Wednesday, April 27, 2016

Dividend Stocks vs Rental Properties

Despite Twitter’s stock price falling 35% year-to-date, I continue to love the service they offer their users. Twitter allows me to view customized news feeds, drives a large percentage of my site traffic, and it provokes interesting conversations. Such an interesting conversation was initiated earlier this week when I received a tweet from Brian @rentalmindset asking me my thoughts on a post he wrote “The 4 Reasons Why Dividend Investors Should Own Rental Properties”.  Even though I disagreed with a couple of reasons he listed in the article, I found it a good read, and wanted to respond to his request more formally through a post of my own.

Brian’s four reasons why rental properties are better than dividends are outlined below along with my comments.

1.       Better Dividends

The comparison Brian makes is between the 9% cash return on his rental properties to the 2-3% dividend yield on the S&P 500 index. A key point to consider here is that Brian’s rental properties are highly leveraged since he pays a 20% down payment and leverages the remaining 80% of the property purchase price. His leverage ratio is 4:1, meaning his un-leveraged cash return on his rental properties is 2.25%. This un-leveraged return figure is pretty much in-line with the dividend yield of a broad-based index in North America.

2.       Better Financing

As discussed above, banks allow investors in rental properties to leverage up to 80% of their purchase. Brian makes the point that most stock investors do not use margin, and when a dividend investor decides to use margin, they are limited to 50%. I thought the 50% looked a bit low and checked my brokerage and found out it actually allows me to use up to 70% margin when buying stocks in my unregistered account. That said, instead of saying that better financing exists for property investors, I would say that higher leverage financing options exist. Not being a fan of leverage, I do not want to get caught up on this point, but the value of stocks and rental properties can both rise and decline. The ability to lose more money in a depressed housing/stock market is not something that interests me as I consider capital preservation to be of paramount importance.

3.       Better Taxes

Brian explains that he lives in California, where his combined federal/state tax rate is 37%. Although I do not feel comfortable disclosing my combined federal/provincial marginal tax rate, I can show you that in Canada, no matter where you live, your dividend income will be taxed at a lower marginal tax rate than your 'other income' which would be earned from rental properties.  From the federal tax rate table for Canada, you will notice that dividends are taxed very favorably at all levels of income. Similarly, in Quebec, where I live, dividends continue to be taxed at a much lower rate than other income. 

In Brian's defense, I would lump better taxes and more control together. If I was investing in rental properties, I would first form a corporation to buy them through (corporate tax rates are lower than personal tax rates in Canadea), then I would attempt to show $0 taxable income each year so as to avoid paying taxes on rental income profits. I would then dividend out myself any excess cashflow income in the corporation that I did not want to reinvest, which would be taxed at a lower marginal rate in my hands. Of course my aggressive tax planning might raise some red flags at the Canada Revenue Agency who might have a hard time understanding why a rental property business constantly shows no taxable income. 

4.       More Control

I am in total agreement with Brian’s argument that when I buy shares in a company, I have negligible control over their strategic direction. Although there have been times when I have been able to at least put a bug in a CFO’s ear of what I think of their dividend policy and ask about their operational strategies, I do not expect this kind of correspondence with C-suite executives. Sorry to all of those Buffet-ists out there who think that your 100 shares of stock means your voice should be heard by the executives at the company you invested in. Sadly, that level of minority shareholder rights simply does not exist, even for companies with small market capitalizations. For the record, I am fine with not having control over the management of companies I invest in. I do control my investment decisions by which I hope to avoid putting my capital to work in companies with management intent on building personal empires and ignoring their shareholders.

In contrast, Brian indicates that he has more control over his rental properties.  I agree with that statement, but only to a certain degree. By control, I assume Brian means that he controls the maintenance he performs on his properties, the property managers he hires, background and credit checks on prospective tenants, etc.. However, I would ask Brian if he has control over the neighborhoods he invests in, the municipal councils who zone the areas, local employers whose decisions impact the regional economy, the banks and mortgage brokers who lend to buyers, the future conditions of the US housing markets, etc.. 

