The preceding posts in this series discussed why people might pursue a dividend investing strategy for a combination of psychological, personal tax, corporate tax, and performance reasons. If, after considering those factors, dividend investing still seems appealing, then the next question is how to do it. In this post, I will discuss some of the practical challenges to implementing a dividend investing strategy through selecting dividend-paying stocks. Handling dividends requires extra effort, and discipline is necessary to stick to your plan amid the opportunities to deviate. Plus, the challenge of picking the right dividend stocks to invest in for future returns based on currently available information remains a challenge.
Dividends Require Effort & Discipline
When a company decides to pay you a dividend rather than deploy that money expanding the business or increasing shareholder value via a buy-back, then you have to do something with that money. That requires decision-making. You have to decide how to deploy that money, and then follow through.
Should you reinvest it in more shares of the same company? Do you use it to rebalance and buy more of something else that has lagged? Do you spend it? Each time you have to make decisions and take action as an investor, it introduces opportunities to deviate from your plan.
Unfortunately, our behavioral biases usually steer us in the wrong direction. We also tell ourselves expensive stories that lead us astray through market-timing and/or stock-picking in its various forms. An automated approach helps to bypass those problems.
Dividend Re-Investment Programme (DRIP)
To automate keeping the money in the company even when it pays dividends, you can sometimes opt into a Dividend Re-Investment Programme (DRIP). Some brokerages will also do that for some ETFs. That will automatically use all or most of the dividend money to purchase new shares each time a dividend is paid. This avoids the potential for the behavioral error of collecting cash to either market-time or allocate to a specific area based on stock or sector picking. Instead, the dividend received automatically buys more of the same thing.
Automatically buying more of the same holding avoids the drag of cash sitting around, but it also has a downside. It misses the opportunity to manage risk by rebalancing. For example, if a holding pays a large dividend and is one of your larger holdings, it will continue to concentrate specific risk by increasing your allocation to that holding rather than diversifying by buying more of a different holding that has dropped below your target allocation.
Using DRIP increases the work of tracking adjusted cost basis (ACB) in taxable accounts. Each time dividends are reinvested, it changes the ACB. If you are doing that with multiple holdings instead of directing all of the dividends toward a few laggards, then it means more ACB adjustments.
On the plus side, DRIP may also help mitigate some of the costs, such as brokerage fees and the bid-ask spread, depending on how the brokerage handles it. However, there are still going to be taxes owing on those dividends. Even though the cash didn’t hit your account. In contrast, capital gains are not taxable until the investment is sold.
Evaluating Dividend Stocks
As discussed in Part 4 of this series, whether a dividend-paying stock will outperform the broader market depends on its paying and growing dividends into the future. If you pick a stock that cuts its dividend, it will be severely punished relative to the broader market. So, if you plan to deviate from a broad market investing strategy and take on higher specific risk from fewer companies, you really want to pick the right ones.
This is one of the challenges. The future is unpredictable, and any commonly known characteristics or factors affecting the outlook of a given company are already priced in by the efficient-enough market. You must know something better than the large market participants to beat that. That said, there are common strategies people use to evaluate and select dividend-paying stocks. We’ll examine those in the next few sections.
Track Record of Growing Dividends
This works on the premise that the past predicts the future. Choosing companies that have historically never missed or reduced dividends. Preferably, ones that have a record of steadily growing them. You will commonly hear these stocks referred to with names like “dividend-growers”, “dividend aristocrats”, or other special-sounding names.
While the past doesn’t really predict the future with investing, a strong record of paying dividends may indicate a conservatively managed and profitable business. Those are both characteristics or “factors” that have consistently and pervasively predicted increased returns. It could also indicate a business that prioritizes paying dividends. That sounds good, and it is if you really want income without a care for your total return. However, that approach could come at the expense of reinvesting in and growing the business or returning money to shareholders as a capital gain instead.
It is also important to note that even a well-run business has specific risks from idiosyncratic events. Those could be something affecting their geopolitical region, industry, or even a critical management mistake. You don’t have to look hard to see examples of that.
Dividend Aristocrats Face French Revolutions
The trouble with using dividend history is easy to illustrate. For example, Bell Canada (BCE.TO) has a long history as a dividend aristocrat. However, they are not immune to disruptive changes to their industry – even with Canada’s regulatory environment. They have a long history of paying out dividends and growing them. Until they didn’t this past year. They were on the dividend aristocrat index until May of 2025, when they announced a dividend cut.
Look what has happened to their total return (including dividends) relative to the broader TSX. The red line in that chart is BCE relative to the TSX (upslope outperforming and downslope trailing the TSX). That dive at the end represents a 50% price drop from the peak for shareholders. If you bought near the 2020 peak, you would have been looking at a multiple-decade-long history of growing dividends from a large Canadian household name. This illustrates that the past does not predict the future, and when specific risk comes home to roost, it can be devastating.
