Is there a correction in the near future?

The simple answer is "No one knows."

That said, the market is on a bit of a tear. It has been in bull market mode beginning back in October 2022. It gained more than 17% in 2024 alone and there is still a month and a half left before the new year.

Considering that the average TSX bull market lasts about five years and nine months, there is reason to hope that the run will continue. On the other hand, a three year bull run would not raise eyebrows. It happens.

The last correction, a pullback greater than 10%, was in 2022 when the TSX declined about 17%, starting in April of 2022 and ending with the start of the present bull market. We never did see the bear. I, and many others, define a bear market as a decline of 20% or more.

Among the analysts that I follow, the present gains are forecast to continue, but I would not bank on this. Analysts are often wrong. I am concerned. Donald Trump may be good the the American market but I fear his presidency might be a disaster for Canada and the Canadian market.

For this reason, I have been hedging my bets. I now have about 14% of my retirement portfolio in a money market fund paying 3.3% interest. I expect this yield to fall when the Bank of Canada announces the next rate reduction.

Diversity is the name of the game here. I do not want to miss the gains of the bull market but I do not want to be caught without cash to buy the bargains if there is a correction. Stocks that are up so much that their dividend yield in now well below four percent are on my stocks-to-sell short list. I will take some of my profits off the table while retaining a very good, but not great, positive cash flow. I can survive nicely on the remaining dividend and interest payments.

When Dividend Investing, the Payout Ratio Does Not Tell the Whole Story

For the most part, I am a dividend investor. Oh, I hold some ETFs for diversity but mainly I hold dividend-paying Canadian stocks. I've written about dividend paying stocks in the past. I have always told my readers to pay attention to the Payout Ratio when buying a stock for the dividend. Too high a payout ratio indicates the dividend may not be secure.

I have come to think this "rule" is not a rule at all. Lots of good, secure dividends are paid by company's with payout ratios above 100%. If the payout ratio is the percentage of a company's earnings going to meet its dividend demands, how is it possible to pay out more than 100%? I will try and give you an answer but if you'd like an explanation from a more knowledgeable source try Morningstar. (Click the link.)

Take Enbridge Inc. (ENB). It has a payout ratio of 123.64%. Yet, ENB has consistently paid its dividend, without missing a payment or reducing it, for the past 29 years. What is going on? I turned to Perplexity for an answer.

"Pipeline companies like Enbridge often base their dividend payout ratios on Distributable Cash Flow (DCF) due to the financial characteristics of their operations. Here’s a detailed explanation:

 

Capital Expenditure Demands

1. High Capital Expenditures: Pipeline companies typically face significant capital expenditure (capex) requirements to maintain and expand their infrastructure. These expenditures can include costs for building new pipelines, upgrading existing ones, and ensuring regulatory compliance.
2. Impact on Earnings: High capex leads to substantial depreciation charges, which can reduce reported earnings. Since these accounting entries do not reflect actual cash flow, relying solely on net income can present a misleading picture of a company's financial health.

Cash Flow Characteristics

1. Stable Cash Flow Generation: Pipeline companies benefit from relatively stable cash flows due to long-term contracts and regulated rates, which provide predictable revenue streams regardless of fluctuations in commodity prices.
2. Distributable Cash Flow as a Metric: DCF represents the cash available for distribution to shareholders after accounting for necessary capital expenditures. By focusing on DCF, companies can provide a more accurate reflection of their ability to sustain and grow dividends.

Enbridge's Payout Ratio Strategy

1. Target Payout Ratio: Enbridge has established a target payout ratio of 60% to 70% of DCF. This range allows the company to balance returning cash to shareholders while retaining sufficient funds for ongoing capital projects and operational needs. (I calculated the ENB DCF at 70.4% today by multiplying the annual dividend by 100 and dividing this by the Cash Flow. Using WebBroker, both figures are found under Fundamentals)
2. Financial Stability: By maintaining this payout ratio, Enbridge aims to ensure that its dividend payments do not jeopardize its financial stability, allowing it to continue investing in growth opportunities while rewarding shareholders consistently."

This brings me to company like Telus (T). When I tried to check the Telus earnings, cash flow, and payout ratio, I discovered that all fields were blank. No earnings, no cash flow and therefore no ratios. Yet, Telus pays a 7.33% dividend -- $1.61 annually. Again, I ask, what is going on? This time I used Google Gemini to get the answer:

"Telus (T) is able to pay a dividend while reporting neither cash flow nor earnings thanks to to several factors:

1. Cash Flow Generation: While specific cash flow numbers may not be publicly disclosed, Telus is a mature telecommunications company with a stable cash flow generation. This cash flow can come from various sources, including subscription fees, equipment sales, and network infrastructure investments.

2. Dividend Policy: Telus has a well-established dividend policy, with a focus on maintaining and growing its dividend over time. This commitment to shareholders is a key consideration for the company.

3. Financial Planning: Telus likely has a robust financial planning process that takes into account future cash flow expectations and dividend obligations. This allows them to assess their ability to maintain the dividend even in the absence of immediate earnings or cash flow reports.

4. Debt Management: The company's debt levels and interest expenses play a significant role in its ability to pay dividends. A strong balance sheet and disciplined debt management practices can help ensure sufficient funds for dividend payments.

