Quant Concepts: Dividends for Inflationary Environments

This strategy from Phil Dabo has provided excellent income to help pay for expenses in times of higher inflation.

Phil Dabo 3 June, 2022 | 8:22AM
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Phil Dabo: Welcome to Quant Concepts' working from home edition. With all the volatility in financial markets these days, it may come as a surprise that dividend paying stocks have actually been performing really well year-to-date with the S&P/TSX Dividend Total Return Index up 4%, while the S&P/TSX is down 1%. An additional benefit of investing in dividend paying stocks is receiving income that can be used to pay for expenses, which can be really helpful during times of slow economic growth and higher inflation. Today, let's take a look at a strategy that focuses on dividend paying stocks.

Now let's take a look at the strategy. We are going to start with all 700 stocks in our Canadian database, and we are going to rank them according to three key factors.

The first two factors are based on price momentum relative to the stock's recent history. The 50 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 12-month high, because our research has shown that certain stocks that are trading close to their previous 12-month high have tended to continue performing well and also provide good downside protection.

Now, let's take a look at our buy rules. We are only going to buy stocks that are ranked in the top 50th percentile of our list, and we are only going to buy stocks that have a yield above 4%, which is 1.5% 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 because we don't want them financing the dividend with that. It's important for a company to finance the 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 these stocks do not have any liquidity issues. The bid-ask spread represents a difference between what investors are willing to buy or sell for a stock. If the bid-ask spread is too wide because there is 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 the sell rules, which are very simple. We are only going to sell stocks if they fall out of the top 75th percentile of our list, and if the dividend yield drops below 1%. We are 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 Total Return Index, and we tested this strategy from January 2011 to April 2022. Over this time period, the strategy generated a very strong 11.6% return, which is 4.6% higher than the benchmark and only a 28% annualized turnover, showing that this is a very good buy and hold strategy. When looking at the annualized performance, we can see market-like performance over every significant time period. However, it's important to note that this strategy has outperformed the benchmark by 5% year-to-date, and it also comes with a 5.4% yield, whereas the S&P/TSX has a 2.5% yield.

It's also important to see here that this strategy has generated very good risk-adjusted returns as you can see by the Sharpe Ratio, and it's done that with market-like risk as you can see by beta.

When looking at this chart, we can see very good outperformance over time, and by looking at the up and downside capture ratios, we can see that this strategy has performed well during down markets, and it still participated nicely in up markets showing that this is a strategy that has performed well throughout different market cycles.

This is a great strategy to consider if you're interested in stocks with a higher dividend yield and that have positive momentum relative to their price history. 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 above 5.4%, 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.

Find the buy list here.

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Phil Dabo  Phil Dabo is Director, CPMS Sales

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