Dividend Growth - What's Working And What's Not

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Includes: BWL.A, CSVI, DEO, ED, FMCB, FNBG, HBNC, ISBA, JNJ, KO, MCD, MMM, PEP, PG, PM, POPE, SO, T, UPS, VZ, WEC
by: Kurtis Hemmerling

Summary

Total return matters when you need to sell stocks - even a dividend growth stock.

Total returns of dividend growth is broken down by dividend streak, sector, and other factors.

Volatility has been an important driver of dividend growth returns lately.

Dividend growth is a popular investment style within the Seeking Alpha community. The main thrust of the strategy is simple: invest in quality stocks with a history of annual dividend increases and grow a large income stream for retirement without ever having to draw on the capital.

The general focus in on income growth - not capital gains. There are, however, reasons why some dividend growth investors would want to consider capital returns. Despite the best of intentions, stocks may need to be sold for various reasons:

  • Dividend does not increase, is frozen or is suspended
  • You want to buy a stock but do not have extra capital. You sell a less desirable holding
  • An unexpected bill or expense
  • You need to adjust dividend strategies because income growth is not on track
  • You want out of a high risk sector
  • You want to diversify into other strategies in addition to dividend growth
  • A stock de-lists or is merged

There are other reasons why you may need to sell but the point is the same - total return matters when a stock is liquidated. Thus, this article will compare recent total return performance of the dividend growth strategy to the broad market. We will also look at sector performance and a few factors that some investors use for dividend growth selection.

Total Returns vs. Market

Since 2015, the total return of all dividend growth stocks with a minimum of 4 years of consecutive annual dividend growth, slightly out-performed the market (Russell 3000 ETF). I use 4 years of dividend growth because the universe of stocks is based on tickers found in the popular CCC list by David Fish. These stocks start with a minimum of 5 years of dividend growth and I am testing one year earlier.

Dividend Growth Universe (CCC List) vs. the Market Click to enlarge

Although portfolio returns seems to follow the market, note that the standard deviation and Beta is lower than the market. This means that individual dividend growth stocks traded with less dispersion than the broad market and combined portfolio volatility was reduced as well. Can we break this down further?

Champions, Contenders and Challengers

  1. Since 2015, stocks with at least 25 years of consecutive annual dividend increases (as of now), truly were the champions. The average annual return is 6.56% with a max drawdown of 9%.
  2. Contenders, which are stocks with 10 - 24 years of dividend increases (as of now), produced an annual return of 1.66% on average with a maximum drawdown of 11.67%.
  3. Challengers, or stocks with at least 5 years of dividend growth (as of now), produced an annual return of 0.36% with a maximum drawdown of more than 17%.

Higher returns and shallower dips were had by stocks with longer dividend streaks. Food for thought.

Breakdown by Sector

Another valuable way to analyze our dividend growth portfolios when looking at total return is to break it apart by sectors. Thus we can see if we are taking on excess risk by being over-weight in any one sector. Here are the dividend growth stock returns when separated into sectors.

Since January 2015

GICS

Sector

Average Annual Return %

Maximum Drawdown %

10

Energy

-24.8

-47.4

15

Materials

-0.5

-21.5

20

Industrials

-0.8

-19.2

25

Consumer Discretionary

-0.2

-20.7

30

Consumer Staples

8.4

-9.4

35

Health Care

7.8

-13.6

40

Financials

3.5

-13.6

45

Information Technology

4.6

-13.7

50

Telecom

12.7

-9.1

55

Utilities

10.5

-13.5

Click to enlarge

How do these short-term performance numbers stack up to a longer simulation? To test that, we will use the Portfolio123 point-in-time simulation engine to test sector performance since 2000. This simulation will not suffer from survivorship bias and will include stocks that used to be dividend growth stocks but have since fallen off the current CCC List due to delisting or failing to increase its dividend. This test will limit itself to stocks with 9 or more years of dividend growth.

Since January 2000

GICS

Sector

Average Annual Return %

Maximum Drawdown %

10

Energy

12.4

-55.0

15

Materials

12.7

-45.5

20

Industrials

12.0

-57.1

25

Consumer Discretionary

10.5

-58.2

30

Consumer Staples

10.8

-29.8

35

Health Care

11.4

-37.8

40

Financials

9.2

-66.4

45

Information Technology

7.7

-48.0

50

Telecom

2.5

-60.0

55

Utilities

11.9

-30.1

Click to enlarge

Cyclical sectors have fallen behind recently, but that is no surprise given market conditions. The defensive sectors of Staples, Healthcare and Utilities continue to out-perform.

