Yield Boosting, Volatility Reducing Dividend Stocks

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Includes: ABT, CBOE, EFC, FLO, GIS, HPP, KKR, MCD, MO, PCG, SDRL, SPY, VIP, WAC, WMT, XEL, XOM
by: Bennington Investment Ideas
For investors seeking current income, this is the proverbial free lunch. Adding these stocks to your existing equity portfolio should provide the dual benefit of increasing current income while lowering portfolio volatility. The other considerations would be for the stocks to be at fair value since the goal is to seek current income and to a lesser extent price appreciation. Stocks that offer this benefit have low correlations to the market, high dividend yields, and low volatility.
The screen was run to identify a short list of stocks with low betas and dividend yields. I also screened for market capitalizations above $300 million. The initial screen identified 523 stocks with a beta less than .5 and a positive dividend yield. First, a low but positive beta on average lowers the risk the portfolio, but does not create as much diversification as a negative beta which automatically implies a negative correlation coefficient. A positive but low beta could simply imply a correlation coefficient near 100% with a very low volatility. The list was then focused to two sublists, the first list was focused on stocks with a negative beta and the second sublist was positive betas.
I will assume that the SPDR S&P 500 Trust ETF (SPY) is the market portfolio. The dividend yield on SPY is approximately 1.7%.
Sublist one had 25 stocks on it ranging with beta from -.01 to -.4. So any stock with a negative beta and a dividend yield above the base portfolio will provide additional current income while reducing the risk. The table below shows all the stocks with a sufficiently high dividend yield. Certain thinly traded OTC stocks were removed from the list, including Worley Parsons (OTCPK:WYGPY) and Fufeng Group (OTCPK:FFNGY).
Negative Beta Dividend Securities
Ticker
Name
Beta
Dividend Yield
Market Capitalization ($ Millions)
Ellington Financial LLC
-0.07
22.4%
$ 386
Hanover Capital Mortgage Holdings, Inc.
-0.16
10.1%
$ 509
KKR & Co.
-0.01
6.6%
$ 3,760
VimpelCom Ltd.
-0.02
2.6%
$ 18,129
Hudson Pacific Properties, Inc.
-0.07
2.5%
$ 340
CBOE Holdings, Inc.
-0.4
1.4%
$ 2,871
Click to enlarge
Data provided by Zacks.com services.
One other key observation is that stocks with negative correlations and high volatility provide larger reductions in overall volatility for the portfolio at a given weighting. This might seem paradoxical since we think of higher volatility as higher risk; however, the key is to view it as an incremental impact to your existing portfolio. The other observation is that this is a pretty short list with some small capitalization stocks. I would carefully consider any of these stocks, prior to making an investment. Also KKR is a master limited partnership which has some tax implications. It is the holding company for private equity firm Kohlberg Kravis Roberts & Co.
Before looking at the second sublist of stocks a quick note: A key issue is to recognize that two stocks could have the same beta, but have a different incremental impact on portfolio volatility. The following table shows this possibility:
Same Beta; Different Impact
Stock A
Stock B
Beta
0.7
0.7
Correlation
49.4%
84.0%
Volatility
8.5%
5.0%
Assumed Current Portfolio Volatility
6.0%
6.0%
Stock Weighting
50%
50%
Current Portfolio Weighting
50%
50%
New Portfolio Volatility
6.3%
5.3%
Incremental Impact on Volatility
0.3%
-0.7%
Click to enlarge
Note that in both cases the beta is the same value of .7; however, the security with the lower correlation has a higher volatility and results in a higher overall portfolio volatility. The weighting at 50/50 assumes that the investor would sell half their existing portfolio and purchase either Stock A or Stock B with the proceeds. In reality, the incremental addition can be any amount and the directional impact on the new portfolio volatility will remain the same. This analysis shows that it is important to distinguish between the correlation coefficient and volatility when looking at beta.
The other sublist of positive betas had 239 stocks on it. These stocks also have to have a dividend above the comparison line to contribute. Of the 239, 189 stocks had a dividend above 1.4%. There are several observations from this list – first utilities were pretty predominant as well as a variety of pipeline companies that are master limited partnerships (MLPs) and Real Estate Investment Trusts (REITs). Given the shear number of possible choices, I’ll focus on the higher dividend yielding stocks and the more common names.
Ticker
Name
Zacks.com Dividend Yield
Zacks.com Beta
Correlation Coefficient to SPY
Volatility
Calculated Beta
SPDR S&P 500 Trust ETF
1.7%
1.00
100.0%
5.7%
1.00
Seadrill Limited
7.2%
0.36
77.6%
15.3%
2.09
Altria Group
6.0%
0.48
49.8%
5.5%
0.48
Xcel Energy Inc.
4.2%
0.44
50.8%
4.7%
0.42
Pacific Gas & Electric Co.