As odd as it may sound coming from a dividend growth investor, I would agree that investing in rental properties is a faster way to achieving financial independence. However, the main trade off in my mind is that my dividend income is quite passive in nature, whereas investing in rental properties is much more hands on. Plus, the leverage involved to successfully and quickly grow a rental property business is scary to a more conservative investor like me. To conclude, I have a great deal of admiration for real estate investors, but it is simply not something that interests me.

To dividend investors - would you ever consider buying a rental property?  Why or Why Not?

Thursday, April 21, 2016

Four Lessons From Completing My 2015 Incomes Taxes

The summer I turned 13, I got a job cooking fries at a local fast food joint on the weekends. When my T4 slip indicating my employment earnings arrived in the mail the next February, my dad informed me that I would have to complete my personal income taxes. I remember sitting down at the kitchen table with my paper return, T4 slip, pencil, eraser and a calculator to complete my first personal income tax return. Since my employment earnings were below the basic personal amount, and because I had income tax deducted from my pay, I received a refund that first year.

Having completed a coop term in an accounting firm during my university studies, and given my dual Finance and Accounting majors, I can safely say that I have seen more than my fair share of personal and corporate tax returns. That said, every year when I sit down to do my taxes (along with those of my wife), I end up learning something new. Since I filed my taxes a few weeks ago, I thought I would share this year's lessons with you in case you had yet to complete your personal income tax return. It is important to note that my personal sources of income, family situation, and residency in Quebec Canada make my tax situation unique.

1. Sources of Income are Taxed Differently

One of my goals for 2016 was to add an additional source of passive income beyond dividend stocks. After completing my 2015 tax return and realizing how high my marginal tax rate was last year, I am scrapping that goal. My reasoning being that given my relatively high marginal tax rate on 'Other Income', it is not tax efficient for me to pursue earning more income unless it is via dividends or capital gains. This table of federal marginal tax rates shows that other income is taxed at the highest marginal federal tax rate, while capital gains are taxed at half that rate, and dividends are also taxed favorably. For those of you invested in bonds or REITs (including ETFs and funds), you should consider transferring them into a TFSA or RRSP in order to avoid paying the higher marginal tax rate on the income they generate.

2. Harvesting Capital Losses is Smart Tax Planning

After completing my Schedule 3 to account for the capital gain from selling my shares of H&R REIT in my taxable account during 2015, I realized my capital loss carryforwards from previous years have fallen below $100. Given I have two companies in my taxable account with unrealized capital losses (Corus Entertainment and Bank of Nova Scotia), I am considering harvesting those capital losses in order to help me avoid paying capital gains taxes in the future. In particular, I have been thinking of selling my shares in the Bank of Nova Scotia, waiting a month plus one day in order to avoid tax penalties, and then buying them back. This transaction could prove very beneficial for me in future years.

3. Buying My Wife's Charitable Contributions Paid Off

Since my wife was off work on maternity leave and unpaid leave for eight months in 2015, she had a lower income level than normal. However, she continued to make charitable contributions to causes that are important to her. Given the larger than usual gaps between our income, and the fact that I had contributed over $200 to charities in 2015, I was eligible for a 29% tax credit on additional charitable contributions in excess of $200. When the tax software we use suggested that I claim my wife's charitable contributions, I noticed that by paying her $1 per contribution, I would effectively receive $1.47 in benefits. Although I do not see this situation repeating itself in future years, buying my wife's charitable contributions definitely paid off.

4. Taxes are the Main Downside of Living in Quebec

During my 20+ years of living and filing tax returns in Ontario, I had refunds every year but one. Each of the past four years since I moved to Quebec, I have had to cut progressively larger cheques to our inept provincial government. Do not get me wrong, I enjoy living in this beautiful province, even when being English puts me in an often ignored minority. That said, the sheer magnitude of taxes I pay to the Quebec government each year is depressing.  Comparing the marginal tax rates between Ontario and Quebec using these tables, for someone earning around $100,000 per year, there is about a 5% difference of taxation between the two provinces. I have even started  to consider if buying myself a cheap shack/apartment/townhouse in Ontario would be worthwhile over the long-term if it allowed me to file my taxes as a resident of that province. To summarize, please carefully consider the advice of all the personal finance writers who suggest you live in a low tax jurisdiction while pursuing financial independence.

