Even 'Fallen Dividend Aristocrats' Outperform The Market

| About: ProShares S&P (NOBL)
This article is now exclusive for PRO subscribers.


In previous articles, I have demonstrated the long-run structural alpha of the Dividend Aristocrats, which have generated higher returns with less variability of returns than the broader market.

A recent article by another contributor raised questions about potential survivorship bias in the Dividend Aristocrats given the number of constituents that failed to increase dividends during the Global Financial Crisis.

This article looks at the fallen Dividend Aristocrats and measures their total and excess return relative to the market through the date of change in dividend policy.

When you are presented with evidence that challenges one of your core investment thesis, you have to take a hard look at the new facts. One of the key strengths of the Seeking Alpha community is the broad range of differing viewpoints presented. Recently, a contributor authored "These 26 Dividend Aristocrats Won't Let You Sleep Well at Night", which suggested that there is survivorship bias inherent in investing in Dividend Aristocrats.

I have demonstrated the long-run alpha achieved by the Dividend Aristocrats in many articles on Seeking Alpha. Buying these companies that have increased dividends for twenty-five consecutive years or more has generated higher risk-adjusted returns versus the broad market gauge over the last quarter-century. For this reason, I included the Dividend Aristocrats as one of my "5 Ways to Beat the Market". A depiction of the total return performance of the Dividend Aristocrats relative to the S&P 500 (NYSEARCA:SPY) is pictured below:

(Source: Standard & Poor's; Bloomberg)

The aforementioned article demonstrated that 26 of the 59 companies on the Dividend Aristocrats in 2007 subsequently failed to meet the index's inclusion rules after dividend cuts, dividend freezes, and M&A. The Dividend Aristocrat Index above includes the performance of constituents until the company no longer meets the index inclusion criteria, including the need to maintain increasing dividends. Just as the return history of the S&P 500 does not exclude former constituents, there is no survivorship bias in the index. Dividend Aristocrats have generated higher risk-adjusted and absolute returns, including the constituents that have exited the index.

Drilling down into the 26 companies that lost their status as Aristocrats since 2007, I subdivided them into four categories below:

(Source: Standard & Poor's; Bloomberg)

Five of the twenty-six companies that exited the Dividend Aristocrats did so because of a corporate takeover. With these buyouts happening at a premium to prevailing market levels, these five companies generated very strong total returns and excess returns relative to the S&P 500 over the 5-, 10- and 20-year historical periods in the study. These five companies produced 15%+ total returns over the 20 years to their takeover date, beating the market by over 6% per year - a remarkable performance.

Unsurprisingly, banks were also a large component of the exiting Aristocrats, as these financial institutions were forced to cut shareholder payouts during the Global Financial Crisis. Ten of the twenty-six exiting Aristocrats were banks forced to adjust their payout ratio. While these banks had very weak returns over the 5- and 10-year periods that culminated in dividend cuts during the crisis, they still managed to outperform the market with a 1.05% excess return over the trailing twenty years through the month end of their change in dividend policy, in spite of the dramatic drawdown in financial prices at the end of that study horizon.

The companies that actually performed worse, lagging the market in each 5-, 10-, and 20-year period, were companies that saw a secular change in their businesses. These are the types of companies that Dividend Growth Investors should be actively trying to avoid. Avery Dennison (NYSE:AVY) faced secular declines in its office products market from the digitization of the office environment and rise of the personal computing industry. CenturyLink (NYSE:CTL) has faced pressure from the transition of the wireline industry amidst the rise of wireless telephony. Gannett (NYSE:GCI) has faced challenges in its newspaper and publishing business, which it separated as Tegna (NYSE:TGNA) in 2015. SuperValu (NYSE:SVU) has been embattled the competitive onslaught of the rise of Wal-Mart (NYSE:WMT).

Seven additional companies did not fit neatly into one of the previously described categories. These companies have outperformed the broader market over 10- and 20-year periods.

The main takeaway for Seeking Alpha readers should be that over long time intervals, even Dividend Aristocrats that are forced to cut their dividend distribution have still outperformed the broader market. While it may be disconcerting that such a large swath of the Dividend Aristocrats failed to meet the dividend inclusion requirement through the last downturn, investors who owned this universe of securities, inclusive of the exiting names above, still meaningfully outperformed the broader market.

I am an owner of the ProShares S&P 500 Aristocrats ETF (BATS:NOBL), and this analysis of the fallen Aristocrats has not changed my view that this strategy is likely to outperform over long time intervals. Promising to return increasing levels of cash to shareholders over time is a capital deployment discipline that keeps management focused on delivering value for its key stakeholders.

Disclaimer: My articles may contain statements and projections that are forward-looking in nature, and therefore inherently subject to numerous risks, uncertainties and assumptions. While my articles focus on generating long-term risk-adjusted returns, investment decisions necessarily involve the risk of loss of principal. Individual investor circumstances vary significantly, and information gleaned from my articles should be applied to your own unique investment situation, objectives, risk tolerance, and investment horizon.

Methodology: I began with the 26 companies identified in the critique of the Dividend Aristocrats. For each company, I determined the date at which the dividend policy was changed using the Dividend/Split Summary (DVD) function on Bloomberg. I then calculated the 5-, 10-, and 20-year annualized total return through the month end after the change in dividend policy. I used the Total Return Analysis (TRA) function on Bloomberg, and included reinvested dividends. For the companies involved in M&A, I measured total return through the month end prior to the deal close. I compared each of these return periods relative to a matched time horizon for the S&P 500 to determine excess returns relative to the market.

Disclosure: I am/we are long NOBL, SPY.

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.