Top-Performing Quantitative Dividend Growth Picks And Pans

by: Tyson Halsey, CFA

Income Growth Advisors, LLC's quantitative dividend growth strategy completed its quarterly rebalancing two weeks ago. Our 14 stock model has had an 11-year simulated record investing in dividend growth stocks that has outperformed the S&P 500 total return index by 12.25% per year before fees.

The strategy screens for a 5% historic dividend growth profile, 3% minimum yield, and $100 million market capitalization minimum, as well as several operating and earnings screens to drive earnings, price momentum, and continued dividend growth. It also has average market capitalization of $19 billion, average trailing dividend yield of 3.6%, and average forward dividend yield of 4%. The model offers a macro market risk management overlay predicated on S&P 500 earnings revisions and the equity market risk premium. This signal would have removed investors from the 2001-03 and 2008-09 bear markets. The model has had no down years.

Our buy recommendations were as follows: WPP (NASDAQ:WPPGY) ($59.12), Darden Restaurants (NYSE:DRI) ($51.21), Southern Copper (NYSE:SCCO) ($30.42), Cullen/Frost Bankers (NYSE:CFR) ($55.42), Bayer Atkienges ADS (OTCPK:BAYRY) ($66.72), Hudson City Bancorp (NASDAQ:HCBK) ($6.18), and Wadell & Reed Financial (NYSE:WDR) ($29.66).

WPP is a $15.41 billion market capitalization advertising, media, and communications services company with a 12.5 trailing P/E multiple whose trailing dividend is 3.1% and forward dividend yield is 4.1%. The company has been growing its top-line revenues by 7% across all business geographies and sectors.

Darden Restaurants is a $6.6 billion market capitalization operator of 2,000 restaurants featuring Red Lobster, Olive Garden, LongHorn Steakhouse, and The Capital Grille and has a trailing P/E of 14.35. Its trailing dividend yield is 3.4% and its forward dividend yield is 3.9%. DRI's margins are improving on modest sales growth of 3.8%. It is expanding and innovating its popular mid-priced restaurant choices in this great recession.

Southern Copper is a $27.28 billion market capitalization copper mining and exploration company with operations in Peru, Chili, and Mexico. Its trailing dividend yield is 6.5% and its forward dividend yield is 6.7%. Recent strength in the stock price, after a period of prolonged consolidation, may suggest that the slowdown in China is fully discounted and it's an opportune time to add to your portfolio in this weak economy.

Cullen/Frost Bankers is a Texas-based $6.5 billion market capitalization commercial and consumer bank. Its trailing yield is 3.2% and forward yield is 3.3%. CFR is benefiting from the natural gas boom in Texas. Further, recent data have indicated that the largest banks in the Keefe Bruyette index have been cutting back on commercial loans to meet higher reserve requirements, while mid-sized operators like CFR have been growing commercial loans.

Bayer Atkienges is a German $60 billion market capitalization pharmaceutical and healthcare company. Its trailing dividend yield is 3% and has no forward dividend indicated on It trailing P/E is 17 and forward P/E is 10.8, which implies strong earnings growth. Bayer is growing its exposure to the emerging markets with 35.6% of its revenues coming from emerging markets in 2010 and 36.4% in 2011.

Hudson City Bancorp is $3.17 billion market capitalization retail bank located primarily in New York, New Jersey, and Connecticut. Its trailing and forward dividend yield is 5.1%. The company appears to be recovering from the financial crisis without much of the baggage haunting larger financial institutions. HCBK appears to have bottomed technically crossing its 200-day moving average at $6 and down from a high over $18 in 2008.

Waddell & Reed Financial is a $2.67 billion market capitalization diversified regional broker dealer. Its trailing dividend is 2.1% and forward dividend yield is 3.3%. WDR recently crossed its 200-day moving average has good revenue growth and a conservative balance sheet.

Our sell recommendations were as follows: British American Tobacco (NYSEMKT:BTI) ($97.91), American Software (NASDAQ:AMSWA) ($8.34), Taiwan Semiconductor Manufacturing (NYSE:TSM) ($13.7), Royal Bank of Canada (NYSE:RY) ($49.85), Pearson (NYSE:PSO) ($18.66), Chevron (NYSE:CVX) ($103.14), and Alto Palermo SA (NASDAQ:APSA) ($13.63).

British American Tobacco a $102.5 billion market cap tobacco manufacturer and marketer. Its trailing dividend yield is 3.9% and its forward dividend yield is 5.5%. While BTI has the income and cash flows we like, its relative appeal on our ranking system led it to be dropped relative to higher ranking buy recommendations. This may be suggestive of the market seeking more cyclically sensitive investments like Southern Copper and dropping traditional defensive tobacco stocks.

