the biggest and most dominant companies in their industry. The names include Apple, McDonald’s Visa and Morgan Stanley.

That is overlaid with a covered call strategy that reduces risk, while safely generating more income. The strategy involves selling a portion of the potential rise in a stock’s price in exchange for a fee. The fee limits the gain a bit, but it also acts as a cushion if share prices fall, because you keep the fee no matter what. Covered call options are a Harvest specialty.

Here are examples of stocks held in the ETF:

McDonald’s (NYSE: MCD) is the world’s largest operator of fast-food restaurants with more than 37,000 outlets in 120 countries.

It has increased its dividend in each of the last 42 years. In the past 10 years, the average increase has been 8.90%. If that dividend growth is maintained at the same rate, it means McDonald’s dividend payments double on average every 8 years.

Its payout ratio has been between 48% and 72% for the past decade and is currently at 61%. This means McDonald’s is paying 61% of its profits to shareholders and retaining the rest for investment in its business. That gives it a cushion that will allow it to keep paying the dividend should profits fall.

UPS is another holding.  UPS is the world’s largest package delivery company, with a market capitalization of US$83.6 billion. It operates in 220 countries, employs 481,000 people and its operations include a cargo airline, freight-based trucking, and 5,000 franchised UPS stores.

UPS has raised its dividend in 18 of the last 20 years. The two years where the dividend was not increased were 2002 and 2009, both years of sharp economic contraction.   The dividends were maintained in those years.

During the past 10 years, the average growth in UPS dividends per share has been 7.90% per year. Its payout ratio is 66% with a 10-year median of 63%, indicating a cushion to continue paying in weaker conditions.

If you reinvest the growing stream of dividends in companies like these through Harvest Distribution Reinvestment Plans (DRIPs), your returns are supercharged. That’s because you receive distributions on dividends.

The power of dividends was illustrated through an analysis in the UK a few years ago. It suggested that dividends provide between 30% and 40% of investment gains in the short and medium-term.

In a review of dividend growth called Why Dividends Matter, the total returns of the 500 companies in the S&P 500 index were reviewed for the period between 1940 and 2012. It found that for an average holding period of one year, dividends accounted for 27% of total returns. Over 3 years, they accounted for 38% of returns. After 5 years it was 42%.

The study pointed out that many non-dividend-paying stocks are also excellent performers and there is no one size fits all. Some growth companies pay token dividends but have strong share appreciation.

But in general, dividends are a positive indicator showing management’s faith in the business. Since the decision to pay a dividend is made at the beginning of a year and the sum is set aside against expected profits, it indicates that management has confidence in the future.

Dividends are at the heart of the Harvest Advantage which also includes a diversified portfolio of investment products. The Harvest Brand Leaders Income Plus ETF’s investment strategy is as follows:

  • Globally diversified by sector and region;
  • Chosen from a universe of companies among the World’s Top 100 Brands;
  • Consistent dividend paying companies with high recurring revenues;
  • Available for an active covered call strategy which generates an attractive tax efficient distribution stream.

For more on Harvest Portfolios Group click here.

The views and/or opinions expressed in the blog are of a general nature and are for informational purposes only. Blog contents should not be considered as advice and/or a recommendation to purchase or sell the mentioned securities or used to engage in personal investment strategies. Investors should consult their investment advisor before making any investment decision.