We regularly slice and dice the S&P 500 to determine what general categories of stocks are doing well. Periodically, we do what we call a strategy check. Simply put a strategy check is an analysis of the three or four investment criteria that we believe are at the core of our Rising Dividend investment strategy. The following is a brief discussion of the criteria we follow most closely and how companies with those characteristics have fared over the past twelve months.
Quality: As we have detailed many times in these blogs, our investment selection process begins with the quality door. Except on rare occasions, we invest only in companies whose bonds achieve at least an investment grade rating by one of the major rating agencies. The reason for this is obvious: sooner or later, tough times come, and when they do winnings stocks are almost always found among companies with good credit histories and ratings.
The following are the 12-month median total returns of the S&P 500 companies broken down by ratings.
Quality: As we have detailed many times in these blogs, our investment selection process begins with the quality door. Except on rare occasions, we invest only in companies whose bonds achieve at least an investment grade rating by one of the major rating agencies. The reason for this is obvious: sooner or later, tough times come, and when they do winnings stocks are almost always found among companies with good credit histories and ratings.
The following are the 12-month median total returns of the S&P 500 companies broken down by ratings.
Rating
|
Median Total Return
|
AA-AAA
|
12.8%
|
A
|
4.8%
|
BBB
|
4.0%
|
B-BB
|
-10.5%
|
NR
|
-1.8%
|
Standard and Poors 500 Index
|
3.72%
|
The last twelve months have been a roller coaster ride for stocks of monumental proportions. In this kind of environment, it is not surprising that the higher quality stocks have performed well versus lower rated stocks. It is a bit surprising that the total returns by bond rating are so symmetrical. As we have noted before, the stocks in our Cornerstone investment strategy have an average bond rating of A+.
Dividend Yield: After a stock makes it through the quality door, the first thing we look at is its dividend yield. Dividends are cash money. Dividend payments place a premium on a management team that focuses on the proper balance between the cash flows necessary to pay the dividends and the capital expenditures necessary to keep the cash flows growing. In short, dividends require a disciplined management team. We think this means that most companies who pay a regular dividend are less likely to be taking wild-eyed fliers with our money.
Dividend Yield Quintiles
|
Median Total Returns
|
Top 100 Dividend Yielders
|
8.2%
|
2nd 100 Stocks
|
4.7%
|
3rd 100 Stocks
|
2.4%
|
4th 100 Stocks
|
3.8%
|
5th 100 Stocks
|
-1.6%
|
It is not surprising that the median returns of high yielding stocks are showing good results. Bond yields are historically low, and people have been moving to higher yielding stocks in a steady stream. What is surprising to us, again, is that the results are nearly symmetrical. We believe this might be a cautionary signal. Many high yielding stocks we see on the list of top performers have very little dividend growth and are presently borrowing money to pay the dividend. That is not a good sign and could signal some dividend disappointments in the year ahead. That is the reason we focus so intently on dividend growth. It is the best way we know that a company can offer tangible signals about it future prospects. Talk is cheap, but dividend hikes mean a company's money is where its mouth is.
Dividend Growth:
We learned a long time ago that dividend yield alone is not enough; dividend growth also plays an important role in the long-term performance of a stock. The following tables show the median total return over the past 12 months of stocks in the S&P 500 sorted by dividend growth quintiles.
Dividend Growth Quintiles
|
Median Total Returns
|
Top 100 Dividend Growers Last 12 Months
|
4.8%
|
2nd 100
|
5.9%
|
3rd 100
|
7.6%
|
4th 100
|
2.5%
|
5th 100
|
-8.1%
|
The table shows that investors have not rewarded the top dividend growth companies that are located in quintiles 1 and 2. Investors have been buyers of the lower dividend growers in quintile 3. A closer look at that group is very revealing. The average dividend yield for the stocks in quintile 3 is 3.4% and the average annual dividend growth is 5.9%. This compares to the S&P 500 where the dividend yield is approximately 2%, with dividend growth last year of near 10%.
It is important to note, that while quintile 3’s slower dividend growth was the top performer, quintiles 1 and 2 also outperformed the S&P 500 total return of 3.7%. That is also the the case in our Cornerstone investment strategy. The 30 stocks in that portfolio have a current yield of 3.5% and dividends grew last year at just under near 10%.
Our bottom line summation of what this strategy check is telling us is that, indeed, in this low interest-rate, slow growth environment our concept of “bond-like” stocks is still a winning strategy. The markets are rewarding higher quality over lower quality. Investors are buying dividend yields that are higher than bond yields and are favoring current yield over dividend growth, although companies with high dividend growth are outperforming the average stock. We have spoken about these bond-like stocks in several previous blogs. Please access these links,1. Bond-Like Stock Audio, 2. Bond-Like Stocks, to see and hear a more expansive discussion of why we believe this concept is working and will continue to work.
