Financial Jungle

Being a BC resident, this makes me happy. I’ll be reading through your posts trying to figure out how to invest in dividend stocks. I’m pretty new to investing, and will be trying to expand past GICs and money market funds.

[…] Financial Jungle explains why British Columbia is as good a tax haven as the Cayman Islands. […]

I’m a BC resident and I found out about BC’s great dividend tax rate at the same time I looked into dividend investing, which I am currently pursuing.

Regarding the OAS clawbacks in general, is there any income that is not included when this is calculated? Is CPP included?

My investment strategy is to retire as early as possible, not pay taxes, and take advantage of every offering. Therefore I’m not concerned with retiring super rich, and I’d rather spend money early than simply have it held back from me when I’m 65.

FJ, That is interesting. How does this compare with Ontario?

Squawkfox - Good for you on parking your cash in GIC and money market funds until you educate yourself about investing. Also, don’t just take my words for it. There are many valuable and diverserd resources on the Internet for you to discover.

Warren - To the best of my knowledge, CPP must be included in the calculation. According to taxtips.ca, “High income seniors must pay back all or a portion of their OAS if their annual income exceeds a certain amount. If your net income before adjustments for 2006 (line 234 on your tax return) is $62,144 or less, you will not have to repay any of your OAS benefits. If 2006 net income before adjustments is greater than $62,144 then you will have to repay 15% of the excess over this amount, to a maximum of the total amount of OAS received.” More information from:

http://www.hrsdc.gc.ca/en/isp/pub/factsheets/oasrepay.shtml

MoneyGardner - I’m sorry to say the Ontario dividend tax credit rate is only 6.7% compared to 12% in BC. I’m a little shock of the staggering difference. But, you still receive 18.97% from the Federal rate for a total of 25.67%.

The formula to calculate how much dividend tax you pay is:

Dividend Tax = (Grossed Up Dividends x Marginal Tax Rate) -
(Grossed Up Dividends x (Federal + Provintial Tax Credit Rates))

The secret to tax-free living
http://tinyurl.com/2kj4j3

“In Ontario, for example, it’s possible for an individual to earn up to $48,000 in dividends without forking over any federal or provincial tax, apart from a $600 Ontario health premium. In British Columbia dividend tax credits, an investor can earn up to $66,000 essentially tax-free, according to Michael Smith, an analyst with National Bank Financial. And the tax-free thresholds are set to rise over the next few years as provinces boost their dividend tax credits.

…

But dividends are attractive for another reason: Many companies-including banks, insurers, pipelines and utilities-raise their payouts once a year or more. Manulife Financial, for example, has hiked its dividend at an annual rate of about 25% over the past five years.

…

That’s why, for my own portfolio, I buy nothing but dividend stocks with rising payouts. “

I spent a couple of days to read through this blog and I am very intrigued with the idea of dividend investment. Great work. Thanks a lot for all these very useful information.

However, I have a few worries right now. Looks like a recession is near the door. Dividends do not come from thin air, if business went bad, will the dividend company still be able to maintain the dividend level? Citigroup just slashed their dividends. I like Boston Pizza. But if economy is really weak, people will reduce the time eating out, and won’t that mean Boston Pizza will reduce their dividend?

Also, it looks like the stock market will be in a bear market or already is. That could mean whatever you buy now could lose capital in the near future. Is now a good time to buy dividend stocks if I have money, or should I wait for a while? For example, the BMO you recommended a few times, now it’s value far under your buying price. Would you a little bit worried about that?

Another thing that confused me for quite a while is return of capital. A lot of trust fund’s distribution contains return of capital. Sometimes could be a large percentage, for example, BPT-UN.TO that has been recommended by you, has about 50% return of capital. Is return of capital good or bad? I know it is tax friendly. But in the other hand, I read this is just my money returned back to me, not any earnings on company’s side. Then what’s the purpose of this return of capital if it does not increase my real money? I know it is good for retired people live on this kind of income, but my purpose of investment would be accumulating wealth and all distributions will go back to investment again so it looks not much sense to me.

If a fund’s distribution rate is 10% but 50% is return of capital, does it mean the actual earning is only 5%? While another fund’s distribution rate is only 6% but none of it is return of capital, does it mean the actual earning is better? In this case, should I pick the 6% percent one?

I will really appreciate it if you could kindly give me some hints.

Dropby – these are excellent questions you have.

>>”I like Boston Pizza. But if economy is really weak, people will reduce the time eating out, and won’t that mean Boston Pizza will reduce their dividend?”

As long as a portfolio is properly diversified, dividend increases in the other holdings should overwhelm a few selected dividend cuts here and there. For example, a cut in Boston Pizza is immaterial when standing next to a 100% hike by Encana, 50% hike by Parkland Income fund or a 20% hike by Telus.

Moreover not all cuts should be treated equal. Boston Pizza Royalty trust is less sensitive to an economic downturn because they harvest their income by collecting 4% royalty off the operators’ top line or revenue. On the other hand, operators are more sensitive to the economy. Just as an example, the first 800 patrons who walk into a restaurant may only cover the costs of operating a restaurant, but the next, say, 200 are pure profits. If during an economic downturn, the foot traffic is reduced 10%, the operator stands to lose half the earnings. A recent example is Priszm Income fund (operator of KFC, Pizza Hut, Taco Bell and Long John Silvers) who cut their monthly distribution from 11 cents to 3 cents last year, a nearly 3 quarters reduction! Yikes!

