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Phil Dabo: Welcome to Quant Concepts working from home edition. It can be challenging to find yield when interest rates declined the way that they have over the past year. Most guaranteed investment certificates provide a yield that is lower than 3%. And they also restrict you from withdrawing your money. Although they offer significantly lower risk, they also don't allow you to participate in the momentum of the stock market, which has recently hit new highs. Today, let's take a look at a strategy that focuses on companies that provide a higher yield and also capitalize on the momentum of the stock market.
Now let's take a look at the strategy. We're going to start with all 700 stocks in our Canadian database, and we're going to rank them according to three key factors. The first two factors are based on the price momentum of a stock relative to its recent history. The 50-day and 200-day moving averages are popular technical indicators that attempt to capture stocks that are trending in a positive direction relative to the average price over the past 50- and 200-days. We've also used the price change to a 12-month high because our research has shown that certain stocks that are trading close to their 12-month high tend to continue performing well and provide good downside protection.
Now let's take a look at our buy rules, we're only going to buy stocks that are ranked in the top 50th percentile of our list. And we're only going to buy stocks if their yield is above 3.8%, which is 1.2% higher than the current yield on the S&P/TSX. We also don't want companies that are paying out more than 100% of their current-year earnings per share estimate because we don't want them financing the dividend with debt. It's important for a company to finance a dividend internally. And if the payout ratio is too high, then it's an indication that the dividend is not sustainable. Our last buy rule is the average monthly volume over the past year, because we want to make sure that the stock does not have any liquidity issues. The bid ask spread represents the difference between what investors are willing to buy or sell for a stock. If the bid ask spread is too wide because there's not enough volume, then it poses a liquidity risk and investors might find it difficult to exit their investment.
Now let's take a look at our sell rules which are very simple. We're only going to sell stocks if they fall out of the top 75th percentile of our list. And if the yield drops below 1%. We're also going to sell stocks if they start paying out more than 120% of their earnings in dividends. Now let's take a look at performance. The benchmark that we used is the S&P/TSX High Dividend Total Return Index, and we tested the strategy from January 2011 to July 2021. Over this time period, the strategy generated a very strong 11.7% return which is 4.6% higher than the benchmark and only a 27% annualized turnover, showing that this is a very good buy and hold strategy.
When looking at the annualized performance, we can see that this strategy has outperformed the benchmark over every significant time period, and it's done so with a yield that typically averages above 6%. When looking at the standard deviation, we can see that this strategy has slightly higher price risk, but it also has significantly better risk adjusted returns as you can see by the Sharpe ratio. We can also see by looking at beta that the strategy has market like risk. However, when looking at the performance chart, we can see very good outperformance over time.
It's also important to look at the up and downside capture ratios. Here we can see that this is a strategy that has very good downside capture, which shows that this is a strategy that has very good overall market capture, but it performs well in down markets. This is a great strategy to consider if you're interested in having companies that have a higher income. And if you want to capitalize on the momentum of the stock market. This is ideal for investors that are comfortable with the inherent risks of investing in the stock market and also want income while their money is invested. The current buy list has a yield of 5% which is almost twice the amount on the S&P/TSX. You can find the buy list along with the transcript of this video.
From Morningstar, I'm Phil Dabo.
To see the buy list, click here.
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