Other Factors

There are other factors which may have had a direct influence on returns since 2015. I tested 6 of these factors since January 2015 with one year rebalancing periods on all stocks in the current CCC List. From the start date of the simulation this would include all stocks with 4 or more years of dividend growth. Below is a chart showing what relevance, if any, these factors had on returns.

6 Investment Factors on Dividend Growth Stocks since 2015 Click to enlarge

What you would hope to see is a steady relationship between the factor weight and return. It is desirable to have the bars steadily increasing or decreasing to show that more(less) of factor X relates to more(less) return. The only 2 factors that seem to have this relationship is Beta and ATRN.

Beta is a comparison of the stocks movement compared to the market. If the market moves 10% in one month and the stock moves 5%, Beta is low. If the stock moves 20%, Beta is high. The Beta here uses monthly returns over the past 5 years. Here is a sampling of stocks that would meet the 'low Beta' criteria if that was your strategy.

Ticker

Name

Sector

Yield

Payout Ratio

(OTCQB:FNBG)

FNB Bancorp

Financials

2.05

15.56

(OTCQX:FMCB)

Farmers & Merchants Bancorp

Financials

2.43

37.53

(OTCQX:ISBA)

Isabella Bank Corp

Financials

3.5

46.91

(NASDAQ:HBNC)

Horizon Bancorp/IN

Financials

2.44

30.86

(OTCQX:CSVI)

Computer Services Inc

Information Technology

2.66

45.87

(NYSE:ED)

Consolidated Edison Inc.

Utilities

3.56

61.44

(NYSE:SO)

Southern Co (The)

Utilities

4.28

80.92

(NYSEMKT:BWL.A)

Bowl America Inc

Consumer Discretionary

4.81

191.33

(NYSE:WEC)

WEC Energy Group Inc

Utilities

3.38

71.32

(NASDAQ:POPE)

Pope Resources LP

Materials

5.07

207.25

Click to enlarge

Average True Range Normalized is a calculation that looks at daily volatility. In addition to calculating volatility based on the daily high and low, it also factors in yesterday's closing price. This is useful in the event of a major gap between yesterday's close and today's open such as when a major earnings report is announced after the close. This volatility is normalized against the closing price so that you can compare average % volatility amongst stocks. Even when rebalancing once per year, stocks with the lowest 100 day average ATRN performed the best.

Here are some notable names on the low volatility list right now:

Ticker

Name

Sector

Yield

Payout Ratio

(NYSE:JNJ)

Johnson & Johnson

Health Care

2.79

53.04

(NYSE:T)

AT&T Inc

Telecommunication Services

4.98

76.43

(NYSE:PG)

Procter & Gamble Co (The)

Consumer Staples

3.19

85.21

(NYSE:VZ)

Verizon Communications Inc

Telecommunication Services

4.24

47.75

(NYSE:KO)

Coca-Cola Co (The)

Consumer Staples

3.07

78.1

(NYSE:PM)

Philip Morris International Inc

Consumer Staples

4.16

90.94

(NYSE:PEP)

PepsiCo Inc

Consumer Staples

2.77

74.1

(NYSE:MCD)

McDonald's Corp

Consumer Discretionary

2.87

71.32

(NYSE:MMM)

3M Co

Industrials

2.69

52.99

(NYSE:UPS)

United Parcel Service Inc

Industrials

2.97

52.13

(NYSE:DEO)

Diageo PLC

Consumer Staples

3.17

57.02

Click to enlarge

Dividend Growth vs. the Market

The average annual market out-performance of dividend growth stocks with at least 9 years of consecutive increases from 2000 to the end of 2014 is 6%. Since 2015, that annual out-performance has dropped to 3.4%. Part of the reason could be that interest rates were expected to rise and this led to some performance drag on these dividend stocks. Another theory is that with increased attention on dividend growth stocks it is possible that valuations were driven up in previous years and they needed to deflate a little. Or it could just be noise and lumpy returns and out-performance is within a reasonable range.

Currently, the defensive sectors of Healthcare, Consumer Staples and Utilities seem to be holding up well. Telecom is currently doing well but with few stocks in this sector I don't put much weight on the numbers.

As far as other factors go, low volatility seems to be what has been working best since the 2015. Whether this trend continues remains to be seen, but it is an interesting possibility worth exploring further.

Disclosure: I/we 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.