Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Dividend investors seek succulent returns from stocks offering high yields and strong dividend growth. But it’s possible to get too much of a good thing when looking for both qualities simultaneously.
The two factors are examined in O’Shaughnessy Asset Management's Dividend Yield vs. Dividend Growth. In one study, they pick global stocks (from the Worldscope database, which represents more than 25,000 active companies in developed and emerging markets) using dividend yield and three-year dividend growth.
The top 10 per cent of stocks (or decile) by dividend yield gained an average of 14.8 per cent annually from 1990 to 2011. The top decile by dividend growth didn’t fare as well, with average annual gains of 10 per cent over the same period. Both handily beat the global market, which climbed by 6.9 per cent annually.
So far, so good. But the situation in the United States wasn’t as rosy. There, the top decile by dividend yield gained an average of 11.6 per cent from 1930 to 2011 and beat the market, which climbed at a 10.2-per-cent annual rate. The top decile by dividend growth lagged, with annual returns of only 8.1 per cent over the same period.
If you’re like me, you’ll wonder how the combination of the two approaches fared. The research considered the question by narrowing in on the third of U.S. stocks with the highest yields and then splitting the high-yield group into three portfolios by dividend growth.
The stocks with the highest yields and the highest dividend growth gained 10.7 per cent annually from 1930 to 2011. That’s not too bad, but slower-growth high-yield stocks fared better. The high-yield stocks with the middle third of dividend-growth rates gained 13.9 per cent annually over the same period, while the third with the slowest dividend growth gained 12.3 per cent annually.
Intrigued, I decided to see if a similar pattern holds in Canada by applying the Bloomberg backtester to the stocks in the S&P/TSX Canadian Dividend Aristocrats Index. The dividend index currently contains 78 stocks that have increased their dividends for at least five consecutive years.
But the effort was hampered because only six years worth of data are currently available. Nonetheless, the results are suggestive and mesh with the long-term U.S. results reported by O’Shaughnessy Asset Management.
I started by forming a concentrated portfolio with an equal amount of the 10 highest-yielding stocks in the S&P/TSX Canadian Dividend Aristocrats Index rebalanced at the end of each year. It gained 6.5 per cent annually over the six years to the end of 2017, and trailed both the S&P/TSX Composite Index and the S&P/TSX Canadian Dividend Aristocrats Index, which posted average annual gains of 8.4 per cent and 8.6 per cent, respectively. (All returns herein include dividend reinvestment and do not include fund fees, taxes or other trading frictions.)
To break the dividend index down more completely, I sorted its stocks into five portfolios (called quintiles) by indicated dividend yield at the end of each year and tracked their progress. The results are shown in the accompanying graph.
You will note the highest-yielding portfolio gained 7.4 per cent annually. It trailed the dividend index itself and the market over all. But the other four portfolios were winners. On average, they provided an annual return of 13.4 per cent, which is 4.8 percentage points more than the dividend index and 5 percentage points more than the market.
(You can examine the current list of S&P/TSX Canadian Dividend Aristocrats, sorted by yield, by visiting the online version of this article.)
While it’s unwise to draw firm conclusions from such a short time period, the recent results suggest investors should avoid the highest-yielding stocks when picking dividend growers. On the other hand, O’Shaughnessy Asset Management’s long-term study suggests that its best to avoid the fastest dividend growers when picking high-yield stocks.