With my income taxes filed, I am expecting my notice of assessment any day which will tell me how much I can contribute to my RRSP. Of course figuring out which dividend growth company to buy with my 2016 RRSP contribution will be the subject of a future post.

Have you filed your 2015 income tax return yet? Are you expecting a refund or do you have to pay more?

Wednesday, April 13, 2016

12 Monthly Paying Canadian Dividend All-Stars

What is your favorite day of the month? If you are a dividend investor, my bet is that you answered the 15th or the last day of the month, two popular dividend payment days. Although a case could be made that is inefficient for companies to pay dividends monthly as opposed to quarterly or semi-annually, I have a soft spot for monthly payers. Having a little extra cash available to re-invest each month provides me a psychological boost. For this reason, I decided to mine the Canadian Dividend All-Star list to identify monthly payers and take a quick look at their financial characteristics.  As a reminder, the Canadian Dividend All-Star list consists of companies that have managed to increase their dividends annually for a minimum of five years. Out of the 89 Canadian Dividend All-Stars at March 31, 2016, only 12 companies pay monthly dividends.

Here are some fun facts about the 12 monthly dividend payers:
  • The average length of their streak of raising dividends is 8.2 years (vs 10.7 years for the entire list)
  • Their average dividend yield was 5.26% (vs 3.64% for the entire list)
  • Their average amount of their latest dividend increase was 6.63% (vs 9.30% for the entire list)
  • Their average EPS payout ratio was 110.49% (unable to calculate for the entire list)
  • Their average trailing P/E ratio was 21.9 (unable to calculate for the entire list)
  • Their average 1/3/5 year dividend growth rates were 7.4%/6.9%/9.4% (vs 12.2%/13.1%/15.3%)
  • Of the ten sectors used to classify the list, the monthly dividend payers are diversified across seven sectors including Real Estate (3), Communication Services (2), Consumer Cyclical (2), Energy (2), Industrials (2), Financial Services (1), and Utilities (1).
As with any other screen, the above is simply a starting point for further research.  Clearly a deeper dive is required given the average EPS payout ratio of 110%, the expensive 22X average trailing P/E, and the lower relative dividend growth rates offered by the 12 monthly payers. Corus should probably not be included on the list at all as they froze their dividend in January 2016 when announcing their transformational acquisition of the media assets of Shaw Communications. 

Personally, I currently own four of the monthly dividend payers (Corus, Alaris, Enbridge Income, and Granite Real Estate), and have owned Inter Pipeline as recently as last month. Of my current holdings, I would consider selling Corus as it is a vastly different and more leveraged company than when I first invested in it. On the other hand, Cineplex has long been on my watch list as it holds a virtual monopoly on movie theatres in Canada. However, the stock seems very expensive (P/E of 24X) and only offers a 3.1% yield.

Do you hold or are you interested in purchasing any of the 12 monthly payers?

Friday, April 8, 2016

Five Canadian Utility Companies with Growing Dividends

In order to improve the diversification of my portfolio across different industry sectors, I have been considering adding a utility company to my holdings. As a preliminary step in my research process, I constructed the below table to summarize some key indicators for five utility companies that meet various dividend growth, market capitalization, and financial strength considerations . For those readers unfamiliar with the utility sector in Canada, the below table might serve as a starting point for your own research.

EPS Payout
# Years Div Gro
1-yr Div Growth
5-yr Div Growth
1-yr Rev Growth
5-yr Rev Growth
1-yr EPS Growth
5-yr EPS Growth
S&P Rating

My primary observation from the above comparison is that there is no single dominant utility company that immediately stands out based on superior metrics across the board.  Although Canadian Utilities (“CU”) has the longest standing record of annual dividend increases at 45 years, it is the most expensively priced and has seen EPS contract at a 7% compounded rate over the last 5-years.  ATCO, which is CU’s parent company, has impressive dividend growth rates, but has the lowest dividend yield and earnings contracting at an even worse rate than CU. Emera (“EMA”) offers a fair 4% dividend yield and decent dividend growth rates, but their one year revenue and EPS numbers are less than stellar. Although Algonquin Power & Utilities (AQN) has the highest dividend yield, their EPS payout of over 100% and lowest credit agency rating of the bunch given me pause. Furthermore, AQN is far from cheap at 25X last year’s earnings.

