What are we looking for?
Less risky income stocks in the CPMS Canadian universe.
Dividends continue to be top of mind for many different investors. But when hunting for yield, it’s also worthwhile to consider the risk in your portfolio. Coupling income and low-risk characteristics is a good way to achieve your primary objective while adding a measure of safety.
Today, my strategy is to search for income stocks, making a point to minimize the amount of risk the portfolio takes on. The strategy will consider stocks in the CPMS Canadian universe, which as of today holds 695 names.
This strategy ranks stocks based on five-year beta, expected dividend yield and five-year dividend growth rate.
In order to qualify, stocks must have:
- A five-year beta less than one (to reduce market sensitivity);
- A five-year standard deviation of monthly return on equity (a measure of risk) less than at least one-third of peers (today this value is 9.7 per cent);
- A five-year dividend growth rate, an annualized figure, greater than zero.
- A dividend payout ratio (calculated as expected annual dividends divided by expected earnings per share) less than 80 per cent to ensure not all earnings are paid out as dividends and some remain to fund further investments and future growth in the business;
- A dividend yield in the top half of peers (currently this value is 3.6 per cent or higher).
(Five-year beta measures a company’s sensitivity relative to historical changes in the benchmark – here we use the S&P/TSX Composite Index. In trending markets, a stock with beta less than one has historically moved less than the index.)
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 December, 1990, to March, 2019. During this process a maximum of 15 stocks were purchased. Stocks were sold if their five-year beta rose to 1.2 or higher or if their five-year dividend growth rate was negative. 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 13.9 per cent while the S&P/TSX Composite Total Return Index returned 8.5 per cent across the same period. Downside deviation (measured as the variability of negative returns) was 5.5 per cent compared with the S&P/TSX Composite Total Return Index, which had a downside deviation of 9.5 per cent.
Stocks that qualify for purchase into the strategy today 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.