Small-Cap Dividend Aristocrats: Quantifying Out Performance

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Summary

In a recent article, SA Author Ploutos highlighted the outperformance of the Russell 2000 Dividend Growth versus the Russell 2000 and the S&P 500, in terms of rates of return.

The average yearly rate of return for the Russell 2000 Dividend Growth, over a 20 year term, was half as much again as for the other two indexes.

Risk, based on standard deviation of annual returns, was also calculated to be lower for the Russell 2000 Dividend Growth.

I have found it useful to quantify what those rate of return and risk statistics mean for total investment returns and capital preservation.

SA Author, Ploutos, in a recent article, "Small-Cap Dividend Aristocrats", compared the returns from the Russell 2000 Dividend Growth to the Russell 2000 and the S&P 500. The Russell 2000 Dividend Growth average yearly rate of return (ROR) over a 20 year period was 12.58%, versus 8.25% and 7.68% respectively for the Russell 2000 and the S&P 500. Now that might seem like a 1.5 times better result for the Russell 2000 Dividend Growth, but the actual investment result in dollar terms is far better than that, as shown in TABLE 1 below.

TABLE 1

It can be seen from TABLE 1, while the ROR for the Russell 2000 Dividend Growth, is 1.5 to 1.6 greater than the other two, the dollar growth in investment value over the 20 year period is actually 2.5 to 2.9 times greater than for the other two. That is a huge difference brought about by a logarithmic type effect of a combination of a higher ROR coupled with a long time period. This knowledge is particularly important for a younger investor with a long term investment horizon.

To be more certain the particular period chosen is appropriate for comparing returns between the Russell 2000 DG and the other two, I have eliminated the years 1997, 1998, and 2016. These were years at the start and end where the Russell 2000 DG showed much higher returns than for the other two. The results are reflected in TABLE 2 below.

TABLE 2

Eliminating the years 1997, 1998, and 2016, still leaves the average yearly ROR and the dollar investment growth for the Russell 2000 DG well in advance of the other two, leaving it the far superior investment option. But look at the effect on net investment growth. A reduction of 3 years time invested, and a 1.9 percentage point reduction in ROR has reduced cumulative investment growth for Russell 2000 DG from $969 over 20 years, per TABLE 1 above, to $461 over 17 years, per TABLE 2 above, less than half the growth. This serves to highlight the extreme impact of levels of ROR and time in the market on investment growth over time.

I will now turn to the question of risk, not in terms of "standard deviation of annual returns", but from a preservation of capital perspective. To illustrate this, I have determined the investment result for 5 year investment periods, beginning with end of 1996 to end of 2001, through to end of 2011 to end of 2016, as reflected in TABLE 3 below.

TABLE 3

As can be seen from TABLE 3 above, the worst 5 year period to invest in the Russell 2000 DG was the period commencing at end of 2004 and finishing at end of 2009. In this period, an initial investment of $100 would have grown to $109 at the end of 5 years. For the Russell 2000, the worst period was the 5 years ending 2002, where an initial investment of $100 would have decreased to $93. For the S&P 500, the worst period was the 5 years ending 2004, where an initial investment of $100 would have decreased to $89. For the S&P 500, there were also four other 5 year periods where some of the initial investment would have been lost at the end of 5 years.

Summary and Conclusions

Ploutos has certainly identified an alpha opportunity with the Russell 2000 Dividend Growth. Higher returns at a lower level of risk, is the essence of alpha. Compared to the Russell 2000 and the S&P 500, the Russell 2000 Dividend Growth has achieved higher returns at lower risk than either the Russell 2000 or the S&P 500. For those interested in taking action, Ploutos has provided details of the components of the Russell 2000 Dividend Growth in the article referred to above. Ploutos has also provided a link to the ProShares Russell 2000 Dividend Growers ETF (NYSEARCA: SMDV), for the convenience of those readers who may prefer to make a single investment. I find the notion, put forward by Ploutos, of using quarterly adjustments to weightings of the ETF to effectively buy the dips using proceeds from rebalancing stocks that have risen in the quarter quite interesting. I firmly believe buying the dips to enhance returns in periods of volatility can be a safe and profitable objective (see here, here, here, and here). I also believe that we can expect to see a great deal of volatility in the stock market in 2017, giving rise to many opportunities to buy the dips. I intend to write further on this in coming weeks.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stock/s mentioned. Past performance of the company/s discussed may not continue and the company/s may not achieve any projected earnings or dividend growth. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for their specific situation.

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.

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