5. Regulatory Environment: The regulatory environment in Canada, particularly for telecommunications companies, can provide stability and predictability in revenue streams. This can contribute to a consistent cash flow and support dividend payments.

It's important to note that while Telus may not have explicitly reported cash flow or earnings numbers, they likely have internal financial metrics and projections that guide their dividend decisions. "

Lastly, I checked the Telus Dividend Investment page on the company website to see if I could find some published numbers. I discovered that Telus has an expressed goal of making semi-annual dividend increases ranging from 7% to 10% annually through to the end of 2025. The declared payout ratio is 60% to 75% of free cash flow based on prospective basis. But, read the small print: "There can be no assurance that we will maintain a dividend growth program through 2025."

Did you notice that the free cash flow is based on "prospective basis". This is a key point. It indicates  the company is looking forward and making an estimate of its future cash flow. Actual free cash flow is a more accurate measure of a company's ability to pay its dividends.

 

TD Cowen is maintaining its BUY rating. Morningstar has Telus on both its Canadian Core Pick List and its Canadian Income Pick List. Plus, Morningstar rates Telus as a five star stock; it is severely undervalued in the eyes of the Morningstar analysts.

Is the Telus dividend secure? It appears to be at the moment but . . .

 

For more information on Dividend Investing go here: https://www.td.com/ca/en/investing/direct-investing/articles/dividend-stocks 

Cash: good stuff to have around

The market is up, way up. For me that is a sign to take a little off the table. This feels good, having cash is always reassuring but take care not to cash out too much. Diversification is as important here as elsewhere. Cash is but one investment in a well diversified portfolio.

Today, my money market fund (TDB8150) is paying 3.3%. Sounds good but keep in mind that inflation is running at 1.6%. This is good, really good, but it still affects buying power. The return on your money market funds will feel more like 1.7% when it comes time to spend it. Ouch.

Let's compare cash to the TSX. The last decade has been a bit of a dog. The Canadian market has not performed nearly was well as the U.S. one. Still, it managed to return approximately 3.0% annually for the ten years in question.

This 3% annual growth in the index value does not include dividends. Include dividends and the total return—which combines both price appreciation and dividend income—brings the total return closer to 6.0% or a little more.

Converting some of your equity winnings into cash has the following rewards:

• A major expense such as a roof does not pose a threat to your financial well-being. You have the cash to cover it. You will not be forced to sell equities in a falling market.
  
• Drawing from your cash reserves rather than relying on dividends, means you spend the interest paid on your cash as it accumulates rather than allowing it to lose value with the passing of time.
• Having a nice cash cushion enables you to pick up the stock market bargains appearing during a bear market. Buy low is only six letter until you have the cash to fulfill  your "buy low" goal. Warren Buffet likes to hold a fair amount of cash for just this reason: to be able to buy low when the opportunity arises.
• A portfolio is more diversified when a meaningful amount is kept in cash.
  

What kind of investor are you?

What kind of investor are you? This is a very important question and it important for you to have an answer. Generally, investors fall into two main categories: buy-and-hold or short-term trader. Each category has its own characteristics.

What am I? I'm in a sub-category of the buy-and-hold group. I buy-and-hold but, for the most part, only dividend paying stocks. I firmly believe the value of my investments will appreciate with time but it is the dividend that I need in retirement. A rule of thumb says stocks will appreciate two thirds of the times and loose value one third of the time. I ride out market corrections and even bear markets confident that the rule of thumb will hold. Buying on the dips is nice but I don't worry about hitting the ultimate low. Market timing is out.

Short-term traders are different. They buy and immediately begin thinking of selling. They want capital gains. Dividend paying stocks and non-dividend paying stock are treated almost identically. Market timing may play a big role with short-term traders who try to predict the best time to enter or exit stock positions.

Short-term traders are far more likely to use technical analysis with its emphasis on short-term price movements. A belief that historical price movements give an investor a window into today's action is essential. Stuff like Moving Average Convergence Divergence (MACD) is used to identify trends and reveal upcoming reversals.

As a buy-and-hold investor with a focus on dividends, I enjoy the following benefits:

• Dividends: Dividend-paying stocks like Enbridge (ENB) or CIBC deliver a solid income stream which, in my case, can be drawn upon in retirement. How solid is the ENB dividend? ENB has paid dividends for over 69 years without missing a payment. Over the past 29 years, the ENB dividend has grown at an average compound annual growth rate of 10%. As a retiree, this growth is greatly appreciated.

• Simplicity: The buy-and-hold strategy minimizes the need for constant monitoring of market fluctuations and eliminates the stress of being forced to make frequent trading decisions. Short-term volatility is not a concern.

• Lower Trading Fees: Buy-and-hold investors trade less frequently. Far fewer trades means smaller trading fees.

• Tax Efficiency: Buy-and-hold investors face capital gains tax only when they sell. Holding stocks for the long term amounts to a tax deferral until the sale. Although the tax on dividends must be paid annually, dividends are often taxed at favourable rate compared to regular income.

A long term investor is drawn to companies with strong fundamentals and a long history of profitability. When the market dives, a portfolio packed with quality stocks continues pumping out the dividends. A retiree can continue to pay the bills despite the reduced  portfolio value.