(Runtime: 7:00. Read Audio transcript.)
**
Investors should look beyond headline dividend yields and focus on companies with sustainable cash flows and disciplined capital allocation, says Tim Johal, senior vice president and portfolio manager at Mackenzie Investments.
Speaking on the Soundbytes podcast, Johal said today’s environment of trade and geopolitical uncertainty, interest rate swings and AI disruption is rewarding businesses that can consistently generate cash, return capital to shareholders and continue to invest for future growth.
Johal said these characteristics could support strong equity returns with low volatility.
“Dividend-paying companies provide real cash flow generation, and they also have a flexible asset base and strong capital allocation discipline. We think this is important in today’s market,” he said. “Dividend investing allows for strong equity returns with low volatility. And we believe this is especially attractive in today’s market environment.”
While many investors are attracted to high yields, those yields may indicate that the company is actually a value trap – a stock that looks cheap but whose underlying fundamentals are weak.
“These stocks tend to perform poorly over time and should really be avoided,” he said. “To distinguish between a good high-yield investment opportunity and a good dividend opportunity, investors must really pay attention to the fundamentals.”
Johal said a rigorous investment process should assess free cash flow generation, balance-sheet strength, payout ratio and the company’s ability to consistently grow its dividend.
“We continue to like pipelines within the energy sector,” he said. “Global energy demand is growing, and the market disruption caused by the wars in Iran and Ukraine has really highlighted the need for companies to diversify their energy supplies.”
Johal said North American oil and gas producers should benefit from efforts to diversify global energy supplies, with Canadian pipeline companies playing a key role in moving energy to export markets.
In particular, he likes TC Energy, which was yielding about 3.8% in early July and has increased its dividend annually for the past 25 years. He said the company has also been a strong free cash flow generator.
“The current management team has proven itself to be a strong capital allocator. They have made great allocation decisions, even through some difficult times, as they continue to build out their pipeline network.”
He also likes select stocks in the utility sector, especially power generation and infrastructure sectors.
“We believe these companies will benefit from continued AI and data center buildout. For the first time in decades, we are seeing significant power demand growth in North America, and indeed data center buildout has been the main source of this new demand. We see these trends continuing and expect our power generation and infrastructure companies to benefit.”
In other areas, he likes Manulife, which he describes as a well-managed company with a strong management team.
“We believe their global insurance and global wealth and asset management platforms will continue to drive massive growth on a very capital-light basis,” he said. “Right now that stock’s yielding about 3.6%. We find that very attractive.”
While he is increasingly selective about Canadian banks given current valuations, he likes Royal Bank.
“It has the advantage of low-cost funding,” he said. “And Royal has really been leading this transformation of banks to provide greater digital capabilities to their customers and allow AI integration into their businesses and its operations.”
He sees headwinds for dividend investors in some sectors, particularly consumer discretionary, given the impact of the upcoming mortgage reset on household spending, and multi-family real-estate investment trusts where new supply is still coming to the market even as the government has slowed immigration.
“We think the combination of lower demand and increased supply due to immigration will still continue,” he said. “And in real estate these cycles tend to last longer, so we remain cautious on REITs in general, but particularly multifamily REITs.”
Johal said dividend stocks should remain part of a diversified portfolio, but investors should not select them based on yield alone.
Companies that consistently grow their dividends, supported by strong cash generation and disciplined reinvestment, represent a more attractive long-term opportunity, he said.
**
This article is part of the Soundbytes program operated by Canada Life. The article was written without sponsor input.