The table below contains numbers for the 15- and 20-year periods (ending 2008). As can be seen, the dividend-growth approach beats the S&P 500 by about 1.5 percentage points a year in both periods. The one qualm is uncertainty over Mergent’s choice of S&P 500 Index. It would be appropriate to do the comparison with the total return S&P 500 yet I could not find in the document an explicit reference to using that version.

Regardless, a 9.73% average annual return in dividend growth stocks over 20 years is laudable in itself. So is the 8% average annual return over the past 15 years. And with dividend yields currently still elevated relative to historical norms in the aftermath of the financial crisis of 2008, the return from owning dividend-growth stocks over the next 15 to 20 years could potentially be even better than what is shown below.

Their price gains have considerably lagged the advance and their dividends are still significantly higher than historical averages. They also provide substantially better income than bank deposits, money market funds, and government bonds.

Moreover, if the green shoots in the economy don’t blossom to the extent expected, these defensive stocks may regain some popularity. They could be the answer for investors who have doubts about the growth path of the economy in the short or long term.

Some examples (with yields in brackets) from Canada and the U.S. are:

Canada
Fortis Inc. (FTS) 4.5%
TransAlta Corp. (TA) 5.5%
TransCanada Corp. (TRP) 4.7%

U.S.
Duke Energy Corp (DUK) 6.8%
Progress Energy (PGN) 7.2%
Southern Company (SO) 6.3%

Line 120 – If you include Canadian dividend paying stocks in a taxable investing account, you’ll pay less tax due to the dividend tax credit. 

Line 121 – Interest and other investment income is taxed at the highest marginal tax rate. The more your taxable investments generate capital gains or Canadian dividends, the less tax you’ll pay.

Line 121 – Make sure you set up a Tax Free Savings Account: the profits you make inside the account will not be taxed, reducing your line 121 income. It may not look like much at first with the $5,000 limit on annual contributions, but in 10 years, you can be sheltering $50,000 plus accrued interest.

Line 127 – You can carry 2008 capital losses forward indefinitely. If you had 2008 losses, these could offset the tax on capital gains made in 2009.

Line 221 – You can deduct investing expenses such as safety deposit box charges and certain fees for investing advice.

Royal Gold Inc. (RGL) manages royalty interests on precious metals properties in the U.S. It has returned 73.7% YTD and delivers a dividend yield of 0.74% based on a stock price of $52.19

The Cash Store Financial Services Inc. (CSF), previously named Rentcash Inc., offers financial services such as cheque cashing, pay day loans and brokerage though about 400 “Cash Store” and “Instaloans” branches across Canada. It returned 43.2% YTD with a dividend yield of 4.4% based on a stock price of $5.93

Metro Inc. (MRU.A) A Quebec-based food and pharmaceutical distributer and retailer with about 1,300 supermarkets, grocery, convenience and drug stores located mainly in Ontario and Quebec.  Metro has delivered a 41.9% YTD return and carries a dividend yield of 1.36% on a stock price of $36.70

Canadian Energy Services LP (CEU.UN), which was listed in March 2006,  provides drilling fluid systems to western Canada’s energy industry. A YTD return of  30.3% has resulted in a stock price of $6.55 and a dividend yield of 14.5%

Fairfax Financial Holdings Ltd. (FFH) Though subsidiaries provides property and casualty insurance and related services in Canada, the United States, Europe and Asia. This stock has posted a 27.9% YTD return and delivers a 1.4% dividend yield on a stock price of $360.70.

The other 21 who posted positive year-to-date returns are:

Kinross Gold Corp. (K) 20.7%

Daylight Resources Trust (DAY.UN) 17.3%

Empire Co. Ltd. (EMP.A) 13.8%

Goldcorp. Inc. (G) 13.1%

Molson Coors Brewing Co. (TAP.B) 11.5%

George Weston Ltd. (WN) 10.6%

Enerflex Systems Income Fund (EFX.UN) 10.2%

Boyd Group Income Fund (BYD.UN) 8.6%

Northbridge Financial Corp. (NB) 7.4%

Constellation Software Inc. (CSU) 6.8%

Loblaw Cos. Ltd. (L) 6.1%

Enbridge Income Fund (ENF.UN) 5.6%

Computer Modelling Group Ltd. (CMG) 4.1%

Emera Inc. (EMA) 4.1%

Agnico-Eagle Mines Ltd. (AEM) 3.2%

Enbridge Inc. (ENB) 2.4%

Crescent Point Energy Trust (CPG.UN) 2.3%

Barrick Gold Corp. (ABX) 1.4%

Laurentian Bank of Canada (LB) 0.9%

ARC Energy Trust (AET.UN) 0.7%

Phoenix Technology Income Fund (PHX.UN) 0.4%

Up to now, shareholders have consoled themselves with the thesis that the Canadian banks were prudent lenders and didn’t have a housing bust to pull them down. But house prices are falling all the same, with the Canadian Real Estate Association reporting a decrease of 4.5% over the year to November, according to its new methodology. And TD Bank (TD) and Bank of Montreal (BMO) have about a quarter of their loan portfolio at subsidiaries in the U.S.

