The 3 Best Dividend Growth Stocks In Canada For 2017 (And Beyond)

This is a guest contribution from The Financial Canadian.

Before we dig into Canada’s best dividend growth stocks, I wanted to say that I was absolutely delighted to have the opportunity to write for the Sure Dividend website. I immediately knew that Ben and I had a lot in common when I read the following passage:

Sure Dividend helps individual investors build dividend growth portfolios made of shareholder friendly businesses with strong competitive advantages trading at fair or better prices.”

Now, onto the body of the post.

The Underlying Assumption

Throughout this post I will be providing investment research. However, this research is not valid without the assumption that readers will be investing with a long time horizon (meaning a minimum of three years).

“The single greatest edge an investor can have is a long-term orientation.” – Seth Klarman

Long-term systematic investing is extremely important. Investors can lose out on outstanding long-term returns by trading too often. With a short time horizon, we are subject to the whims of the market and investor psychology.

“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” Benjamin Graham

Over the long-run, however, better businesses outperform the overall market. This is especially true in the world of dividend growth investing. Reinvesting those dividend payments results in a snowball of compound earnings that can eventually grow into a substantial passive income.

This is not possible with a short time horizon, so keep that in mind as you read the rest of this post.

Criteria

This post is titled “The 3 Best Dividend Growth Stocks In Canada for 2017 (and Beyond).”

The word “Best” is ambiguous by nature, so before continuing I wanted to define the criteria by which I would be judging these stocks. Long-time Sure Dividend readers will notice that my criteria are very similar to the Eight Rules of Dividend Investing. This is no coincidence. I selected this stocks by looking for:

  1. High dividend yield
  2. Low payout ratios
  3. Strong history of dividend growth
  4. Attractive valuations based on P/E and P/B Ratios
  5. Wide economic moat and strong competitive advantage

Note that none of these criteria are completely stiff. If a stock is lacking in one category, this may be compensated for with fantastic performance in another.

Let’s dig into the first stock.

Toronto-Dominion Bank

The Toronto-Dominion Bank (TD) is a diversified financial services provider with operations in both Canada and the United States. From their website, their business is divided into three main segments:

  • Canadian Retail including TD Canada Trust, Business Banking, TD Auto Finance (Canada), TD Wealth (Canada),TD Direct Investing and TD Insurance.
  • U.S. Retail including TD Bank, America’s Most Convenient Bank, TD Auto Finance (U.S.), TD Wealth (U.S.) and TD’s investment in TD Ameritrade.
  • Wholesale Banking including TD Securities.

TD has a pleasant blend of both organic growth and growth through acquisition. Organically TD continues to mature in the Canadian markets, being the largest bank by assets and the second largest bank by market capitalization (behind RBC). Their acquisitions are predominantly in the U.S. Retail segment, and include the privatization of TD Banknorth, Commerce Bank N.A., and The south Financial Group, Inc to form TD Bank N.A.

Key Stats:

  • P/E Ratio: 13.11
  • P/B Ratio: 1.628
  • Dividend Yield: 3.78%
  • Payout Ratio: 43.16%

In my recent analysis of the financial performance of the “Big 5” Canadian banks over the past 3 fiscal years, the Toronto-Dominion Bank (“TD”) came out on top. I was encouraged to read that Sure Dividend is a supporter of this bank as well, as Ben detailed in his September 7th post “Why TD Bank Is A Buy At Current Prices.” Let’s dig into why we both like this stock.

Investment Thesis

A Safe, Growing Dividend

First of all, in recent history TD has had the best dividend growth among it’s peer group. More importantly, their payout ratio has been among the best in their peer group. In 2015, only the Canadian Imperial Bank of Commerce had a lower payout ratio than TD. Take a look at the data:

Dividend Growth Stocks

This low payout ratio means that TD has plenty of room to further grow their dividend. It also means that they might have sources to reinvest their money at high rates of return. The U.S. Retail Banking segment comes to mind.

A World-Class Management Team

TD’s senior management team has gone through two serious changes in the past few years.

First and foremost, Bharat Masrani succeeded Ed Clark as the President & CEO of TD effective November 1, 2014. This means that the 2015 fiscal year was Masrani’s first full year as CEO. Though he is new as CEO, Masrani is no newcomer to the bank. After joining the bank in 1987, he most recently served as the head of their U.S. Retail Banking segment, and the Bank’s Chief Operating Officer. The bank’s performance was fantastic during Masrani’s first full year at the helm, as the bank set a record for adjusted earnings.

The second major change was a shakeup at the executive suite of TD, which reflects a focus on technology. These changes were announced in November of last year, and were highlighted by the departure of Tim Hockey, the former head of TD’s Canadian Retail operations. Hockey has assumed the role of President and CEO of TD Ameritrade, in which TD has a 40% ownership interest. There were a few other changes, which are outlined in this helpful article from Newswire.

Both changes are positive in my opinion. TD’s management team remains one of the best in the business.

A Strong Economic Moat

In Canada, banks enjoy some of the largest barriers to entry of any industry. The banking industry is dominated by the “Big 5” – TD, the Royal Bank of Canada, the Canadian Imperial Bank of Commerce, the Bank of Nova Scotia, and the Bank of Montreal.

In the US, there are many more smaller competitors, but barriers to entry are still significant. The US barriers to entry are regulatory in nature, not due to an oligopoly as in Canada.

In some senses it is advantageous that there exist smaller counter parties in US banking, as this presents acquisition opportunities for the Bank (more on that later).

Fantastic Growth Prospects In US Banking

TD’s presence in the United States was initiated with their purchase of Banknorth Group Inc. in 2005, which they successfully privatized in 2007. They later purchased Commerce Bancorp and a slew of Florida banks until their operations ran across the entire Eastern seaboard of the United States. Fast forward to today, and they now have more US branches than they do in Canada.

At the present, I think there is tremendous opportunity for growth in the US retail bank for TD. Since they have been progressing through a combination of acquisitions and organic growth, the bank’s penetration in their US business is not at the level of the Canadian counterpart. In an interview with the Financial Post, the Bank’s CEO said:

“We’re not as mature in our U.S. business as we might be in Canada, so just penetrating basic banking products for our customers would be huge progress.” – Bharat Masrani

I’m excited to see how TD

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