Dividend Aristocrats Will Continue to Outperform 17 comments
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There are some solid arguments that dividends will represent the bulk of returns from stocks for a number of years into the future. Regardless of whether this is correct or not, there is a broad consensus that capital appreciation will be sufficiently low that we will see, on average, 8% annual returns per year from domestic equities. This is generally in line with estimates from a range of sources, albeit on the conservative end. These factors suggest that even investors who are not specifically focusing on income may do well to spend some time looking closely at dividend yields. That said, the dismal performance of dividend focused index funds like DVY over the last couple of years makes it clear that it is unwise to blindly invest on the basis of yield.
For the two years through March of 2007, DVY had average annual returns of -35.8% per year. The S&P 500 (IVV) had an average annual return of -25.7% per year, with about the same level of volatility. The Dividend Aristocrats, an index of stocks with a consistent increase in dividends over the trailing 25 years, out-performed the S&P 500 by a margin of more than 15% in 2008. That still makes for a bad year for the Aristocrats, of course, but this level of out-performance sure tempered the worst beat market in 70 years. Now, here’s the interesting part: the out-performance of the Dividend Aristocrats was predicted two years ago on the basis of portfolio theory.
At the end of March 2007, I published an article called Outlook for Select S&P Dividend Aristocrats that predicted an average annual out-performance for a portfolio of these stocks of 8% per year beyond the S&P 500, with no additional risk. Quantext Portfolio Planner had a long-term outlook of 8.3% in average annual return for the S&P 500, but the portfolio of 20 Dividend Aristocrats had a projected average annual return of 16.3%. This portfolio had a Beta of around 60+%, which is low for a portfolio of equities but still leaves the portfolio exposed to market risk.
When I went back to evaluate how this portfolio had performed over the last two years, I faced a problem in that two of the stocks had been de-listed because of mergers and acquisitions. Budweiser (BUD) has been acquired by InBev and Compass Bancshares merged with BBVA (BBV). I have not been able to get the data for BUD and CBSS to track their exact performance up until they were acquired, plus we have the problem of what to assume we did with the funds upon acquisition—an investor might have kept the shares in the acquiring firm or have invested in something else. To deal with this problem, I ran the portfolio of Dividend Aristocrats from the original article, minus these two stocks, so we have a portfolio equally weighted between the following stocks:
Quantext Portfolio Planner (QPP) yielded projected return and risk of this modified portfolio that was essentially identical to the original analysis. The Dividend Aristocrats were projected to massively out-perform the S&P 500, to the tune of more than 8% per year with no increase in risk (all baseline inputs and three years of trailing data to initialize the model).
In the two years since the original article was published (April 2007 through March 2009), the portfolio of Dividend Aristocrats generated average annual return of -18.4% with volatility less than the S&P 500. The S&P 500 has returned -25.7% per year. The portfolio of Aristocrats has out-performed the S&P 500 by 7.3% per year, remarkably close to the projected out-performance from QPP. The out-performance of the Dividend Aristocrats portfolio is particularly notable because a range of dividend-focused funds have performed far worse than the S&P 500 over this two-year period. DVY, which tracks the Dow Jones Select Dividend Index, has generated an average annual return of -35.8% from April 2007 through March 2009, lagging the S&P 500 by ten percent per year. This under-performance was largely due to a heavy allocation to financial stocks.
When we run QPP for this equal-weighted portfolio of stocks (using baseline settings and three years of historical data through March 2009), we obtain a projected average annual return of 12.9% with an annualized standard deviation of 16.2% vs. a projected return of 8.3% and a standard deviation of 15.1% for the S&P 500 (assuming reinvestment of dividends). QPP is projecting that this portfolio of stocks will generate 4.6% in return per year above the S&P 500, with just slightly more volatility than the S&P 500. The projected out-performance for the Dividend Aristocrats is now less impressive than it was a couple of years ago. Looking at the potential for an extended era of depressed capital growth, however, an edge of this magnitude would be enormous. We can get even higher projected returns and/or lower risk by varying the allocations to the individual stocks.
