Regarding portfolio management, there appear to be as many DGI investing styles as there are DGI investors. At one end of the spectrum, some dividend investors resolutely refuse to sell any amount of any stock, with prolific Seeking Alpha commenter "buyandhold2012" being a well-known proponent of this strategy. On the other hand, in an analysis of Hasbro (NASDAQ:HAS) stock last year, DGI expert David Van Knapp stated that his criterion for considering selling dividend stocks is if its yield drops below 2.5% and/or it becomes seriously overvalued.
In yet another approach, experienced DGI investor and writer Mike Nadel, after a very thorough review process, decided to sell half of his Kinder Morgan (NYSE:KMI) stock, which turned out to be an extremely prescient decision. Another common strategy that I've come across is to sell a stock if it reduces or freezes its dividend.
Can academic research be used to improve DGI investor performance? Eugene Fama, father of the efficient market hypothesis, has famously written that "the premier anomaly is momentum." A portfolio that emphasizes momentum will buy stocks that exhibit strong recent price performance, while selling stocks that have faltered. Another academically validated factor is the value factor, which advocates buying cheap stocks and selling more expensive stocks, or a "buy-low sell-high" approach.
In this study, I've decided to take a group of well-known blue-chip DGI stocks and assess whether executing a momentum or a rebalanced/equal-weight* strategy would have improved upon the performance of a buy-and-hold portfolio over the last 20 years (1996-2015).
*A rebalanced/equal-weight strategy is, strictly speaking, not the same as a value strategy. However, they can still be understood to be intuitively similar as both involve buying low and selling high.
The rules for the two strategies are presented below. Both portfolio management strategies require adjustment once per quarter, which shouldn't be prohibitively difficult.
- Momentum strategy: every quarter, buy the top 30% of stocks with the best trailing 12-month performance, excluding the last 1 month (i.e., this involves selling stocks from the previous quarter so that at any time, the strategy is only invested in the top 30% stocks).
- Rebalanced/equal-weight strategy: every quarter, equally weight the portfolio.
The buy-and-hold portfolio is much simpler:
- Buy-and-hold portfolio: on the start date, equally weight the portfolio.
The stocks chosen for the exercise are Chevron (NYSE:CVX), Coca-Cola (NYSE:KO), Kimberly-Clark (NYSE:KMB), Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), Exxon Mobil (NYSE:XOM), McDonald's (NYSE:MCD), Southern Company (NYSE:SO), PepsiCo (NYSE:PEP), AT&T (NYSE:T), Colgate Palmolive (NYSE:CL), General Mills (NYSE:GIS), Realty Income (NYSE:O), Target (NYSE:TGT), 3M (NYSE:MMM), Altria (NYSE:MO), Genuine Parts Company (NYSE:GPC), Lockheed Martin (NYSE:LMT), Microsoft (NASDAQ:MSFT) and Walgreen Boots Alliance (NASDAQ:WBA).
How did I choose these 20 blue-chip dividend stalwarts? These were the stocks that were picked by at least 7 out of 10 DGI experts in Mike Nadel's effort to construct "The New Nifty Fifty," which he deemed to be the "best of the DGI bunch." Unfortunately, PM could not be included because of its relatively short history as an independent company. With 20 stocks, this means that the momentum strategy will buy the top 6 stocks (top 30%) each quarter.
Portfolio Visualizer was used for the following analysis, and total return calculations include the effect of reinvested dividends.
How have these stocks performed individually over the last 20 years? The following chart shows the total return growth of $10K invested in each of the 20 stocks over a period from Jan. 1996 to Dec. 2015.
We can see that these DGI stocks have been absolutely stellar performers over the last two decades, with MO leading the pack at a fantastic $228K return, followed by O at $159K and TGT at $143K. 18 out of the 20 stocks beat the S&P 500 (NYSEARCA:SPY), with only T and KO being laggards.
Instead of putting $10K into a single stock, if one had split the initial investment into $500 portions in the 20 different stocks, he would have ended up with a final portfolio value of $93K ("Portfolio 1" in the below chart), which is still nearly twice the ending value of SPY ($47K). Thus, we can conclude that a buy-and-hold investment into these blue-chip dividend stocks two decades ago would have easily trumped the market since then.
But could we have done even better? Let's see what happens with the momentum ("Timing Portfolio" in below chart) and rebalanced/equal-weight strategies ("Equal Weight Portfolio").
We can see from the chart above that both momentum and rebalanced portfolios have done substantially better than the broad market. The timing portfolio ended with $175K, compared to $109K for the rebalanced portfolio and only $47K for SPY. Notably, both portfolio management strategies outperformed buy-and-hold ($93K).