Moreover, Canada did have a commodity boom and it is now unwinding. Plus, there is recession elsewhere, notably in auto manufacturing. The Canadian industry is concentrated in Ontario, where the banks have half their loan portfolios.

The recent round of equity issues from Canadian banks is reminiscent of what occurred before the U.S. meltdown. It’s not a comforting sign when equity is issued after a 40% decline in prices and when dividend yields are in the unheard of range of 5% to 8% (earnings will be reduced by the dividends to be paid on the new shares).

Dividend payout ratios are rising too. TD has climbed from 36% last year to just below 50%. The worse case, BMO, is currently at 75%. With its dividend yield now over 8%, speculation seems to growing that BMO will be the first to slash its payout.

Will this turn out to be the “DOPE-DUD” phase? Francis Chou called it the DROP phase when he applied it to US banks in early 2008 but I like the DOPE-DUD nomenclature, which stands for: Dribbling the bad news out slowly with the most Optimistic Projections while raising as much money as possible from Every investor (DOPE), followed by Divulging all the Unpleasant news and Dousing (DUD) investors with a big bath.

But with the tsunami of a global commodity bust and severe U.S. recession headed their way, Canadian bank stocks might get knocked down even deeper into bargain territory. Cheaper share prices and richer yields may be the likely consequence of higher loan-loss provisions, slower growth in loan volumes, and declines in market-sensitive business.

An Oct. 31 update on the banking sector by eResearch projects loan-loss provisions for fiscal 2009 of $9.6 billion, double the estimated level for fiscal 2008 (versus a previously projected 30% increase by eResearch). Business-loan losses will contribute nearly half of the jump, while consumer and credit-card loan losses will contribute the other half.

Loan volume growth in Canada was revised down to 2% to 5% for fiscal 2009, compared to “three year annual growth rates of 10% for mortgage and consumer loans and 15% for credit card loans.” The report is also factoring in a 15% decline in revenues from the “market-sensitive” business lines of investment banking, retail brokerage, and trading commissions (which have risen from 19% of total revenues in 2002 to 25% in 2008).

So are the dividends safe? “Yes!” exclaims the eResearch report. Dividend payout ratios currently average 45.8%. The declines in earnings per share projected to fiscal 2009 should raise the average payout ratio to 52%.

While there likely will not be any dividend cuts, there likely won’t be any dividend hikes either in 2009. The average payout ratio of 52% for fiscal 2008 is slightly above the upper boundary for the banks’ payout targets. Royal Bank and TD will still be inside their target range, and so may still have room to increase dividends. Bank of Montreal, with a projected payout ratio of 67% in fiscal 2009, is least likely.

The decline in the Canadian dollar will help offset some of the impact of the commodity bust and U.S. recession, especially for Royal Bank, TD Bank, and Bank of Nova Scotia (because of their foreign operations). Canadian banks also appear to be benefiting from the financial crisis by winning deposits and accounts as clients flee U.S. banks.

The investor’s strategy may be to establish or raise a position in stages, looking for opportunities to buy on the dips when bad news hits share prices. There is a good chance by the end of 2009 that an investor could have four or five of the banks in their portfolio with an average dividend yield geater than 6% – and poised to resume growth at the banks’ historic average rate of 5% to 7% per year.

Bank dividend yields (Oct. 31) 

Royal Bank 4.3%

TD Bank 4.1%

Bank of Nova Scotia 4.8%

Bank of Montreal 6.5%

CIBC 6.3%

“Dividends are an important measure of financial strength. They’re an indication that a company is financially sound and is looking ahead with a positive view to the future,” notes the report. If so many are raising their dividends, are things all that bad – at least in Canada (where AIC Fund is based)?

“Investors have lumped all financials – both good and poor performers – together under the same category, and have generally stayed away,” adds the commentary. “During this time, it’s important to remember that each financial company is different and should be evaluated individually on its own merits.

“Solid core financials entering times of market or economic crisis often emerge stronger in the end, obtaining increased market share from weaker performers who fall by the wayside.” AIC Fund’s list of dividend-raising financials might then be a screen of sorts for the latter kind of companies, so let’s offer it here.

Dividends were raised at: Bank of New York Mellon Corp., Bank of Nova Scotia, HSBC Holdings, JPMorgan Chase & Co., Lloyds TSB Group, National Bank of Canada, Royal Bank of Canada, Toronto Dominion Bank, American International Group, AGF Management Ltd., CNP/NPM, IGM Financial Inc., Invesco Limited, Investor AB, Power Corporation of Canada, Great-West Lifeco Inc., Manulife Financial Corporation, Power Financial Corp., Sun Life Financial Inc.

Those holding the line on dividends were: CI Financial, Barclays PLC, Royal Bank of Scotland Group plc, Dundee Corporation, Merrill Lynch & Co. Inc. One company cut: The Wharf (Holdings) Limited.