What are we looking for?
S&P 500 stocks with sustainable dividend yields.
Dividend yield can sometimes be a finicky metric. Companies have the ability to prop up their dividends by dipping into their earnings excessively, which is not sustainable over time. To find companies paying a reasonable and sustainable yield, I use Morningstar CPMS to first rank the companies in the S&P 500 total return index on the following metrics:
- Five-year deviation of earnings (a statistical measure showing how volatile a company’s earnings have been, lower figures preferred);
- Yield on expected dividends (based on dividends announced by the company but not yet paid);
- Annual cash-flow momentum (calculated as the past four quarters of operating cash flows compared with the same figure four quarters ago, higher figures preferred);
- Five-year historical beta (recall that beta measures the sensitivity of a stock historically to an index. In trending markets, stocks with beta of less than one move less than the market – lower beta is preferred here).
To qualify, companies must pay out less than 80 per cent of their trailing earnings or less than 60 per cent of their trailing cash flow in the form of dividends. This ensures that the dividends being paid are conservative and reasonably sustainable over time. Additionally, the yield of the stock must be higher than the median in the S&P 500 index. Today the median yield is 2.3 per cent.
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.
What we found
I used Morningstar CPMS to back test this strategy from January, 2006, to December, 2018. During this process, a maximum of 15 stocks were purchased and equally weighted with no more than three in a given economic sector. Once a month, stocks were sold if their rank fell below the top 25 per cent of the S&P 500 based on the above metrics, if the median earnings-a-share estimate dropped by more than 10 per cent over three months, or if the company missed earnings expectations by more than 5 per cent. 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 9.5 per cent while the S&P 500 total return index gained 7.6 per cent. The overall portfolio beta over this time period was 0.6, implying that the strategy was not highly correlated to the movement of the index.
The stocks that meet my requirements are listed in the accompanying table. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is a relationship manager for CPMS at Morningstar Research Inc.