Barron’s recently ran an article (written by Research Affiliates), which is titled “Get Smart About Picking Dividend-Rich Stocks.” The article highlights that high-quality high-dividend-paying stocks outperform low-quality high-dividend-paying stocks. The quality of the firm is measured by profitability, financial distress, and accounting red flags.
We investigate a Simpler Way to Identify Top-Performing Dividend Stocks
We sort the high dividend-paying firms by a simplevalue investing measure–EBIT/TEV. We choose this value investing measure based on our own research discussed here.
First, let’s set up the experiment.
We examine all firms above the NYSE 40th percentile for market-cap (currently around $1.8 billion) to avoid weird empirical effects associated with micro/small cap stocks. We form the portfolios at a annual frequency with the following 2 variables:
Dividend Yield = Cash dividends / market capitalization. Assessed on 6/30 each year.
Value = EBIT/(Total Enterprise Value). Assessed on 6/30 each year.
Here we describe the four portfolios we examine. All portfolios are annually rebalanced on 6/30 each year.
Top Div. Quintile, High Value EW = Top quintile of firms on dividend yield, then choosing the top half on Value. Portfolio is equal-weighted.
Top Div. Quintile, Low Value EW = Top quintile of firms on dividend yield, then choosing the bottom half on Value. Portfolio is equal-weighted.
Top Div. Quintile EW = Top quintile of firms on dividend yield. Portfolio is equal-weighted.
Universe EW = Total return on the universe of securities. Portfolio is equal-weighted.
Results are gross of management fees and transaction costs. All returns are total returns and include the reinvestment of distributions (e.g., dividends).
Here are the returns (1/1/1964-12/31/2014):
Value Investing Portfolio Results:
The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.
The top quintile of dividend paying firms outperformed the universe over the past 50 years when comparing CAGR, Sharpe and Sortino ratios (comparing column 3 to column 4)
Splitting high dividend-paying firms by value worked historically. Column 1 (top dividend payers, high value) outperformed column 2 (top dividend payers, low value) across all performance measures — CAGR, Sharpe and Sortino ratios.
The results suggest that a sort on a simple value investing measure works well at sorting dividend stocks. Compared to the more complex quality screen proposed by Barron’s, this sorting variable is a good alternative for investors who prefer high dividend stocks.
Jack Vogel, Ph.D., conducts research in empirical asset pricing and behavioral finance, and is a co-author of DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His dissertation investigates how behavioral biases affect the value anomaly. His academic background includes experience as an instructor and research assistant at Drexel University in both the Finance and Mathematics departments, as well as a Finance instructor at Villanova University. Dr. Vogel is currently a Managing Member of Alpha Architect, LLC, an SEC-Registered Investment Advisor, where he heads the research department and serves as the Chief Financial Officer. He has a PhD in Finance and a MS in Mathematics from Drexel University, and graduated summa cum laude with a BS in Mathematics and Education from The University of Scranton.
Performance figures contained herein are hypothetical, unaudited and prepared by Alpha Architect, LLC; hypothetical results are intended for illustrative purposes only. Past performance is not indicative of future results, which may vary. There is a risk of substantial loss associated with trading stocks, commodities, futures, options and other financial instruments. Full disclosures here.