Quant Concepts: A magical blend of momentum and income

Dividend investors want high yield and low volatility, but as CPMS's Emily Halverson-Duncan shows, mixing in a little momentum can yield significant long-term outperformance while maintaining downside protection

Emily Halverson-Duncan 9 August, 2019 | 1:32AM
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Emily Halverson-Duncan: Welcome to Quant Concepts. When considering a dividend-focused strategy, two things typically come to mind, high yield and low volatility. This is because companies that pay consistent dividends tend to be larger corporations with a steady return stream, making it easier for them to withstand fluctuations in the market. On the flip side, momentum strategies are often associated with both big wins and big losses. While these strategies tend to do very well over time, the accompanying volatility is often enough to deter the average investor from pursuing these types of stocks.

So, what happens when we put these two styles together? Today's strategy is going to be a blend of both income and momentum factors searching for stocks in the CPMS Canadian universe. So, let's take a look at how to build that.

First off, as always, we're going to rank or universe of stocks in order of preference. Here we're doing a very simple rank, which is a combination of both an income factor and a momentum factor. The first factor, income-focused, is the dividend yield. The second is the price change from a stock's 12-month high. So, what you're looking for is the stock's price to be as close as possible as it can be to its highest price across the last 12 months.

From there, we're going to move into our second step, which is where we're going to screen out stocks we don't want to own. First off, we're going to screen out stocks with a quarterly earnings momentum less than zero, so negative quarterly earnings momentum. What that's looking at is a stock's earnings quarter-over-quarter and we're hoping for them to grow. We're also going to look at a stock's quarterly earnings surprise, so whether or not they beat what was expected for their earnings. And again, we want that to be positive. We're looking for a dividend yield in the top half of peers and today that has a value of 3.77%. And lastly, we're looking for a one-year price change to be greater than negative 5%.

On the sell side, we're going to sell stocks if either their quarterly earnings momentum or their quarterly earnings surprise falls below minus 4%. So, let's take a look and see how this model did.

Okay. So, this strategy actually did quite well. 16.6% annualized, that's across the entire timeframe, which resulted in the outperformance of 8.6% over the TSX. Turnover was high at 102%. So, what that means is, of those 25 stocks you're going to be trading roughly all of them in any given year. Again, that number can go up or down depending on the particular calendar year. But this is the annualized number across that timeframe.

Now for a few metrics that I want to look at because we did talk about volatility at the beginning. Downside deviation, that looks at the volatility of negative returns. For the model, it was 6.6%. And for the TSX's comparison, it was 9.9. So, that was significantly less. So, we can see a lot less volatility in this model. Another chart that I like to look at is this green and blue chart here. What this shows us is how the model did in both up and down markets relative to the benchmark. So, in up markets, it outperformed 54% of the time relative to the benchmark and in down markets it outperformed 84% of the time. So, very strong performance in the down markets.

So, this goes to show that even though there are momentum factors, coupling them with those dividend-focused factors really help build a very strong performing strategy but very strong on the downside as well.

For Morningstar, I'm Emily Halverson-Duncan.


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Emily Halverson-Duncan  Emily is Director, CPMS Sales at Morningstar

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