Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Halloween is a joyous holiday for children who scour their neighbourhoods for sugary treats. It's also a happy one for investors because it marks the end of a traditionally weak period for stocks. If history is a guide, odds are good that the market will fare reasonably well over the next few months.
But rather than diving into and out of the market, wise investors simply take advantage of weak periods to load up on good companies at a discount. It's something dividend investors have been happily doing over the last few weeks.
In many ways, dividend investing provides a prophylactic against the panic that a market downturn can inspire. After all, dividend yields rise when share prices fall, which naturally makes them more attractive to investors looking for income.
History has been kind to income seekers in Canada, according to data complied by Dartmouth College professor Kenneth French. In one study, he split the universe of Canadian stocks into three different groups based on yield. One group contained the 30 per cent of stocks with the highest yields and another the 30 per cent of dividend payers with the lowest yields. The third group was reserved for non-dividend payers. Each group was rebalanced annually and followed over the course of many decades.
The high-yield group fared the best, with average annual returns of 13.2 per cent from 1977 through 2014. By way of comparison, the market gained an average of 11 per cent annually over the same period, while the low-yield group gained 10.7 per cent annually. The no-yield group fared poorly, with annual returns of only 3.7 per cent.
The high-yield group outperformed the market by an average of 2.2 percentage points annually, which represents a considerable bonus for a very simple strategy.
On the other hand, the no-dividend group suffered mightily and lagged the market by an average of 7.3 percentage points annually. As a result, investors should think twice before buying stocks that don't pay dividends.
But investors shouldn't get carried away with the findings. While large stocks with generous yields have fared quite well, loading up on stocks with extremely high yields can be risky. After all, failing companies often trade at very low prices and some keep paying dividends until the bitter end when creditors shut them down.
Unfortunately, businesses can also collapse quickly and with little warning. As a result, even careful dividend investors are likely to run into an unfortunate case from time to time. Because such mistakes happen, it's important to hold a large number of stocks. That way one or two failures won't put a real dent in your nest egg.
Investors who want to build their own dividend portfolios can head to the market and do a little stock picking. But it's even easier to start with a low-cost, high-yield exchange-traded fund.
While several different dividend ETFs are available, I prefer the Vanguard FTSE Canadian High Dividend Yield Index ETF (VDY-TSX). It has a low annual fee (MER) of 0.23 per cent and Vanguard has a habit of reducing their fund fees over time. It also sports a trailing distribution yield of 4 per cent and pays distributions monthly.
I hasten to add that the ETF is a little more concentrated than I'd prefer, but it also reflects the nature of the Canadian market. It held 93 stocks at the end of September and about 65 per cent of the fund's portfolio was invested in its 10 largest holdings. Financials represented about 64 per cent of the portfolio, oil and gas firms 15 per cent and telecoms 5 per cent. Over all, the ETF provides a handy starter portfolio for dividend investors.
With a little luck, dividend stocks will continue to be profitable for years to come. If they do, trick-or-treaters might be able to collect even bigger bounties in the future.
Norman Rothery