Many investors, especially retired persons, prefer to put their savings in dividend stocks. After all, historically, dividends have accounted for about half the return from stocks. However, before creating a dividend stocks portfolio, an investor often runs into a dilemma: what will bring him the highest return? A high yielding portfolio, or maybe a portfolio of companies that are not paying high yield dividends, but have raised their payouts at a very high rate for the last years.
Trying to find an answer to this dilemma, I used the Portfolio123's powerful screener to perform the search and to run 15 years back-tests on two groups of dividend stocks:
Top Yielders - the twenty stocks with the highest yield among Russell 1000 large cap stocks.
Top Dividend Growers - the twenty stocks with the highest annual rate of dividend growth over the past five years among Russell 1000 large cap stocks.
The tables below present the actual portfolios, as of May 30, of the two groups.
Top Dividend Growers
In order to emphasize the difference between the two groups, the table below presents a comparison of the valuation metrics between the first stock of each group; Prospect Capital Corporation (NASDAQ:PSEC) and UnitedHealth Group Incorporated (NYSE:UNH).
The high-yielding Prospect Capital has a lower P/E ratio, and lower price to book value, but also lower earnings growth prospects. On the other hand, the dividend grower UnitedHealth has a lower debt to equity, and it has outperformed the market in 2013 and year to date, while Prospect Capital has significantly underperformed the market in 2013 and in 2014.
In order to find out how the two groups of dividend stocks would have performed during the last year, last 5 years and last 15 years, I ran the back-tests, which are available by the Portfolio123's screener.
The back-test is based on running the screen every four weeks and replacing the stocks that no longer comply with the screening requirement with other stocks that comply with the requirement. It means that every four weeks, the 20 highest yielders at that time for the first group, and the 20 highest dividend growers for the second group are taken into account.
The theoretical return, which includes dividends is calculated in comparison to the benchmark (Russell 1000), considering 0.25% slippage for each trade and 1.5% annual carry cost (broker cost). The back-tests results are shown in the tables below.
One year back-test
One-year return of the top dividend growers was high at 21.42%, higher than the 16.51% return of the Russell 1000 index, while the return of the top yielders was much lower at 13.68%. Furthermore, the maximum drawdown, which usually is much bigger in a small portfolio than in the benchmark, was smaller for the top dividend growers group.
Five years back-test
The 5-years average compound annual return of the top dividend growers was high at 21.02%, while the average annual return of the top yielders during the same period was almost the same at 21.79%. Both groups were much better than the Russell 1000 index with an average return of 16.25%.
Fifteen years back-test
The 15-years average compound annual return of the top dividend growers was at 11.66%, significantly higher than the average annual return of the top yielders during the same period, which was at 7.68%. Both groups were much better than the Russell 1000 index with an average return of 3.33%. Moreover, the maximum drawdown of the top dividend growers was much lower at 57.30%, while the maximum drawdown of the top yielders was at 80.31%. That means that during the last 15 years a portfolio of the top Russell 1000 yielders was much more risky.
The one year and the fifteen years back-tests have given better return for the group of the twenty top Russell 1000 dividend growers over the group of the twenty top Russell 1000 top yielders, while the five years back-test has given similar results. Furthermore, the maximum drawdown of the top dividend growers was much lower than that of the top yielders in all the three tests.
The higher return of the dividend growers group and even more its much lower maximum drawdown, bring me to the conclusion that a portfolio of dividend growers has better return prospects and a lower risk. Of course, some researcher might argue that a fifteen years time frame is not sufficient. However, we have seen in the last fifteen years periods of euphoria and periods of severe crisis with the market gaining new records and suffering major losses, such that the last fifteen years can serve as a good basis for drawing a conclusion.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.