What are we looking for?
Stocks offering spectacular yields amid the current bear market.
If there is any good news about a bear market, it is that depressed stock prices, which elevate yields, offer income-hungry investors a very attractive point of entry.
Valuations have not seen these levels in a number of years. For context, today’s median price-to-book ratio on Canada’s largest 115 companies (top one-sixth by size) sits at 1.6 times, very close to the multiple during the financial crisis when it dropped to 1.5. The 30-year median of this figure is close to 2.0.
This said, it seems an opportune time for those with capital to deploy to consider picking up a few quality names. Additionally, with the recent surprise interest-rate cuts from the central banks, dividend-paying stocks will appear much more attractive than bonds for those who require an income stream from investments.
Although, historically, savvy investors will have likely steered clear of superhigh-yielding companies with the rightful concern of their ability to sustain dividends, today I purposely look for such ultrahigh yields, but restrict my search to those companies with reasonable payout ratios and a history of stability to take advantage of the depressed valuations that we are seeing.
To find these companies, I ranked the stocks in the S&P/TSX Composite Index on the following metrics:
- Dividend yield;
- Average and standard deviation of return on equity over the trailing five years. (Recall that ROE is a profitability metric, often used to measure a company’s quality. Here we look for higher figures for the average, and lower figures for the standard deviation, implying that profitability is stable);
- Deviation of earnings over the past five years (here we measure how consistent earnings are over this period, lower figures preferred).
To qualify, companies must have a payout ratio on expected earnings and trailing cash flow of less than 80 per cent and 60 per cent, respectively. Additionally, I’ve put a screen on the five-year growth rate of dividends, ensuring that it is positive.
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 December, 1995, to March, 2020 using a maximum of 15 stocks with no more than three per economic sector. Once a month, stocks were sold if they dropped below the top 35 per cent of the index based on the factors listed above, or if the payout ratio on earnings or cash flows exceeded 90 per cent or 70 per cent, respectively. The strategy produced an annualized total return of 10.4 per cent while the S&P/TSX Composite Index advanced 6.9 per cent on the same basis. The stocks that meet the requirements to be purchased into the model today are listed in the accompanying table. The average yield on this list of stock is 6.3 per cent, while the index has an average yield of 3.7 per cent.
This column does not constitute financial advice. It is always recommended to speak to a financial adviser or investment professional before investing.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
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