What are we looking for?
Whether a stop-loss order improves performance and efficiency for a dividend growth portfolio.
In a previous article, we looked at whether stop-loss orders for beat-up Canadian dividend growth stocks provided any benefit. Based on the results of the analysis, it didn’t appear as though adding in a stop-loss provided any substantial advantage. Today, I’m going to repeat this exercise within the U.S. market.
Recall a stop-loss refers to selling stocks that fall below a certain prespecified drop in price – that is, putting a cap on the amount you can lose from a particular holding. The stop-loss used in this test limits the price a stock can drop to no more than 10 per cent within the past 30 days.
This strategy ranks stocks based on:
- Five-year dividend growth – annualized dividend growth across the past five years, high values are preferred;
- Expected dividend growth – percentage change in the next four quarters of expected dividends to the trailing four quarters of paid dividends, high values are preferred;
- Quarterly earnings surprise – proprietary measure of the difference between actual and expected quarterly earnings, high values are preferred.
In order to qualify, stocks must have a five-year dividend growth in the top third of peers (today this value is greater than or equal to 9.4 per cent); a positive expected dividend growth (not shown); a five-year standard deviation of returns in the bottom 50 per cent of peers (today this value is less than or equal to 43.4) in order to help manage swings in returns; a dividend payout ratio less than or equal to 75 per cent to ensure companies have excess earnings for growth purposes; and lastly, a five-year sales growth greater than or equal to zero (not shown).
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers. CPMS data cover more than 95 per cent of the investable North American stock market. With more than 120 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
I used Morningstar CPMS to back-test this strategy from January, 2005, to November, 2018. During this process, a maximum of 15 stocks were purchased. No more than five stocks per economic sector could be held at any time. Stocks were sold if their five-year dividend growth fell into the bottom third of peers, if their dividend payout ratio went above 80 per cent, or if their price dropped more than 10 per cent over the previous 30 days. When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio.
Over this period, the strategy produced an annualized total return of 11.3 per cent while the S&P 500 Total Return Index returned 8.6 per cent across the same period. The same strategy – with no stop-loss – returned 11.7 per cent with a turnover (annualized metric representing how often stocks are bought/sold each year) of 63 per cent, whereas the strategy with the stop-loss added had almost double the turnover, at 125 per cent.
The results here seem to have a similar conclusion as we found in the Canadian example: Adding a stop-loss for this dividend strategy required investors to trade almost twice as much and actually detracted slightly from performance. Stocks that qualify for purchase into the strategy today (using the stop-loss) are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.