What are we looking for?
Boring Canadian dividend-payers.
As the saying goes, if you can’t stand the heat, get out of the kitchen. In the world of investing, staying out of the kitchen may not be such a bad idea given the recent fluctuations in commodity prices, which tend to drive Canadian stock returns. With this in mind, conservative investors who seek a steadier return stream without the heart-pounding price action might glean some ideas from today’s strategy, which ranks the Morningstar CPMS Canadian database (consisting of 704 companies) on the following factors:
- Five-year standard deviation of earnings and return on equity (a statistical measure of volatility, in this case of bottom line earnings and profitability over the past five years, lower figures preferred);
- Five-year standard deviation of total return (similar to the above, but measuring the volatility of the stock’s return inclusive of dividends, lower figures preferred);
- Five-year price beta (recall that beta measures the historical sensitivity of a stock relative to an index. A stock with a beta of one has historically moved in tandem with an index in trending markets. Here we prefer stocks with lower betas);
To qualify, stocks must pay a dividend greater than 2.8 per cent, a figure representing the median dividend in the universe today. To ensure dividends paid are reasonably sustainable, only companies with a payout ratio against earnings of less than 80 per cent, or a payout ratio against cash flow of less than 60 per cent, were considered.
Finally, only stocks with a market capitalization of greater than $170-million were included, which excludes the bottom one-third of stocks in the database by size.
What we found
I used Morningstar CPMS to back-test the strategy from January, 2004, to March, 2022, assuming an equally weighted 15-stock portfolio with no more than four stocks per economic sector. Once a month, stocks were sold if they fell below the top 35 per cent of the universe based on the above metrics, or if dividend payout ratios exceeded both aforementioned limits. When sold, stocks were replaced with next qualifying stock not already held in the portfolio, considering the sector limits.
On this basis, the strategy produced an annualized total return of 10.6 per cent, while the S&P/TSX Composite Total Return Index advanced 8.3 per cent. Though the results may seem somewhat unimpressive on the surface, back-test results show that the strategy outperformed the index in 19 of the 22 quarters where the index fell (or 86 per cent of the time), further showcasing the defensive nature of the strategy.
The stocks that meet requirements to be purchased into the strategy today are listed in the table.
This article does not constitute financial advice. Investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Ian Tam, CFA, is director of investment research for Morningstar Canada.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.