Even good companies have a lifespan – you don’t know where in their lifecycle you are buying. You don’t know whether you are buying BCE at the 2006 part of the chart above and benefiting. Buying at the 2016 part and taking on specific risk without being rewarded, or buying in 2020, and the bright outlook is the headlight of a train. As is typical, the price dropped for BCE long before the dividend cut. You would have had to have seen further into the future than the market (which reflects the collective current knowledge) to have gotten out unscathed.
For those thinking that BCE is a one-off, there is actually significant turnover amongst dividend aristocrats. For example, the turnover of CDZ (an ETF that tracks the Canadian Dividend Aristocrat Index) was 24% from stocks joining or being punted. The NOBL ETF that tracks the SP500 Dividend Aristocrat Index has a similar turnover of 20%.
Predicting Dividend Sustainability
Dividend Payout Ratio
Clearly, the history of paying and growing dividends is not predictive of the future. Further, a dividend cut is devastating. Companies know this, and management will avoid cutting dividends until they really have to. Could you couple the dividend history with watching for signs of dividend sustainability to spot risk? Sure. The dividend payout ratio is classically used for this. The payout ratio is the proportion of a company’s profit that is paid out as a dividend.
A stock with a low payout ratio has lots of cash flow kept in the company to invest or absorb shocks without impacting the dividend. One that is paying out most of its cash flow as dividends is more vulnerable. Some industries have more consistent cash flow than others. There may also be regulatory requirements, like Canadian REITs that have to payout 90% of their net income to shareholders each year. Therefore, comparing the payout ratio to peers or analyzing a change in the payout ratio for a given stock may be more useful.
Free Cash Flow Payout Ratio
Due to accounting practices, the net earnings may not always reflect cash flow. So, the free cash flow payout ratio may be more reflective. Free cash flow (FCF) is the operating cash flow minus capital expenditures.
While using dividend or FCF payout ratios may help show risk, the probability of that risk manifesting as a dividend cut is uncertain. So, is the timing, if it does happen. For example, the FCF payout ratio for BCE started rising from its baseline of ~80% to over 100% of free cash flow in late 2021. The stock price started falling two years later as it continued to rise. The market was pricing in the increasing probability of the eventual dividend cut that materialized in mid-2025.
Keeping an eye on the FCF payout may have given a warning. It worked out in the above example in 2020-2025. However, on the same chart, you can also see the massive FCF payout spike in 2007 while BCE went on to continue increasing dividends and outperformed the TSX for many years. It may be a warning sign, but it is not precise or certain. There are false positives that could lead to trading costs, taxes, and missed opportunities, too.
Management & Profitability Factors
Dividend Payment as a “Factor”
Factors are characteristics of stocks that help to explain their returns. That is done through regression analysis of historical data. So, it could be prone to data mining of nonsense factors, like sunspots or who wins the Super Bowl, for example. However, there are some factors that have been persistent over time, pervasive across different markets, have a logical explanation, and are investable. Dividend-paying would be one example of a factor.
Excluding stocks with very high yields (and possibly sustainability issues), dividend-payers have historically outperformed non-payers. However, further research by Fama & French showed that it was actually explained by the value (HML), conservative management (CMA), and profitability (RMW) factors. When they are added to the regression analysis for returns, dividend payment becomes non-significant. Dividends are just a surrogate, and you could better capture those qualities by targeting them directly. There are dividend-payers that do not have favorable management and quality characteristics, and non-payers that do.
It seems logical that when trying to select dividend stocks (for psychological or tax purposes), you should aim to pick stocks with good management and quality. You can look through the company data to glean information. Beyond the labor intensity and financial knowledge required, other complexities make it impractical for most of us.
In particular, it is the strength of the characteristic being looked at relative to its peers that was used in the original research. You would need to sift through the whole market, rank the stocks, and then pick the top 30% while shorting the bottom 30% if you wanted to truly emulate the factor research. That would be expensive in terms of time spent and trading costs. The premium associated with factors is also strongest in small-cap companies, which are typically not what dividend investors target. That all said, I will explain what the characteristics to look for are.
Value: High Minus Low Price (HML)
Value is the market value of a stock relative to its underlying assets. This is commonly quantified as the book-to-market ratio.
Determining the market value is pretty straightforward. It represents the value of all outstanding shares. The book value is the company’s assets minus its liabilities. You can find this by looking at the balance sheet in their financial reports. It sounds simple, but there are actually different ways to value assets. In particular, how do you value intangible assets such as intellectual property, patents, and goodwill? That is going to be subjective, but important.
The original research did not value intangible assets. Tangible assets, such as buildings, equipment, and infrastructure, are easier to quantify and, in the past, have been a significant component of company success. Think railroads, manufacturing, etc. However, intangible assets have become an increasing contributor to company success in the modern technological era. Undervaluing intangible assets has been flagged as one of the possible reasons why the value factor has underperformed since 2007.