Looking at Boston Pizza Royalty trust, a 10% reduction in revenues amounts to a 10% reduction in earnings. Yes, a cut is plausible, but shouldn’t knock the wind out of a dividend portfolio. In other words, choose the investment wisely.

To be continued… sorry, due to time constraint (still in the office :P), I’ll have to finish my thoughts this evening…

Thanks for the rapid reply. Waiting for the continued part.

Wow. You spent 2 days catching up on this blog? Thank you for your support.

Just a warning though. This is only a personal blog and I don’t make profits out of giving advice. In fact, I’m forking money out of my own pockets just to keep this blog running. Whatever expressed here is my opinions only, so please don’t interpret them as investment advice as I’m not a qualified investment advisor.

>>”Is now a good time to buy dividend stocks if I have money, or should I wait for a while? For example, the BMO you recommended a few times, now it’s value far under your buying price. Would you a little bit worried about that?”

My investment philosophy has evolved quite a bit since I started Financial Jungle. I learned a couple of hard lessons from BMO: (1) always ease into a position in deep intervals. For example, nowadays, I always initiate half positions whenever stocks hit my target price, but I conserve the cash until the stocks fall another 10-15% before filling another quarter or half position. (2) Have a bias toward the leaders (RY, TD, BNS). No matter how cheap the secondary stocks are, the leaders should be the cornerstones of the portfolio.

In my opinion, there are a lot of bargains on the street. Many stocks are trading below the level 2 or 3 years ago even though earnings and dividends are up substantially. If I were in your situation, I’d glean a few high quality stocks here and there. If they go up, fine. If they retreat further, I still have enough dry powder. Nobody knows where the bottom is. Trying to time the bottom is unproductive use of my time. I’d much rather put more effort in researching the long-term prospect of the company instead of guessing the short-term market volatility.

>>” Sometimes could be a large percentage, for example, BPT-UN.TO that has been recommended by you, has about 50% return of capital. Is return of capital good or bad?”

In many cases, ROC suggests a Ponzi scheme where the trusts issue new units and debts in order to finance the distributions to existing unit holders. I’m no accountant, but my understanding is ROC is only a return of your money in the eyes of the taxman. Sometimes trusts (e.g. BPT.un) over depreciate their assets on paper so they don’t appear as profitable. That way, they can distribute more tax-free ROC to unit holders.

Boralex Power fund is a classic income trust. They’re boring and they generate tons of cash. According to their 2006 cashflow statement, BPT pumped out $58.8 millions from internal operations. This is greater than the $53.16 millions paid in distributions. I.e. they’re real income, not simply return your capital. It’s true that their payout ratio is running a little tight, but that’s okay. I don’t expect much growth anyway, as I’m content with collecting the stable 14% yield.

Good luck

Don’t worry, fj, any of your analysis/advice would be appreciated. But of course the one responsible for my investment will be me and only me.

You are very knowledgeable. Although I will not rely on your blog to make my invsetment decision, I learned a lot here and it will definitely help. Thanks so much for spending time and money to share your knowledge. Much appreciated.

Back to time to enter the market, I understand it’s impossible to time the market. However, there is time you might be able to sense a trend. F.g, you won’t buy a house now because it is obviously overpriced. As for the current stock market, if it is the beginning of a bear market, then maybe cash will be king for a while?

It’s very interesting that ROC could be good or bad depending on where it comes from. Maybe you could write a blog entry to explain on this more and give some general guidelines to distinguish them?

Trends and valuations are two different things.

Maybe this will surprise you, but I don’t buy low sell high. Rather, I buy cheap and hold “almost” forever.

For example, during enduring bull run from 1995 to 2000, Nortel at one point tumbled from $250 to $115 before soaring to $1,200+ (reverse split adjusted). $115 was the low at the time, but no rational value investors would come close to touching the stock.

I’m reasonably confident that dividend stocks, like Power Financial, are cheap today, but it’s entirely plausible that PWF will continue the retreat. I just don’t own a crystal ball.

My general rule of thumb is:
Dividend + Dividend Growth > 10%

The riskier the stock, the higher the required risk premium.

In the case of Power Financial:
3.4% + 10% growth = 13.4%.

Borelax:
14% yield + 0% growth = 14%.

Boston Pizza:
10% yield + 5% growth = 15%.

Calloway REIT:
7.6% + 3% growth = 10.6%.

Scotia Bank:
4% yield + 10% growth = 14%.

I am a shareholder of Boston Pizza now.

FJ, could you kindly explain how dividend from US stock works? I understand 15% will be withhold by IRS, and the rest will be treated as income. So suppose the stocks gives me 100 dividend, and my tax bracket is at 30%, then what I actually get will be 100 * 85% * 70% = 59.5 dollars?

>>” am a shareholder of Boston Pizza now.”

Looks like you’re a better bargain hunter than me. I paid $14.35 for my units.

Regarding US dividends, my understanding is…

Inside RRSP, the entire dividend is deposited into your account with no withdrawal. Outside RRSP, 15% is withheld but when you file your Canadian tax, you treat the 15% as nonrefundable tax credit. So, if your marginal tax rate is 35%, you’d pay a difference of 20%.

Using your example, of the $100 US dividend received, $15 goes to US, $20 goes to Canada, and $65 goes to you.

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