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Quant Concepts: High-Yield U.S. Equities

With dividend leaders outperforming in the downturn, Phil Dabo builds an income stock strategy that has beaten broad markets.

Phil Dabo 8 July, 2022 | 4:38AM
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Phil Dabo: Welcome to Quant Concepts' working from home edition. It's been a very difficult year for investors with the S&P 500 remaining in bear market territory after going down by more than 20% since the beginning of the year. It's not uncommon for correlations across asset classes to increase by a lot as everything goes down at the same time during a broad market sell-off. The S&P 500 is about to post its worst performance for the first half of the year since the 1970s, and the benchmark for the U.S. investment grade bonds is also down around 11% year-to-date.

The Morningstar Dividend Leaders Index is actually up 2.8% year-to-date, which shows that performance has been much better for higher yielding equities. Today, let's take a look at a strategy that focuses on U.S. equities that have a higher yield.

Now, let's take a look at the strategy. We are going to start with all of the stocks on the S&P 500, and we are going to rank them according to five key factors. The first factor is the market cap for more emphasis on larger companies. The second factor is a three-month earning revision to find companies that analysts have a positive outlook for. The third factor is the industry relative yield to identify companies that distribute more income than their peers. The last two factors are the return on equity to find companies with good operational performance and the return on total assets to find companies that are efficiently generating income with the assets that they have.

Now, let's take a look at our buy rules. We are only going to buy stocks that are ranked in the top 10th percentile of our list, with a market cap above 500 million, and the stock has to have a yield greater than the average stock, which is 2.21%. To support the yield, the company has to have a quarterly earnings momentum above 0%, and they can't pay out more than 100% of their earnings

Now, let's take a look at our sell rules, which are very simple. We are going to sell stocks if they deteriorate and fall out of the top 30th percentile of our list and if the yield drops below 1.33%. We are also going to sell stocks if it appears that the yield is going to be less sustainable as indicated by a quarterly earnings momentum that drops below negative 5% and if the payout becomes more than 100% of earnings.

Now, let's take a look at performance. The benchmark that we used is the S&P 500 Total Return Index, and we tested this strategy from January 2006 to May 2022. Over this time period, the strategy generated a very strong 13.6% return, which is 3.9% higher than the benchmark and only a 14% annualized turnover, showing that this is a very good buy and hold strategy. When looking at the annualized returns, you can see very good performance over the one year, but also very good performance over longer periods of time as you can see that the strategy has outperformed the benchmark over every significant time period. It's done that with lower price risk as you can see by the standard deviation, which has contributed to higher risk-adjusted returns as you can see by the Sharpe Ratio. It's no surprise here that this strategy has lower market risk as you can see by beta.

When looking at the performance chart, you can see very good outperformance over time. And when looking at the up and downside capture ratios, you can see that this is a strategy that has performed very well throughout different down markets which has contributed very well to the overall market capture ratio, showing that this is a strategy that has performed very well over time.

This is a great strategy to consider if you are interested in stocks with a higher dividend yield and that have had really good performance compared to the S&P 500. A lot of the companies on the buy list have a very large market cap and tend to be less volatile compared to others in their industry. 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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