Super size me?
The investing world's nutrition cops will tell you differently, but dividend stocks with extra-large yields can be both tasty and good for you.
It's often said that the healthiest approach to dividends is to ignore yield and instead focus on a company's record of increasing the amount of cash paid out quarterly to shareholders. Growing dividends feed share price gains, and they provide a source of income that rises in a way that bonds and term deposits can't match.
High yields are almost like junk food from this perspective. Remember, yields rise when share prices go down. Really high yields mean investors are seriously worried, maybe about the possibility that dividends will be cut or suspended. At best, you would have to say a high-yield dividend stock would offer reduced potential for a dividend increase.
Still, high-yield investing has some appeal. For one thing, you get a return on your dividends that is far higher than anything available from government bonds and guaranteed investment certificates. There's also the possibility that a good stock with a high yield could be a turnaround play.
The idea of focusing on high-yield stocks gained popularity through the Dogs of the Dow strategy, where you buy the 10 highest yielding stocks in the Dow Jones industrial average at the beginning of the year. The dogs strategy was popularized in a 1991 book called Beating the Dow , by Michael O'Higgins.
David Stanley, a retired University of Guelph professor who writes for Canadian MoneySaver magazine, has long followed a similar strategy called Beating the TSX. The concept here is to buy the 10 highest yielding stocks in the Dow Jones Canada Titans 60 index at the end of May.
Now, there's a new approach to high-yield investing that we're going to call the Dogs of the S&P 500 for lack of a better name (feel free to suggest one). You simply buy the two highest-yielding stocks in each of the 10 index sectors, and then rebalance at the beginning of the year.
The story behind this high-yield idea begins with the most recent annual update of the two-minute portfolio, a simple stock-picking strategy of investing in the two largest dividend-paying stocks in each of the 10 sectors that make up the S&P/TSX composite (read it online at: http://tgam.ca/GQV). The deciding factors for the two-minute portfolio are, first, the total value of a company's shares and, second, the fact that it pays a dividend (yield is of no consequence).
Several readers have asked whether the two-minute strategy might be applicable to the U.S. market. To investigate, I contacted CPMS, an equity research and portfolio analysis firm owned by Morningstar Canada. CPMS maintains the two-minute portfolio and agreed to apply the same strategy to the S&P 500.
The result was a 16-year average annual return of 3.6 per cent in Canadian dollar terms, poor enough to prompt CPMS to try a reboot using the two highest yielding stocks in each S&P sector.
This time, the results shone. CPMS has calculated an average total return (price plus dividends) of 8.8 per cent over the past 16 years, compared with 6 per cent for the S&P index. Again, these are Canadian-dollar returns, which reflect the impact of moves in our dollar against the U.S. buck.
The Dogs of the S&P 500 is a twitchy investing strategy, so approach it with caution. In fact, it serves as a warning about the dangers of high-yield investing in general.
Let's start with what happened during the global financial crisis. From May, 2007, through February, 2009, the dogs of the S&P plunged a nasty 55.5 per cent in U.S. dollar terms, compared with 51 per cent for the index itself.
