Do you dream of breaking free from cubicleville and visiting far-off lands, exploring castles of yore, or sipping your way through wine country? Wouldn’t it be grand if your stocks paid for the experience? To help launch your retirement world tour, we’ve ranked the largest dividend stocks in Canada based on their ability to put cash in your pocketbook.

Before we reveal this year’s top picks for income investors, let’s check out how last year’s crop fared. Our stocks have paid big dividends since the spring of 2009, with our A-grade Retirement all-stars shooting skyward with average gains of 58.3%. That includes non-reinvested dividends which we assumed were spent on pleasurable pursuits. (If they had been reinvested, the gains would have been even more breathtaking.) Meanwhile, the stocks that were rated either A or B gained an average of 48.8%. (Note that last year’s picks did not appear in the magazine, but were posted online at StingyInvestor.com.)

Of course, the last year or so has been a pretty remarkable one for the markets, as they bounced back from their March 2009 lows. Still, the markets lagged our picks over the same period. The iShares S&P/TSX Capped Composite exchange-traded fund (ETF), which tracks Canadian stocks in general, gained 33.6%, while the iShares Canadian Dividend ETF, which tracks 30 of Canada’s largest dividend stocks, climbed 39.0%. That means our A-grade Retirement all-star stocks beat those markets by 24.7 and 19.3 percentage points respectively.

The long-term gains, however, haven’t been quite as spectacular. We started grading stocks under the Income 100 moniker in the summer of 2007 (they have since been rechristened the Retirement 100, because high-yielding stocks are well-suited to retirement portfolios). It turned out that 2007 wasn’t such a great year to start, as we quickly ran into the crash of 2008-09. Indeed, the iShares S&P/TSX Capped Composite ETF, has fallen 2.5% since we started, while the iShares Canadian Dividend ETF has eked out a 0.6% gain.

Thankfully, our picks fared much better. If you bought equal amounts of each stock and moved into the new crop each year, your A-grade portfolio of Retirement all-stars would be up 28.4%. Similarly, the A-B group gained 14.8% on average over the same period. That’s not bad considering the period included one of the biggest bear markets of the last 100 years.

While we’re pleased with these results, we aren’t saying that you’ll make a fortune by buying every A-rated stock. As the past few years have amply demonstrated, the stock market isn’t nearly that predictable. Sometimes the entire market catches flu and profits vanish. Even in more buoyant times, individual stocks can disappoint. But the A-rated firms deserve your attention.

How we did it
We graded Canada’s largest dividend stocks based on their ability to provide generous income to investors for a reasonable price. If you’ve read a report card, you’ll be able to understand our grades. The best firms score an A, and good ones nab a B. Solid candidates slip through with a C while those with mediocre prospects get by with a D, or even an F.

The grades themselves are based entirely on the numbers. We didn’t factor in any personal opinions about a firm. Instead, we scoured the Bloomberg database for detailed financial information starting with Canada’s largest dividend-paying stocks by market capitalization. We then trimmed the initial list to remove candidates that have been around for less than a year or lack the detailed financial data we need for numerical analysis. Finally, the marks are awarded based on three primary criteria.

Yield
The more money a firm puts in your pocket, the better. We gave top marks to stocks with high dividend yields. We also reward stocks that have a robust record of dividend growth because firms that grow their dividends are confident about their future prospects.

Reliability
While a good yield is great, we like it even more when we have some assurance that the dividends will continue to be paid. (Indeed, sometimes an extraordinarily high yield can be a warning sign, which is why we employ a bevy of additional tests.) As a result, we reward stocks that have earned more than they pay out in dividends. Stocks that pay dividends that aren’t backed up by earnings tend to cut them.

We also give additional marks to firms with little debt because balance sheets stuffed to the brim with debt are riskier than those of more conservative businesses. We prefer to stay away from firms that have to borrow money just to keep the lights on because lenders tend to snap their wallets shut in bad times. Indeed, even strong companies had a hard time borrowing during the panic of late 2008. To measure each firm’s reliance on debt we compare its debt-to-equity ratio against other companies in the same industry.

Value
On the value front we want to be able to buy lots of assets for a low price. As a result, better grades went to companies with moderate-to-low price-to-book-value (P/B) ratios. This number compares the market value of a company to how much cash you could raise by selling off the company’s assets (at their balance-sheet prices) and paying off the firm’s debts. Low P/B ratios provide some assurance that you’re not paying much more for a stock than its parts are worth. We also prefer profitable stocks with lower price-to-earnings ratios.

Putting all of these factors together we arrived at the final grades for each of Canada’s largest 100 dividend stocks. In total, only seven stocks made our all-stars team by earning an A (see the “Retirement all-stars” listing above), but 15 managed a solid B this time around. We believe both the A and B groups are worth considering for the Canadian portion of your equity portfolio.

The number of A-grade stocks declined this year after the markets rebounded. Simply put, stocks are not as cheap as they once were and, as a result, you should expect decent but not extraordinary long-term returns from them going forward.

You should also keep in mind that the numbers only tell a fraction of the story. Savvy investors look out for businesses with unique, or intangible features, that might not be reflected in the numbers. Sometimes these features are beneficial, such as hidden assets or a technological breakthrough, but other times they can be detrimental. Perhaps the firm has a looming legal liability or it is facing new competition. It is well worth your time to consider such possibilities.

It’s best to use our grades as the foundation for your own research and then build from there. Importantly, before buying any stock, make sure that a firm’s situation hasn’t changed significantly. Read press releases, regulatory filings, and recent news stories to get up to speed on the latest developments. Like any screening strategy, the purpose of the Retirement 100 is to help you spot a few good ideas that you can then investigate in more detail.

View the Retirement 100 list