Let's take a look at some of the statistics from this backtest, starting with CAGR (compound annual growth rate) and standard deviation (a measure of volatility).
We can see from the chart above that the momentum strategy has the highest CAGR at 15.37%, followed by the rebalanced strategy at 12.71% and the buy-and-hold portfolio at 11.82%. The SPY has the lowest CAGR of 8.08%. This is consistent with what I described above, showing that the momentum strategy had the highest portfolio ending value.
The standard deviation data is more interesting. The momentum strategy (14.09%) was more volatile than the rebalanced (11.50%) or buy-and-hold (12.39%) strategies. However all three portfolios were less volatile than the broader market (15.39%).
The following chart shows the best year, worst year and maximum drawdown for the various portfolios.
As can we seen from the data above, the momentum portfolio had the highest "best year" of 62%, and also the lowest "worst year" of only -9%. It also had the lowest maximum drawdown of -25%. The rebalanced and buy-and-hold strategies had similar best years to the S&P 500, but superior worst year and maximum drawdown metrics.
Finally, we can look at the Sharpe and Sortino ratios of the portfolios, as well as the US market correlation. Sharpe and Sortino ratios are metrics that take into account both the return and the volatility of an investment. Simply put, the higher the number the better, because this indicates a superior risk-adjusted return.
The data above shows again that the momentum strategy is the clear winner, with higher Sharpe and Sortino ratios than the rest. The rebalanced strategy also has superior risk-adjusted return metrics compared to the buy-and-hold portfolio. In terms of U.S. market correlation, the momentum strategy has a surprisingly low correlation of only 0.60, compared to 0.75 for the rebalanced strategy and 0.79 for the buy-and-hold portfolio.
Full data are shown below.
|Portfolio||Initial Balance||Final Balance||CAGR||Std. Dev.||Best Year||Worst Year||Max. Drawdown||Sharpe Ratio||Sortino Ratio||US Mkt Correlation|
|SPDR S&P 500||$10,000||$47,307||8.08%||15.39%||33.48%||-36.81%||-50.80%||0.43||0.63||0.98|
Discussion and conclusion
This article illustrates two simple portfolio management strategies that could improve the total return performance of the buy-and-hold DGI investor. With a portfolio of 20 top stocks from Mike Nadel's "New Nifty Fifty," the momentum strategy ended up with $175K at the end of 2015 from a $10K investment 20 years prior, compared to $109K for the rebalanced/equal-weight strategy and only $93K for the buy-and-hold portfolio (the S&P 500 ended with $47K). Of course, I have encountered DGI investors who care not one iota about total return and are only concerned with increasing their dividend stream; if that is you, all I can say is thank you for reading to this point!
Also, this analysis did not consider the impact of taxes or brokerage commissions, which are variable depending on each investor.
The momentum and rebalanced portfolios also exhibited better risk-adjusted return metrics (Sharpe and Sortino ratios) compared to the buy-and-hold portfolio, as well as superior "worst year" and maximum drawdown values. Although some DGI investors celebrate when the prices of their stocks decline (because this allows for reinvestment at lower prices), I believe that in general, it is better to aim for lower portfolio drawdowns, as these can place undue psychological stress on an investor resulting in poor decision making.
On the topic of psychology, a systematic portfolio management strategy such as momentum or rebalancing removes subjectivity and human emotion from buy/sell decisions, which can be a helpful for some investors. Additionally, the two portfolio strategies highlighted here require adjustment only once per quarter, which I do not think is excessively laborious.
Are the results that surprising? Seeking Alpha author Ploutos has regularly expounded the virtues of the Guggenheim S&P 500 Equal Weight ETF (NYSEARCA:RSP), which equally weights S&P 500 stocks, due to its long-term historical outperformance versus the cap-weighted S&P 500. On the other hand, Mike Nadel has found that even within the New Nifty Fifty, the strong often get stronger, which lends credence to the momentum strategy.
A curious point to note is that the momentum and rebalanced/equal-weight strategies are philosophical antipodes of each other. With momentum, the idea is to "cut losers and let your winners run," while with a rebalancing approach, the investor regularly trims the winners and adds to the losers. Somewhat surprisingly then, both strategies beat buy-and-hold, although momentum was by far the superior of the two. One message therefore seems to be that it doesn't matter what kind of portfolio management strategy you have in place, as long as it is followed systematically.
If you have enjoyed my article, please consider clicking the "Follow" button next to my name to be alerted to my new content!
Author's note: If you have found my articles useful in the past, please consider subscribing to the Cambridge Income Laboratory to receive my best trade ideas in advance, view my personal ETF/CEF income portfolio, request ETF/CEF analysis, and be alerted to possible fund misbehavior.
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.