This discussion does not mean that I like or would invest in all of these stocks, but Dividend Aristocrats provide a fertile hunting ground for individual stocks—especially if dividends provide a large fraction of returns from equities in coming years. The problem with looking just at historical performance of the Aristocrats is that the sample is biased. An Aristocrat that cuts dividends is going to be a firm in trouble. Once that stock is dropped from the list, the historical performance of the remaining Aristocrats is biased upwards—just as in survivorship bias among mutual funds. This is why forward-looking projections as provided by a model like QPP are important: they provide a basis for reasonable expectations for a group of stocks. Back in April 2007, QPP projected a substantial out-performance for a selection of the Aristocrats. They have, indeed, out-performed. Going forward, QPP still projects a substantial out-performance, but considerably less than in April 2007.
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This article has 17 comments:
However--big problem! Returning -18% is nothing to brag about. In fact, it's a good argument against investing in stocks at all.
But it gets worse. If you argue that the outperformance is still valid because the S&P will go back up, then you have to believe that cap gain is going to be a big positive--which negates the advantage of a dividend strategy.
Ultimately, the driving factors aren't so different from fees at mutual funds - a dividend payer may or may not be a better run company, just as a fund's stock picker may or may not be a smarter stock picker, but reasonable dividends/low fees translates into advantages that compound over time.
Trust me--I am well aware that -18% is not a happy outcome. For the people who are net short or who have otherwise sustained no losses in the last couple of years, I am duly impressed. For the institutional investors and retail investors who maintain net long positions, relative out-performance matters a great deal. The Dividend Aristocrats have turned a REALLY bad year into far less substantially bad year. You seem to be suggesting that the only good strategy is one that never has losses. If you believe that this is possible, I wish you luck.
If price appreciation is anemic, I will be very grateful for the dividends for my net long positions.
With regard to comments from donzelion and Whidbey:
The theory etc. behind why companies pay dividends and why investors care is long and interesting. Dividends are a signal to investors. Some companies have tried to exploit this with leveraged dividend strategies or simply payouts that were simply too high to be sustained. Dividends that are raised or maintained over long periods can signal managements approach to growth, etc. Yes, companies can and do cut their dividends and they may do so in the future. Do you think that the out-performance of the Aristocrats in 2008 was just coincidence? Time will tell.
Regards,
Geoff
They can't lie (as much) when they have to pay a dividend.
I'm interested because I own a couple I thought should be on the list, but didn't make this one.
First, dividends are not a "lure" for anything, unless you are a pure conspiracy theorist. Every company has to decide what to do with its profits: Reinvest them in the company for future growth, buy a corporate plane, fund promising internal projects, build a new headquarters, buy back shares, add to a rainy-day fund, make acquisitions--the list is endless. One thing the company can do is pay dividends. Often this is called "sharing profits with shareholders," but I prefer to see it as giving shareholders (who are the owners) what is rightfully theirs: payback on their investment.
Second, the success of dividend investing is measured over years and decades, not months or a couple of years. It is a long-term strategy fueled by the dividends received (and often re-invested). It has been adequately studied and documented that a dividend reinvestment strategy, over long periods, is a very good, if not the best, stock investing approach. A good source is Jeremy Siegel's "Stocks for the Long Run," widely available. I'll also plug my own "The Top 40 Dividend Stocks for 2009," available at my Web site: www.sensiblestocks.com...
Third, many companies have a culturally embedded practice--tantamount to policy--of paying and raising dividends every year. Management at these companies will go to great lengths every year to pay and raise the dividend. But sometimes hard times--such as in the banking industry--force them to abandon or to suspend that policy.
Fourth, it was almost inevitable that the dividend funds (such as DVY) would get hammered over the past year or two, because they held so many financial stocks. Those stocks have not only slashed their dividends, they have crashed in every way possible. Many of these difficulties were predictable, and it's surprising that the fund managers held onto these stocks for too long. But they did, probably hemmed in by stock-picking rules that didn't work in the financial meltdown of the past couple years.