This leaves me considering Fortis (“FTS”) which offers a middle of the road yield, decent dividend, revenue, and EPS growth, and the lowest payout ratio, at the cheapest valuation. The main reason why Fortis is relatively cheap is their planned USD 11.3B proposed acquisition of ITC Holdings Corp, a US-based electricity transmission operator announced in February 2016. The acquisition would be financed through debt and equity, and introduces integration risk given Fortis’s smaller comparable size evidenced by their CAD 11.2B market capitalization. As an investor, it is my preference to steer away from companies currently undertaking transformational acquisitions, as they introduce a greater degree of uncertainty concerning the combined entity’s future prospects.

With no Canadian utility company that leaps off the page at me currently, I think it is best to hold onto my capital until a clear opportunity presents itself.

Do you hold or are you interested in any of the five utility companies outlined above? 

Monday, April 4, 2016

Dividend Growth Stock Considerations for April 2016

Since my 20-month old son no longer enjoys sitting patiently in the shopping cart at the grocery store, but instead prefers to run up and down the aisles as fast as he can, my wife sent me by myself to do the weekly grocery shop yesterday. My wife knows that I used to grocery shop for myself in a spontaneous manner, browsing here and there, selecting whatever caught my eye. On the other hand, my wife is incredibly well organized, and because she risked eating steak and potatoes for every meal this coming week if she left me to my own method, she provided me with a very detailed list to follow. Even though my grocery shopping experience yesterday was pretty boring (I only picked up one thing not on the list), it was incredibly efficient to follow the list.

In the same light, heading into a new month with a small list of stocks I would like to purchase, along with target prices, simplifies my investment process. Although none of my four companies (Bank of Montreal, Cisco, Canadian Utilities, and Tanger) on my March shopping list hit their target price last month, there is no way I am heading into April without a list in hand. However, I do plan on holding over two of my companies from last month, Bank of Montreal and Cisco, at their same target prices, as I would like to complete my positions in each company. Onto the companies that I am strongly considering investing in this month.  

Bank of Montreal (TSE = BMO); Target Price = $70

Cisco Systems, Inc (NASDAQ = CSCO); Target Price = $24 

Granite REIT (TSE = GRT.UN); Target Price = $37

When researching my recent post on Canadian REITs With Growing Distributions, Granite leaped out at me as having the highest combination of yield plus 1-year distribution growth rate. As I dug deeper, I found the company had an investment grade rating of Baa2/Stable, a vacancy rate just north of 1% at YE15, and was priced pretty cheap with Price/FFO under 10X. Even with Magna (another investment grade company) accounting for 79% of rental revenue, I continue to think that Granite REIT offers excellent short-term (due to recent interest from a private equity buyer) and long-term potential (given the low P/FFO). I would welcome the opportunity to initiate a position in Granite in my TFSA or RRSP in April if it meets my target price.

QUALCOMM, Inc (NASDAQ = QCOM); Target Price =$49

Let me preface this write-up by saying, that I would really love to buy is Microsoft at around $48-$50, but my gut tells me Microsoft will not dip that low in 2016. Therefore, given I am underweight in Technology, I would consider adding QUALCOMM ("QCOM") to my collection of US technology companies with global exposure. At a high-level, I see QCOM as a conservatively capitalized (Debt/Equity = 36%), free cash flow generating (FCF =~ $5B 12-months YTD), financially stable company (A+/Stable, A1/Stable), who recently grew their dividend by over 10%. The company is trading near 17X last year's earnings, which is reasonable, but my lower target price reflects my need for a higher margin of safety when purchasing a technology company.

The only other company I am interested in this month is my largest holding, Alaris Royalty, as I would like to start shifting some of my holding from my RRSP to my taxable account. I would do this by purchasing shares in my taxable account, waiting a month to avoid tax consequences, and then selling an offsetting amount of shares in my RRSP. I plan to do this in order to free up funds in my RRSP to invest in US companies and REITs. I see this as a way to use the growing amount of cash in my taxable account productively, as it is approaching an all-time high. 

Which dividend growth companies are on your watch list for April???