High Dividend Stocks and Value Investing
Barron’s recently ran an article (written by Research Affiliates), which is titled “Get Smart About Picking Dividend-Rich Stocks.” The article highlights that high-quality high-dividend-paying stocks outperform low-quality high-dividend-paying stocks. The quality of the firm is measured by profitability, financial distress, and accounting red flags.
We investigate a Simpler Way to Identify Top-Performing Dividend Stocks
We sort the high dividend-paying firms by a simple value investing measure–EBIT/TEV. We choose this value investing measure based on our own research discussed here.
First, let’s set up the experiment.
We examine all firms above the NYSE 40th percentile for market-cap (currently around $1.8 billion) to avoid weird empirical effects associated with micro/small cap stocks. We form the portfolios at a annual frequency with the following 2 variables:
- Dividend Yield = Cash dividends / market capitalization. Assessed on 6/30 each year.
- Value = EBIT/(Total Enterprise Value). Assessed on 6/30 each year.
Here we describe the four portfolios we examine. All portfolios are annually rebalanced on 6/30 each year.
- Top Div. Quintile, High Value EW = Top quintile of firms on dividend yield, then choosing the top half on Value. Portfolio is equal-weighted.
- Top Div. Quintile, Low Value EW = Top quintile of firms on dividend yield, then choosing the bottom half on Value. Portfolio is equal-weighted.
- Top Div. Quintile EW = Top quintile of firms on dividend yield. Portfolio is equal-weighted.
- Universe EW = Total return on the universe of securities. Portfolio is equal-weighted.
Results are gross of management fees and transaction costs. All returns are total returns and include the reinvestment of distributions (e.g., dividends).
Here are the returns (1/1/1964-12/31/2014):
Value Investing Portfolio Results:
- The top quintile of dividend paying firms outperformed the universe over the past 50 years when comparing CAGR, Sharpe and Sortino ratios (comparing column 3 to column 4)
- Splitting high dividend-paying firms by value worked historically. Column 1 (top dividend payers, high value) outperformed column 2 (top dividend payers, low value) across all performance measures — CAGR, Sharpe and Sortino ratios.
The results suggest that a sort on a simple value investing measure works well at sorting dividend stocks. Compared to the more complex quality screen proposed by Barron’s, this sorting variable is a good alternative for investors who prefer high dividend stocks.***
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