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Chasing Dividend Yields Works

As a group, the stocks of the companies that consistently pay increasing dividends have been shown to provide higher total returns. Since the number of such stocks is quite large, the process of selecting the dividend growth stocks in which to invest is generally somewhat subjective.

A quick calculation shows that a simple approach, wherein the stocks with the highest dividend yields from a basket of pre-selected dividend growth stocks are selected for investing at the beginning of every year, may work quite well. The results, though, should not be taken as definitive due to a number of statistical biases inherent in such a calculation.

If ones starts with the current list of dividend champions available at dripinvesting.org/tools/tools.asp, and at the beginning of each year starting in 1991 invests in an equally weighted portfolio of ten stocks whose yields in the prior year are the highest, the CAGR during the period 1991-2011 is actually a bit higher than the CAGR of the equally weighted portfolio of all the 103 current dividend champions. The growth of $1 invested in 1991 for both of these portfolios is shown below:

Growth of $1 invested in highest yielding dividend champions vs. the performance of all dividend champios

It is notable that both the portfolios perform better than the MP63 fund www.mp63fund.com/index.html which invests in a subset of dividend paying stocks.

Though the overall performance of the yearly rebalanced portfolio is slightly better, the differences in the annual returns are not very significant as shown in the following figure. It appears, therefore, that it may be possible to reap the benefits of investing in dividend growth stocks just by investing in a handful of them by using the simplest possible strategy.

The quantitative performance measures of the two portfolios are not very different as well, although selecting the highest yielding stocks has a slight advantage during this period. Note that the 3, 5 and 10 year performance of most mutual funds does not come close to the performance of these portfolios.

Performance Measure Top 10 All
Performance of the two portfolios during 1991-2011
3 year CAGR 14.5% 16%
5 Year CAGR 6.5% 6.7%
10 Year CAGR 13.3% 10.2%
15 Year CAGR 14% 12.5%
21 Year CAGR 16% 15.2%
Sharpe Ratio .78 .72
Three Factor Alpha 7% 5.7%
Three Factor Beta .47 .64

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