A bank stock with high dividends is one way to supercharge your portfolio, but select wisely

Canadian banks stocks have always been some of the best income-producing securities.

Below we share tips for finding and buying a top bank stock with high dividends.

Canadian bank stocks have long been one of our top choices for growth and income

We’ve long recommended that most Canadian investors should own two or more of the Big Five Canadian bank stocks—Bank of Nova Scotia, Bank of Montreal, CIBC, TD Bank and Royal Bank. That’s mainly because of their importance to Canada’s economy. That hasn’t changed despite concerns about the oil industry and the exposure those institutions have to energy and the resources sector, as a whole.

Banks remain key lower-risk investments for a portfolio. As well, the big five Canadian bank stocks all have long histories of annual dividend increases.

We believe Canadian bank stocks are still well positioned to weather downturns in the Canadian economy, contrary to pessimistic forecasts on the banks’ prospects from some in the business media. They trade at attractive multiples to earnings and continue to raise their dividends.

Look for Canadian bank stocks with consistent dividends

One of the best ways to pick a quality stock is to look for banks that have been paying dividends for at least 5 to 10 years. Dividends are cash outlays that an unsuccessful bank could never produce. A history of dividend payments is one trait that all the best dividend stocks have.

A bank stock with high dividends is a sign of investment quality

Some good banks reinvest a major part of their profits instead of paying dividends. But failing banks hardly ever pay dividends. So if you only buy stocks that pay dividends, you’ll automatically stay out of almost all the market’s worst banks.

Dividends can grow for a bank stock with high dividends already

Stock prices rise and fall, so capital losses often follow capital gains, at least temporarily. Interest on a bond or GIC holds steady, at best. But banks like to ratchet their dividends upward—hold them steady in a bad year, raise them in a good one. That also gives you a hedge against inflation.

For a true measure of stability, focus on bank stocks with high dividends that have maintained or raised their dividends during economic and stock market downturns. These banks leave themselves enough room to handle periods of earnings volatility. By continually rewarding investors, and retaining enough cash to finance their businesses, they provide an attractive mix of safety, income and growth. Canadian banks stocks are well known for their financial stability in the face of economic downturns.

Dividends are far more reliable that capital gains

A stock that pays a $1 dividend this year will probably do the same next year. (It may even raise the rate to $1.02). As well, some investors forget about the wonderful effects compounding interest can have on your portfolio. As quick refresher, compound interest is earning interest on interest which can have an enormous ballooning effect on the value of an investment over the long term, and lift the overall returns on your portfolio. Dividend payments act in a similar fashion.

All in all, we think that dividends can contribute up to a third of your long-term investment returns, even without the tax-cutting benefits of the dividend tax credit.

Dividends can be a big part of long-term investment gains

We think that Canadian dividend stocks rarely get the respect they deserve from investors. But with today’s low interest rates, savvy investors are paying more attention to dividend yields (a company’s total annual dividends paid per share divided by the current stock price). Dividend-paying companies are responding by doing their best to maintain, or even increase, their payouts.

If you stick with top quality high dividend yield stocks, the income you earn can supply a significant percentage of your total return—as we mentioned above, as much as a third of your gains. And at the same time, dividends are more dependable than capital gains as a source of investment income.

To summarize then, when it comes to investment safety, a long history of steady dividends is in some ways more important than a current high dividend yield.

Have you been following the performance of a bank stock with high dividends in your portfolio? How has it performed thus far? Share your story with us in the comments.