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Dividend growth stocks deliver ... in good times and bad

McDonald’s endured recent market turbulence, and even raised dividends by 10 per cent.


John Heinzl is the dividend investor for Globe Investor's Strategy Lab. Follow his contributions here. You can see his model portfolio here.

Studies have shown that stocks with growing dividends outperform those with stable dividends or no dividends at all.

Now here's another reason to like dividend-growing stocks: They provide protection in down markets.

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George Vasic and Garry Cooper, strategists at UBS Securities Canada, examined the seven largest down cycles on the S&P/TSX composite index since 1995. The average drop was 24.3 per cent, with the two worst being the 44.8-per-cent collapse from May, 2008, to February 2009, and the 39.2-per-cent skid from August, 2000, to September, 2001.

How did dividend growth stocks perform during these bouts of selling? Not nearly as badly as the market.

UBS's "financial dividend growers" – a group that includes the Big Six banks – fell an average of 15.6 per cent, or just 64 per cent of the broader market's decline. "Non-financial dividend growers" – a diverse group that includes railways, cable, pipeline and retail stocks – posted an average drop of 6.1 per cent. And a "high-yield" group – which includes telecoms – fell just 5.5 per cent.

Some investors believe that, in exchange for such downside protection, dividend growers are left far behind when the market rebounds. But that's not always the case, Mr. Vasic and Mr. Cooper said in their study.

In the eight major upturns since 1995, the S&P/TSX composite averaged a gain of 56 per cent. The financial dividend growers did better, however, rising an average of 66.5 per cent, while the two other dividend growth groups lagged, with non-financials gaining 41.2 per cent and high yield 31.3 per cent.

"The key to the long run success of dividend growers is that their participation in up markets is higher than many think, and more importantly, it is higher than their participation in down markets," they wrote.

Looking at both bear and bull markets, respectively, the financials shared in 64 per cent of the downside but 111 per cent of the upside; non-financials had 25 per cent of the downside but 69 per cent of the upside; and high yield participated in 22 per cent of the downside but 52 per cent of the upside.

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"This asymmetry provides the upward bias over time … and is what should make dividend growers attractive for both bullish investors as well as bears," the authors conclude.

Indeed, all three of UBS's dividend growth groups posted higher annualized total returns than the S&P/TSX 60 index over the past 17 years. The financials gained 11.7 per cent annually, non-financials 11.4 per cent and high yielders 7.6 per cent, compared with 6.8 per cent for the S&P/TSX 60.


Speaking of downside protection, let's see how our Strategy Lab model dividend portfolio held up during the recent market turbulence.

We created the portfolio on Sept. 13 by "investing" a total of $50,000 in 12 dividend stocks. Good news: Through Nov. 12, the portfolio was up $32.84, or 0.07 per cent. Whoo-hoo! (Note: the portfolio online is updated only to Oct. 31, which is why the returns are different.)

Two months isn't nearly long enough to judge the success of any strategy, of course, but we're pleased with the results so far. Over the same period, the S&P/TSX composite index was down 0.96 per cent.

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What's more, seven of our stocks have paid dividends since the portfolio was started, and two – namely McDonald's and Telus – have raised their dividends, by 10 per cent and 4.9 per cent, respectively. We're expecting more dividend increases in the months ahead, so stay tuned.

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