In summary, the price you pay for a stake in a company relative to its value is an important factor. However, it is a challenge to actually determine book value depending on the attention to intangible assets.
Conservative Minus Aggressive Investment (CMA)
This is an attempt to measure how aggressively the management of a company spends money to grow the company’s assets (investment). You can quantify this by examining how quickly a company’s assets are growing year over year. A fast expansion of total assets would be considered aggressive, while a slow expansion would be considered conservative.
This “investment” rate can be quantified as a ratio by dividing the total assets at the end of a company’s current fiscal year by the total assets at the end of the previous fiscal year. Again, there is no specific ratio to define aggressive vs conservative. The research was done by ranking all companies within a group and separating the top 30% as aggressive and the bottom 30% as conservative.
It is also worth noting that CMA was the weakest of the factors in the Fama-French Five Factor model.
Robust Minus Weak Profitability (RMW)
Having robust profits underpins the ability of a company to pay dividends. Or alternatively, to return value to shareholders through price appreciation (capital gains), whether they pay a dividend or not. So, it makes intuitive sense to invest in profitable companies. Plus, no one wants to stand around the water-cooler talking about their weak stocks. Flexing about strong stocks is way more fun.
Fama & French assessed profitability by subtracting expenses (cost of goods sold, administrative and general costs, interest on debt) from a company’s revenue. That operating profit was divided by the company’s book value. The stocks with the top 30% of that profitability ratio were robust, and the bottom 30% weak.
Dividend Investing Implementation
The Trade-Offs
People choose a dividend strategy because they feel that it is more beneficial to them. That could be due to their psychology around receiving income regularly, some tax advantages, or beliefs about dividend stock outperformance. However, that approach comes with some trade-offs.
By its nature, dividend investing is less diversified than investing in the broader market. That means more specific risk from companies and the environment in which they operate. Specific risks are not priced in, and you would not be able to expect compensation for taking them. Hence, most investors try to limit specific risk. You could try to limit that by putting caps on the amount allocated to a single company or sector. Another approach is to invest in more companies and sectors. However, the more you do that, the more your portfolio would resemble the broader market and less it would be focused on dividends.
Managing a larger portfolio of dividend stocks increases another potential downside. The more dividends you receive at different times, the more opportunities you have to deviate from your plan with buying decisions. There are also more trading costs. A DRIP plan helps with that, but it may worsen concentration risk and increase the work to track ACB for when you eventually realize capital gains.
The time and effort required to select dividend stocks is also much more than taking a broad market approach using a low-cost ETF. The specifics of that strategy also matter, along with how well you implement it. Whether focused on dividends or other predictive factors from a company’s history to date, how these translate into future performance is also uncertain.
Picking Canadian Dividend Stocks
Canada has a relatively small stock market, accounting for approximately 3% of the global market. So, it may be a less daunting task than dividend stock picking from a larger market. Still, a focus on Canadian dividend payers will automatically make your portfolio overconcentrated from a geographic perspective. There are some good reasons to have some home country bias. Probably in the range of 20-40% of your portfolio. Therefore, if you choose a Canadian dividend-focused strategy, it is still best to make it only part of your overall portfolio. Global diversification is still important.
Even when focusing on the Canadian market, you must have enough stocks to be diversified. That is challenging because Canada’s big dividend payers, and the Canadian market in general, are concentrated in the banking and energy sectors. So, the stocks will have a high correlation with each other, making it hard to diversify away some risks.
The Challenge of Factor Investing in Canada
A factor investing approach may yield a more diversified mix of companies and more directly target positive stock characteristics. However, the notion that investors should target value, conservative management, and profitability rather than focus on dividends has some practical challenges.
It would be labor-intensive for the average investor to seek out and analyze the data to select stocks with those factors. Further, the premiums for those factors were studied using a strategy of going long the factor and shorting stocks at the other end of the spectrum. Shorting adds other risks and costs. So, investing for the partial benefit due to going long a factor is more practical. Even then, there will be portfolio turnover as stocks move in and out of meeting the selection criteria. You can find ETFs and mutual funds that select holdings for these factors. However, they must have low enough management fees and trading costs to not nullify the small factor premiums.
There are some good options for factor-based funds for the US and international markets from DFA and Avantis. However, coverage of the Canadian market is much slimmer. Vanguard and BMO have low-volatility ETFs that have some loading towards CMA and profitability, but there is not much else. While dividend investing is only a surrogate for the underlying factors, it may be one of the only practical options for Canadian market coverage. However, fees, strategy, and execution impact whether a dividend ETF may be a worthwhile option. I will examine some of the popular Canadian dividend ETFs using that lens in a follow-up post.
