Any one of a thousand factors can drive a dividend-paying stock’s price up or down from day to day. Virtually all of them prove to be utterly insignificant to the long-term returns that stock will generate for investors.

One, however, is always critical: dividend growth.

There’s no better sign a dividend is safe than when a company increases it. And dividend growth always drives a stock’s price higher, producing capital gains even as the flow of dividends rises. Wealth compounds even faster as that rising stream of cash flow is reinvested in the stock.

Conversely, dividend cuts are always toxic to high-yielding stocks. In fact, potential damages are arguably greater than ever with the memory of the 2008 market crash so fresh and investor tolerance for pain and patience at a low.

The worst thing about a company cutting its dividend is it can take years for a stock to recover, if it ever does. That’s because dividend cuts are de facto admissions by management that the underlying business has weakened and previous plans and projections have utterly failed.

Investors are forced to reevaluate the worth of the company at a lower level, and only sustained improvement will restore credibility.

With the exception of companies operating in super-resilient essential-service industries such as utilities and energy, dividend cuts are frequently the symptom of long-term declines in business health. If management is forced to cut once, odds are it will do so again and push the stock price lower still. Selling may mean taking a sizeable loss. But that’s infinitely better than sticking around for what could be much worse to come.

Rating Safety

The purpose of the Canadian Edge Safety Rating System is to gauge dividend risk for every company in our How They Rate coverage universe. We use six basic criteria. The more a company meets, the higher its rating and the safer its dividend.

The six criteria are:

• a manageable payout ratio, based on the nature and stability of the company’s revenue;
• visibility or predictability of future revenue and earnings;
• stability of the underlying business and its ability to withstand economic volatility;
• low refinancing risk, as evidenced by limited debt maturities between now and the end of 2013, as a percentage of market capitalization;
• manageable overall debt, again based on the stability of the company’s revenue;
• and dividend growth in the last 12 months and no dividend cuts the past five years.

It’s the rare company that meets all six of these criteria. One reason is that the past five years have been an extremely volatile time for the North American economy and stock market. Even the most stable industries such as midstream energy saw some dividend cuts following the debacle of 2008.

More economically sensitive sectors like oil and gas production were decimated, with only Crescent Point Energy Corp (TSX: CPG, OTC: CSCTF) and Vermilion Energy Inc (TSX: VET, OTC: VEMTF) able to avoid cutting dividends.

Some investors will want to focus only on companies that rate a “5” or “6” under these criteria, i.e. meet at least five criteria. That’s a good way to tilt the odds in your favor that dividends will hold, even if overall economic, market and credit conditions deteriorate.

And it’s how I weight the CE Portfolio Conservative Holdings, which are chosen for their ability to provide generous, safe and increasingly rising dividends over the long haul.

On the other hand, most investors will probably want to own at least a few stocks with lower ratings, as that’s where real upside lies. For one thing, ratings are only as good as the last set of numbers. They can and do change. And while it doesn’t happen often, sometimes companies that rate highly do falter, taking their CE Safety Ratings lower.

Lower-rated fare can and do often earn higher ratings by posting better numbers, if they’re able to overcome business challenges, or if they make significant headway cutting debt.

Also, companies in more volatile businesses such as natural resources and oil and gas production only very rarely earn as much as a “5” and never a “6,” simply because revenue is affected by commodity prices. If you buy only “5s” and “6s,” you’re not going to own much of what are arguably Canada’s highest-potential sectors.

Finally, highly rated companies can become quite overvalued if enough investors pile into them on the premise that they’re safe havens. Buying these stocks at those prices can trigger deep losses for investors, should the runaway buying momentum reverse, even if all the news and numbers from the underlying business are positive.

In such cases the better course is to take a profit if you own these companies. That is what I advised doing earlier this year with favorites like Keyera Corp (TSX: KEY, OTC: KEYUF).

That 6-rated midstream energy company has been a model of business stability the past year. But the stock shot up well into the 50s in late 2011, only to fall sharply back into the low 40s in early 2012. Keyera is now a buy up to USD42.