Fifth, a good source for beginning your analysis of long-term dividend-paying companies is S&P's Dividend Aristocrats list, because it lists companies that have declared dividend increases for 25 consecutive years. I emphasize that it is just one source, because it has a few peculiarities in its makeup that cause it to not list certain companies that "ought" to qualify, and to retain (for awhile) companies that have declared dividend cuts. I call it a "source," because companies on it need to be studied individually to determine their worthiness as investments. A couple of years ago, many of the banks just mentioned were Aristocrats. Their presence on the list did not make them good investments.
I believe that a better source has been created at DRiP Investing. Its list is more complete, it is updated monthly, it uses a more sensible definition of "increasing dividends," and it includes companies that have reached the 20-straight-year mark for increasing dividends. You can access their list by following this link and then clicking the "Info/Tools/Forms" link on the home page: www.dripinvesting.org/
On Apr 28 03:50 PM notsosmart wrote:
> if you have time on your side drips are the way to go.it worked great
> for me over app.40 yr period. small fees & cost averaging was
> lucky for me.i avoided the tech bubble cause no yields.good cos that
> pay a fair div. is the way to go.wall st now has a new mantra-trade,trade,tra...
> aware that they cant make money anymore on phony rated AAA worthless
> paper so they want you to believe long term investing is dead.dont
> believe them. think for yourself & caution your friends to think.
If agents are rational and forward looking, and past information of returns and risk are at their disposal; knowing that a montecarlo simulation which uses this information shows that a basket of stocks will outperform the S&P, shouldn't create an arbitrage opportunity that will soon erase the return diferential, so that the future expected return of this basket is the same of that of the S&P?
A quick skim of some of the characteristics of your simulation, beta of about 0.60 and equal weighted positions of the dividend aristocrats would indeed predict outperformance of the cap-weighted S&P 500 over the period when it fell 25%. Equal wighted stocks significantly outperformed cap-weighted during the time, and a portfolio with a beta of 0.6 should roughly fall 60% of the amount of the market (and rise only 60%). 60% of -25% is -15%. So, the combination of the portfolio beta and equal weightedness is the primary explanation for the dividend portfolio's performance, not what stocks they are, or, even that they pay dividends. A comparable analysis would hold for any basket of stocks, dividend paying or not, with a portfolio beta of 0.60. I know, most low beta stocks pay dividends, but not all, and not all div-payers are financials.
On May 03 08:54 PM Flav wrote:
> Geoff:
> If agents are rational and forward looking, and past information
> of returns and risk are at their disposal; knowing that a montecarlo
> simulation which uses this information shows that a basket of stocks
> will outperform the S&P, shouldn't create an arbitrage opportunity
> that will soon erase the return diferential, so that the future expected
> return of this basket is the same of that of the S&P?
Ahh--but you have neglected a crucial factor. Let's say that a model predicted two years ago that bonds would out-perform stocks over the future years. Then the market crashed. And your point would be that any bond portfolio would have out-performed in a market crash, so big deal. But, the model--when it predicted this--did not know that the market would crash. The model was implying something important. Same here. Anyone can say that a low Beta portfolio has and should out-perform in a down market, but we did not know there would be a down market when I wrote the original article. Make sense?
On May 04 07:26 PM dkco wrote:
> Geoff
> A quick skim of some of the characteristics of your simulation, beta
> of about 0.60 and equal weighted positions of the dividend aristocrats
> would indeed predict outperformance of the cap-weighted S&P 500
> over the period when it fell 25%. Equal wighted stocks significantly
> outperformed cap-weighted during the time, and a portfolio with a
> beta of 0.6 should roughly fall 60% of the amount of the market (and
> rise only 60%). 60% of -25% is -15%. So, the combination of the portfolio
> beta and equal weightedness is the primary explanation for the dividend
> portfolio's performance, not what stocks they are, or, even that
> they pay dividends. A comparable analysis would hold for any basket
> of stocks, dividend paying or not, with a portfolio beta of 0.60.
> I know, most low beta stocks pay dividends, but not all, and not
> all div-payers are financials.
Article says:
"For the two years through March of 2007, DVY had average annual returns of -35.8% per year..."
It should read:
"For the two years since March of 2007, DVY had average annual returns of -35.8% per year"