A high dividend yield is not always a sign of a great investment. Since dividend yield is calculated by dividing the annual dividend by the share price, a declining stock can make the yield look much more attractive than the underlying business actually is.
Another possibility is that the company is paying out more cash than it generates. If the dividend consistently exceeds free cash flow, management may eventually have to reduce it.
Some companies even borrow money to maintain their dividend, a strategy that can work for a while but is generally difficult to sustain over the long term, especially when interest rates rise.
That is why I prefer looking beyond current yield. Companies that consistently increase their dividends year after year often offer lower starting yields, but they also tend to have stronger underlying businesses. As long as you are not overpaying for those businesses, they can make excellent long-term investments.
What it takes to grow a dividend every year
To raise the payout year after year, a company generally needs steadily growing earnings and free cash flow. It also needs a balance sheet strong enough to withstand economic slowdowns without sacrificing shareholder distributions.
That usually means disciplined management, sensible capital allocation, durable competitive advantages, and a business model capable of generating consistent cash flow across different market environments.
Companies with long dividend growth records also tend to avoid excessively high payout ratios. By retaining part of their profits, they preserve flexibility to invest in future growth while continuing to reward shareholders.
None of this guarantees superior investment returns, and valuation still matters. Even outstanding companies can become poor investments if purchased at excessive prices.
But as a quality screen, dividend growth can be a useful starting point for identifying businesses that have demonstrated financial strength over long periods.
One ETF that does the screening for you
Rather than researching individual companies, investors can outsource the screening process through iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (TSX:CDZ).
The exchange-traded fund (ETF) tracks an index of Canadian companies that have increased their ordinary cash dividends every year for at least five consecutive years. That requirement naturally filters out many companies with inconsistent cash flows or weaker balance sheets, leaving a portfolio of businesses with established dividend-growth records.
CDZ currently charges a 0.66% management expense ratio (MER) and offers a 2.98% trailing 12-month distribution yield, with distributions paid monthly.
The fee is higher than many broad-market index ETFs, but for investors specifically seeking Canadian dividend growers, CDZ provides a convenient way to access a diversified portfolio built around dividend consistency rather than simply chasing the highest yields.