My point is it’s easy to over-rate dividend safety. Safety ratings are a tool for controlling risk to dividends. They’re not an end in themselves.

Rather, the decision to buy, hold or sell a particular Canadian stock should depend on how much risk you’re comfortable taking in pursuit of dividend growth as well as whether the current price represents value.

Dividends: Going for Growth

With that in mind, check out the table “How They Rate for 2012-13,” which highlights my dividend forecast for every company tracked in the Canadian Edge coverage universe.

I’ve identified 47 companies where I expect a dividend increase sometime over the next 12 months as well as 14 where a dividend cut seems a high probability by the middle of next year. The remaining 89 companies currently under coverage either don’t pay dividends at all, or are expected to maintain the same rate.

Some of the 47 likely dividend increasers are currently more than pricing in that probability. That almost certainly includes Canadian REIT (TSX: REF-U, OTC: CRXIF), which yields well under 4 percent even after a 3.5 percent dividend boost this spring. Its units haven’t rated a buy for some time, as they’ve been pricing in all their good news and more well in advance.

By contrast, the share price of Cineplex Inc (TSX: CGX, OTC: CPXGF) and the unit price of Brookfield Renewable Energy Partners LP (TSX: BEP-U, OTC: BRPFF) have mostly tracked their dividend growth over time. Yields have remained attractive in the 4 percent to 5 percent range at the same time, providing good value for new buyers even as current owners have realized steady capital appreciation from rising share prices.

Of the 14 companies I’ve identified as potential dividend cutters, most are already pricing in at least some dividend risk. Chorus Aviation Inc (TSX: CHR/B, OTC: CHRVF), for example, yields nearly 20 percent. That probably limits the immediate downside should management cut.

But keep in mind that one dividend cut in a competitive and volatile industry can easily lead to two or more, if the underlying business fails to stabilize. No matter how far the price has fallen already, it may still make sense to sell if the risk of worse ahead is great enough.

That’s the dilemma for investors who own stocks that have recently cut their dividends.

I currently hold one in the CE Aggressive Holdings, Colabor Group Inc (TSX: GCL, OTC: COLFF). I intend to keep holding it so long as management continues to grow its business, maintain margins and make progress cutting its debt, as it did in the first quarter.

But generally speaking I’ve been making a practice of selling companies the first time they cut dividends.

It probably makes sense for most investors to sell any company where the underlying business is weakening, on the basis that dividends are at risk and that the share price is vulnerable to a steep plunge leading up to and following any actual cut.

That’s what happened to Enerplus Corp (TSX: ERF, NYSE: ERF) this spring. (See Dividend Watch List.)

Forecasts and Strategy

So what should we expect for dividends the next 12 months?

At the beginning of 2012 I highlighted a return to dividend growth as a key potential catalyst for a fourth consecutive year of solid Canadian Edge Portfolio performance.

That’s still my expectation, at least for Conservative Holdings. These stocks aren’t particularly vulnerable to waxing and waning economic growth. Rather, their ability to maintain and grow dividends depends on how well they run their assets and their ability to find opportunities to add new ones.

We’ve already seen sizeable boosts at several companies, including Atlantic Power Corp (TSX: ATP, NYSE: AT), Bird Construction Inc (TSX: BDT, OTC: BIRDF), Brookfield Renewable Power, Cineplex and Pembina Pipeline Corp (TSX: PPL, NYSE: PBA).

Market reaction to their respective announcements has been uneven, with Atlantic and Pembina shares actually losing ground since they raised their payouts. 

Market history, however, is equally clear that sooner or later these boosts will shine through in higher share prices, likely when investor fears about the macro picture abate.

And sometime over the next 12 months these companies are almost certain to increase payouts again. Management teams have clearly laid out strategies to grow their businesses and pay that back to shareholders as raised distributions.

And I expect we’ll see the same thing play out with virtually every other Conservative Holding as well, including Just Energy Group Inc (TSX: JE, NYSE: JE), which now yields close to 11 percent.

