SPY Catches Up With Dividend Growth Portfolios In Q1

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This is an update on my four research-based Dividend Growth Model Portfolios. The Dividend Aristocrat+ portfolio focuses mostly on stocks with 25-year+ histories of dividend increases and uses equally weighted sectors. The DG-SmallCap portfolio concentrates on medium and smaller-cap firms with strong dividend growth, with preference to higher yielders. The DG-IncomeGrowth model is similar, but pursues non-small caps with high yields and high dividend growth rates. The newest model, DG-HYLP, screens for high-yield, low-payout ratio stocks as value plays with safe and growing dividends. The first three models were initiated on August 16, 2011, whereas the DG-HYLP was started on January 1, 2012, so there is less data history for that portfolio.

Performance Summary (March 30, 2012)

Over the last three months, the S&P 500 Index (NYSEARCA:SPY) had a great run, exceeding the total return performance of all of the DG portfolio models by 50% to 300%. Interestingly, the SPY also had less volatility of weekly returns than all of the DG models. Typically, we expect DG stocks to have less volatility. There were some big winners and big losers during this timespan which may have caused this, in conjunction with a more concentrated portfolio of 30-40 stocks versus the SPY's 500. Hence, on a volatility or beta-adjusted basis (Sharpe and Treynor ratios respectively), the S&P outperformed all of the portfolios during 2012 Q1.

Since inception, the DG models have delivered total returns close to the S&P's total return, but with less volatility. All of the DG models had higher volatility-adjusted (Sharpe) and beta-adjusted (Treynor) return ratios than the SPY. In simpler terms, these portfolios produced higher returns for each unit of risk, as measured by volatility or beta. Prior to the recent S&P run-up, the DG models were even further ahead, but ultimately, I'm seeking long-run outperformance. Note that the HYLP model only has 3 months of data, versus over 6 months for the other funds, so it is not directly comparable yet, but it performed very well.

Focus on the Dividend Aristocrat+ Model

This month, I thought I would provide more detailed information about the DA+ portfolio. I will highlight a different model with each update. Since the portfolio rebalance on December 31, 2011, 10 of the 30 holdings are down, but only three by more than 5% and none is down more than 9%. 4 of 30 delivered over 10% in total returns during these 3 months. The top performers mostly belonged to the Industrials, Materials, and Info Tech sectors. Weaker performers were in Telecom, Utilities, and Energy. A few selected stocks are mentioned below.

  • Illinois Toolworks (ITW) delivered 20% in total return, the highest in the portfolio. At the end of January, ITW outperformed earnings estimates. Operating margins were up year-over-year (YOY) and management projected earnings growth of 6%-9% for 2012. With the run-up in price, the stock now yields 2.5% and trades at a PE of 13.4.
  • Technology stocks were strong. Intel (INTC) had another strong earnings report and gained nearly 16% for the quarter. Despite the run-up, INTC still trades at a low PE of 12, has a 3% yield, and a low payout ratio. Its next dividend increase would be expected in August. Most of Linear Technology Corp's (LLTC) gain occurred in January after it beat earnings estimates and offered a positive outlook for 2012.
  • Energy stocks slipped slight during this period, however there was a strong run-up during the end of 2011, so some pullback is not unexpected. Exxon (XOM), Chevron (CVX), and Kinder Morgan Partners (KMP) were all flat or down no more than 3%. Oil prices continued to climb on average, so I would expect these stocks to remain strong.
  • Telecom stocks were relatively weak. AT&T (T) showed a slight gain for the period, despite posting a large loss due to the collapse of the T-Mobile deal. Verizon (VZ) and Atlantic Tele-Network Inc. (ATNI) were two of the worst performers, losing around 6% and 9% respectively for the quarter. Verizon posted a loss due to pension costs and high subsidies paid for iPhones, however, it had strong sales and new subscribers on contract plans. ATNI's revenues declined YOY and it missed earnings estimates due to an impairment charge. This stock triggered my "-20% rule" and has been replaced; see the next section.

DA+ Portfolio Changes

As mentioned above, ATNI triggered my -20% performance gap rule, which my data has shown often signals either a dividend cut or a larger future decline in price. If a stock in this portfolio is 20 or more percentage points below the S&P's performance for 4 consecutive weeks (using end-of-week data), then it will be replaced. This occurred for ATNI on March 23, 2012, as it was 20 points below the S&P's performance, looking at a Google Finance chart starting from

November 2011. Therefore, it was sold on March 23, 2012. Unfortunately, there are no other Dividend Aristocrats from the Telecom sector, so I had to bend the rules and choose a Telecom stock with less than 25 years of consecutive dividend growth. ATNI was replaced with China Mobile (CHL).

Other Portfolio Changes

A few other stocks have also triggered the -20% rule:

  • March 9, 2012: Alliance Resource Partners LP (ARLP) has declined in part due to government regulations that effectively will halt the construction of any new coal-fired electric plants. Coal prices have also been on the decline. A detailed SA write-up on ARLP can be found here. The stock's dividend appears safe, given its low payout ratio, but until there is more visibility regarding the impact on ARLP, the price may remain under pressure. This stock was replaced with Magellan Midstream Partners (MMP) in the DG-IncomeGrowth portfolio, and with Sunoco Logistics Partners (SXL) in the DG-Small Cap portfolio, as MMP was already owned. I own a little ARLP; it has declined about $15 since the signal...guess next time I'll follow the rule!
  • March 9, 2012: NTT DOCOMO (DCM) has steadily declined since peaking in September 2011. NTT reported higher revenues in February 2012, but GAAP earnings were down 56% YOY, operating expenses were up, and free cash flow was down 13%. The remaining Telecom stocks on the DG-IncomeGrowth screen have both recently triggered the -20% rule, therefore this stock was replaced with Verizon , even though it does not meet the 10-year dividend growth criteria.

Note: These stocks were NOT replaced in the DG-HYLP (high-yield, low-payout) model, as I decided to not use the -20% rule given that the dividends are safer for this portfolio. This also provides the opportunity to see the impact of the rule. The DG-HYLP model may be rebalanced at 6 months though, to remove stocks that have had strong run-ups and are no longer values.

-20% Rule Modification Thoughts

With the S&P climbing strongly during the last quarter, more regulated, high-yielding firms in the Telecom and Utilities industries have triggered, or are close to triggering, my -20% stop-loss rule. While past data has shown that overall the rule has prevented losses, I wonder if during strong bull runs, it may take out firms that are simply slow growers and whose dividends are not in danger. I will continue to contemplate whether this rule should not apply to the Utility and Telecom fields, given the nature of those businesses. At the least, I may extend the gap to 25% to account for the higher yields offered by stocks in these sectors, which are not factored into the Google Finance price charts. Or perhaps I should just compare the market price of these stocks against the purchase price and not the SPY's performance. Investors who buy VZ for the dividend don't care if it underperforms the S&P, they are interested in the dividend and not losing their original investment, and these firms do not have high growth rates.


Overall, the DG models are keeping pace with the SPY and doing so with less volatility, which was one of the objectives. The last quarter was very strong for the SPY and the dividend portfolios did not keep up in total return or on a risk-adjusted basis. This is not unexpected, and balances out the strong performance by DG stocks last fall. I will continue to monitor and report on these funds, and welcome any feedback and suggestions for improving them.

Disclosure: I am long VZ, ARLP, INTC, KMP.