American Software is a $238 million market capitalization enterprise software services company. Its trailing dividend yield is and its forward dividend yield is 4.3%. While the company has been a decent investment and has a good yield, the company's dividend growth and size are unattractive on a relative basis, leading it to be dropped from our model.

Taiwan Semiconductor Manufacturing is a $74 billion market capitalization company. Its trailing dividend yield is 3.5% and its forward dividend yield is 2.8%. TSM trades at a trailing P/E multiple of 17. Given its size and the cyclicality of the industry, TSM was dropped due to its being less attractive in our model than our new buys.

Royal Bank of Canada is a $76.2 billion banking institution. Its trailing and forward dividend yield is 4.3%. The stock was dropped at a loss due to price weakness during the euro panic in May and June. I suspect the perception that its size and international exposure might come make it vulnerable to a potential financial contagion in Europe, despite its clean balance sheet. By contrast, Cullen Frost and Hudson City Bancorp were added to the model where loan growth is solid, reserve requirements aren't pressing, and international contagion is unlikely. If the euro financial crisis does take three to five years to work itself out, as Jimmy Rogers recently speculated, investments in regional U.S. bank shares will likely prove a better longer-term investment. RY was added to our portfolio in March and sold at a loss in June.

Pearson is a $16.2 billion market capitalization education services and publishing company. Its trailing dividend yield is 3.4% and its forward dividend yield is 4.5%. With a PEG of 2.54, I suspect that stressed municipal and educational budgets are prompting the headwinds for its ware and dropping it from our model.

Chevron is a $211 billion market capitalization oil company. Its trailing dividend yield is 3.1% and its forward dividend yield is 3.4%. Chevron was dropped from our model due to weakness in oil prices and concerns about global weakness.

Alto Palermo is an Argentine $430 million market capitalization owner operator of shopping centers. Its trailing dividend yield is 15.8% and its forward dividend yield is 12.8%. Unfortunately, Argentina is a poorly run and corrupt country, which is seeing its economy moderate like by its better-known and fast-growing neighbor Brazil.

The seven buys and seven sells for a portfolio of 14 stocks is fairly high. This higher turnover stems from much of the market volatility from the euro crisis. Our model tends to work better in smoother markets.

Our macro market risk management overlay signaled being in all cash from Oct. 1, 2001, to March 31, 2003, and Dec. 27, 2007, to Sept. 21, 2009, and added 1.4% annual performance. Curiously, the hedge offered little alpha in the first period because dividends and dividend growth were so undervalued in the wake of the great dot-com bust. In the second period, the hedge helped greatly due to the model's above-average weightings in financials, which were caught in the market crash. In either case, I think the risk management methodology has great value in identifying market risk. When comparing the two performance charts (dividend growth vs. dividend growth with macro hedge), you can see that there is room for potential additional return built around these macro market sell indicators.

When analyzing the viability of a back-tested system for future performance, analysts typically ask two questions: Will the past market conditions continue into the future? Are valuations fair or extended? In both cases we think these preconditions remain favorable. A sideways market with benign interest rates seem likely for the next five to 10 years, by which time major structural imbalances (massive government, municipal, and consumer debt) are unwound. While dividends did become popular and pricey toward the end of 2011, dividend growth stocks have not seen their valuation expand beyond historic norms.

In an environment where earnings face headwinds, our inclusion of earnings momentum helps us identify winners as well as avoid possible dividend cuts. And as Robert Arnott and Clifford Asness have shown, earnings are closely tied to dividend increases.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: The information expressed in this article and on our website is based upon the interpretation of available data. The data being presented was obtained or derived from sources believed to be accurate, but Tyson Halsey, CFA, and Income Growth Advisors, LLC cannot and does not guarantee the accuracy of these sources which may be incomplete and/or condensed. The data and information presented is provided for informational purposes only, and is not offered as a basis for trading in securities nor is it offered for that purpose. Nothing contained herein should be construed as a recommendation to buy or sell any securities. Readers and potential investors should conduct their own independent investigation before making any investment or business decisions with respect to WPP plc, Darden Restaurants, Inc., Southern Copper Corporation, Cullen/Frost Bankers, Inc., Bayer Atkienges ADS , Hudson City Bancorp, Inc., and Wadell & Reed Financial Inc, British American Tobacco plc, American Software, Inc., Taiwan Semiconductor Manufacturing Co. Ltd., Royal Bank of Canada, Pearson plc, Chevron Corporation, and Alto Palermo SA.

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