3.9%
0.33
39.7%
4.5%
0.31
Abbott Laboratories
3.6%
0.29
32.5%
5.2%
0.30
McDonald's Corporation
3.2%
0.50
54.8%
4.9%
0.47
Flowers Foods, Inc.
3.1%
0.11
11.1%
6.3%
0.12
General Mills, Inc.
3.0%
0.21
29.2%
4.3%
0.22
Wal-Mart Stores, Inc.
2.3%
0.30
37.9%
4.7%
0.32
Exxon Mobil Corporation
2.1%
0.48
50.8%
5.3%
0.47
Click to enlarge
Dividend Yield and Zacks.com Beta are provided by Zacks.com services. SPY yield is estimated from Yahoo!Finance data. Other data is calculated from monthly price histories from Yahoo!Finance. Correlations and Volatilities were calculated over a 4 year period from present. Correlations were also checked against correlations from 2002-2005 and showed no significant changes. Low correlations were consistent.
The first observation is that at times the beta calculation from Zacks.com or any other service will align with your own calculation. The best answer is to probably ignore Seadrill Ltd. (NYSE:SDRL) since it appears to have a high volatility and a high correlation. The next question is to check the incremental volatility reduction to a portfolio. I’ll check the impact of having 25% of each stock added to the market portfolio characterized by SPY. So the new portfolio is 25% of the Stock and 75% of SPY. The new portfolios dividend yield is then just a weighted average of the SPY yield and the stocks yield. The new portfolio volatility is calculated using a methodology I discussed in an earlier article.
Yield Boosting, Volatility Reducing Common Stocks
Ticker
Dividend Yield
Correlation Coefficient to SPY
Stock Volatility
New Portfolio Volatility
Incremental Volatility Reduction
Incremental Dividend Increase
SPY
1.7%
100.0%
5.7%
5.7%
0.0%
0.00%
SDRL
7.2%
77.6%
15.3%
7.6%
1.9%
1.37%
MO
6.0%
49.8%
5.5%
5.1%
-0.6%
1.07%
XEL
4.2%
50.8%
4.7%
5.0%
-0.7%
0.63%
PCG
3.9%
39.7%
4.5%
4.8%
-0.9%
0.56%
ABT
3.6%
32.5%
5.2%
4.8%
-0.8%
0.49%
MCD
3.2%
54.8%
4.9%
5.0%
-0.6%
0.38%
FLO
3.1%
11.1%
6.3%
4.7%
-1.0%
0.34%
GIS
3.0%
29.2%
4.3%
4.7%
-1.0%
0.34%
WMT
2.3%
37.9%
4.7%
4.8%
-0.8%
0.16%
XOM
2.1%
50.8%
5.3%
5.1%
-0.6%
0.09%
Click to enlarge
Dividend Yield is provided byZacks.com services. Other data is calculated from monthly price histories from Yahoo!Finance.
Issues
There are several other considerations that must be considered that span from other risk aspects to overall goals of the investor to tax considerations. The following issues should be reviewed, but are not exhaustive.
  1. Risk – This approach does not consider other risk aspects of these securities. Additional fundamental analysis should be completed to determine if there is any risk of a decline in the overall business due to a weakening business model, management issues, or regulatory risk among others. In examining bond options, it would be important to consider inflation issues and the interest rate risk.
  2. Investment approach – This strategy makes the assumption that the investor has some portion of their portfolio in equities. It is possible to pursue current income through bond funds and other types of investments.
  3. Tax considerations – Qualified dividends are currently taxed at a different rate from interest income. Yields should be calculated on an after tax basis. Foreign stocks may have other tax implications.
  4. Data – The data used for this analysis came from both Zacks.com and Yahoo!Finance. One key issue is the details of the method of calculating betas, correlation coefficients, and volatility since it can vary widely based on time frame. Furthermore, it varies based on whether you look at monthly price histories or daily price histories. SPY and SPDR Dow Jones Industrial Average (DIA) have a very low correlation when looking at daily returns, but a very high correlation on a monthly basis.
Conclusions
  1. Looking at betas is simply a first step since the incremental impact on the portfolio requires an understanding of both the correlation and volatility of the proposed asset to be added. Furthermore, historical correlations and volatilities may not indicate future attributes.
  2. Among the 10 stocks reviewed in detail, Pacific Gas & Electric (PCG), Xcel Energy (NYSE:XEL), and Altria (NYSE:MO) offer the best boost in dividend yield combined with a solid reduction in portfolio volatility.
  3. Wal-Mart (NYSE:WMT) and Exxon Mobil (XOM) provided good volatility reduction but provided more limited boosts in dividend yield.
  4. From the negative beta stocks, CBOE Holdings (NASDAQ:CBOE) may provide the best opportunity.
Prior to making any investment, it is important to complete additional research.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in FLO over the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.