Barron’s recently ran an article titled “Get Smart About Picking Dividend-Rich Stocks,” highlighting that high-quality high-dividend-paying stocks outperform low-quality high-dividend-paying stocks. The quality of the firm is measured by profitability, financial distress and accounting red flags.
Investigating a Simpler Way to Identify Top-Performing Dividend Stocks
Let's start by sorting the high dividend-paying firms by a simple value investing measure–EBIT/TEV. We choose this value investing measure based on our own research discussed here.
First, we set up the experiment.
We examine all firms above the NYSE 40th percentile for market-cap (currently around $1.8 billion) to avoid weird empirical effects associated with micro/small cap stocks. We form the portfolios at an annual frequency with the following two variables:
- Dividend Yield = Cash dividends / market capitalization. Assessed on 6/30 each year.
- Value = EBIT/(Total Enterprise Value). Assessed on 6/30 each year.
Here, we describe the four portfolios we examine. All portfolios are annually rebalanced on 6/30 each year.
- Top Div. Quintile, High Value EW = Top quintile of firms on dividend yield, then choosing the top half on Value. Portfolio is equal-weighted.
- Top Div. Quintile, High Value EW = Top quintile of firms on dividend yield, then choosing the bottom half on Value. Portfolio is equal-weighted.
- Top Div. Quintile EW = Top quintile of firms on dividend yield. Portfolio is equal-weighted.
- Universe EW = Total return on the universe of securities. Portfolio is equal-weighted.
Results are gross of management fees and transaction costs. All returns are total returns and include the reinvestment of distributions (e.g., dividends).
Here are the returns (1/1/1964-12/31/2014):
Value Investing Portfolio Results:
- The top quintile of dividend paying firms outperformed the universe over the past 50 years when comparing CAGR, Sharpe and Sortino ratios (comparing column 3 to column 4)
- Splitting high dividend-paying firms by value worked historically. Column 1 (top dividend payers, high value) outperformed column 2 (top dividend payers, low value) across all performance measures — CAGR, Sharpe and Sortino ratios.
The results suggest that a sort on a simple value investing measure works well at sorting dividend stocks. Compared to the more complex quality screen proposed by Barron’s, this sorting variable is a good alternative for investors who prefer high dividend stocks.
Written by Alpha Architect researcher Jack Fogel. For more market anaylsis from Wesley R. Gray and his team, check out his blog at Alpha Architects here.
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