What are we looking for?
S&P 500 dividend payers that have low levels of controversy.
For a publicly traded company, being a member of a major benchmark index has its pros and cons. On the upside, companies that are part of a major index are able to secure new capital quickly, since new shares are bought up by asset managers and exchange-traded fund providers who follow that index. On the downside, because these companies are widely monitored, any whiff of bad news can quickly affect the stock’s price action.
With the continued keen interest in sustainable investing, it is now more important than ever for investors to keep abreast of controversial news. To this end, today I use Morningstar CPMS to highlight how controversies can affect an investment strategy. To start with, I created a dividend strategy by ranking the stocks in the S&P 500 on the following factors:
- Expected dividend yield;
- Five-year dividend growth rate (on average, how much dividends have grown each year in the past five);
- Five-year average return on equity and return on invested capital (both are profitability metrics, higher figures are better).
To ensure companies have a reasonably sustainable dividend, I also placed a screen on the dividend payout ratio against earnings, such that only companies paying out less than 80 per cent of earnings were considered.
I then placed a screen on the Sustainalytics’ controversy assessment. This proprietary measure looks across 60,000 news sources in search of activity with undesired negative environmental or social effects on stakeholders. Events are categorized around topics such as business ethics, society and community, operations, employees, environmental supply chain, products and services, customers, governance and public policy. The severity of events is also assessed, with those that have a high frequency of reoccurrence and pose a serious business risk to the company rated five (out of five), while events that have low impact are rated one. In today’s screen, we seek companies with a controversy score of two or lower (taking into consideration all detected controversies from a company).
More about Morningstar
Morningstar Research Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. Morningstar offers an extensive line of products and services for individual investors, financial advisers, asset managers, retirement plan providers and sponsors, and institutional investors. Morningstar Direct is the firm’s multi-asset analysis platform built for asset management and financial services professionals. Morningstar Canada on Twitter: @MorningstarCDN.
What we found
I used Morningstar CPMS to back-test this strategy from August, 2009, to May, 2021, using a maximum of 20 stocks with no more than five for each economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the index based on the aforementioned metrics, or if the controversy assessment exceeded two. When sold, the stock was replaced with the highest ranking stock not already held in the portfolio. On this basis, the strategy produced an annualized total return of 17.5 per cent, while the S&P 500 Total Return Index generated 15.1 per cent. For reference, the same strategy without the use of the controversy assessment produced 14.1 per cent, annualized.
The stocks that meet the requirements to be purchased today are listed in the accompanying table. This article does not constitute financial advice. It is always recommended to speak with a financial adviser or professional before investing.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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