On the other hand, the picture for Aggressive Holdings has clouded somewhat, mainly because of a murky outlook for global economic growth, particularly its impact on commodity prices. That’s the dark side of their key attraction, i.e. operating in industries with immense long-term potential for growth.

The good news, at least based on the numbers available now, is all of these companies’ current distribution levels should hold. That even includes Pengrowth Energy Corp (TSX: PGF, NYSE: PGH), which has been the target of dividend cut speculation since Enerplus reduced its payout last month.

The company will release its numbers on Aug. 10, and management is no doubt keeping a sharp eye on what happens to oil prices until then. But with the merger with the former NAL Energy Corp now in the books, this company has great flexibility to adjust its expenses to maintain balance sheet strength and the current payout of CAD0.07 per month.

Unfortunately, the possibility of dividend increases for most Aggressive Holdings appears increasingly remote, as management teams instead try to reduce exposure to volatile credit and commodity markets and focus on what’s sustainable for capital spending, production growth and dividends.

This could change in a hurry, should oil and gas prices continue on the upward trend we’ve seen thus far in July. But with the memory of 2008 still so near in the rearview mirror, I expecting management to stay conservative.

That same breakdown applies across the How They Rate universe. Odds are good that companies with little direct exposure to economic growth and commodity prices will raise dividends the next 12 months. Conversely, the more sensitive a company’s revenues are to commodity prices and growth rates the lower its chance of dividend growth.

At this point I’m not forecasting dividend increases for any of the Oil and Gas producers in How They Rate coverage over the next 12 months. This view isn’t based so much on the numbers that ultimately drive producers’ value as companies, such as reserves and output growth. Rather, it’s the drop we’ve seen this year in oil, natural gas and natural gas liquids (NGL) prices and the potential impact on earnings over the next several quarters.

To date the attitude of most producer managements seems to be similar to that expressed by Bonavista Energy Corp (TSX: BNP, OTC: BNPUF) in a recent press release. Bonavista, which relies more on NGLs for revenue than any other producer in How They Rate, stated it was “concerned” about lower commodity prices. But management also affirmed it would pursue other options such as asset sales and adjusting capital spending as much as possible to preserve the current payout level.

We’ll know more about how much pressure companies are under when second-quarter earnings come out; all the numbers should be in on or about by Aug. 10. And between now and then there’s likely to be plenty of action in oil, gas and NGLs prices, as investor sentiment continues to swing wildly with the latest developments in Europe.

No one should ever own an energy or natural resource producer stock without some appreciation that revenues and profits are affected by commodity prices–and that in a worst-case dividends sometimes follow them lower. There are also some energy producer stocks that aren’t worth holding now.

Low stock prices and potential for rapid upside when energy prices rise, however, are just as valid reasons for owning energy and natural resource producer stocks as ever.

Moreover, many producers’ dividends are secure against all but the worst-case for oil and gas prices, and there’s considerable potential for windfall gains from takeovers should other global energy giants follow the example of Malaysia’s state-owned oil and gas company Petroliam Nasional Berhad. The company better known as Petronas last month announced it would buy Progress Energy Resources Corp (TSX: PRQ, OTC: PRQNF) for a 77 percent premium to the company’s then-prevailing market price.

The midstream and energy pipelines sector is the group most likely to see dividend increases in the next 12 months. These companies are not only enjoying abundant cash flows as Canadian producers build out major long-term projects, particularly in the oil sands. But their capital costs have never been lower, and management teams have laid out transparent and quantifiable plans to predictably raise cash flow over the next year.

That’s hardly anything new: These companies were also the best bets in the Canadian Edge How They Rate universe for holding and growing dividends in the wake of the 2008 crisis as well as during the great conversion wave of 2011, when the vast majority of income trusts overnight became tax paying corporations.

It’s a rock-steady business where the greatest risk to investors is paying too much for favorite stocks. And there’s every indication these companies will continue to perform over the next 12 months as well, spurring sector stocks steadily higher on the back of rising dividend streams. See How They Rate and the Portfolio tables for my favorites and recommended buy prices.