Why moderation is important in dividend investments



Canadian dividend stocks have yielded substantial returns to investors over the past 16 years. To reap the benefits, it is best to focus on stocks with generous returns without avoiding the extremes.

Even simple dividend portfolios proved to be very profitable in recent years. For example, if you had purchased an equal amount of the dividend shares in the S & P / TSX Composite Index and rebalanced your portfolio by the end of each year, you would average 10.2 percent in the course of the 16 years. have earned until the end of 2017.

By comparison, the market climbed 7.5 percent per year in the same period and lagged an average of 2.7 percentage points per year. (All yield figures herein include reinvestment of dividends, but they do not include fund fees, taxes or other trade frictions.)

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An important advantage of dividend investments in Canada is that it encourages investors to move away from riskier parts of the market. For example, speculative mining and energy companies rarely pay dividends. Likewise, distressed companies usually can not pay to pay dividends.

The risks are clear when we look at the non-dividend-paying shares of the index, which performed below par. On average, they reached only 2.5 percent per year during the 16 years until the end of 2017 and the index followed an average of five percentage points per year.

Note, dividends are not a perfect prophylactic against a disaster. Seasoned dividend investors know they are wary of stocks with extremely high returns.

To get a fine-grained appearance, I used the local Bloomberg machine to sort the shares in the S & P / TSX composite on 10 portfolios (or deciles) at the end of each year with (as close as possible to) an equal number of shares. The portfolios were monitored over time and the results were shown in the attached chart. It highlights the annual performance benefit that each group offers to the market during the 16 years until the end of 2017.

For example, the second-highest profitable portfolio grew by 12% on an annual basis and the market outpaced an average of 4.7 percentage points per year. In the course of the 16 years, an investment would have converted $ 100,000 into about $ 629,000, while an investment in the index would have increased by the same amount to just about $ 319,000.

But it was not all roses for dividend investors. The portfolio with the most profitable shares did not go well with an average annual return of only 4.1 percent. It was bad on the market.

The bad results show that it pays to be cautious when it comes to stocks with extremely high returns. In such cases, something bad happened to the company that collapsed the share price. A gigantic yield usually indicates that the market has doubts about the sustainability of the dividend and perhaps of the company itself. As a result, prudent investors should generally remain free of stocks with extremely high returns.

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Even more sophisticated, when I divided the extremely high yield portfolio (decile) in two by revenue to look at the returns of both halves (not shown), it became clear that stocks with the highest yields are particularly problematic. Half of the extreme yield group with the highest yields averaged only 0.5 percent per year over the past 16 years, while half achieved 8.4 percent per year with slightly less extreme yields and even beat the market. That makes it especially important to be careful with the 5 percent shares with the highest yields. In the current market this means shares with yields north of about 7 percent.

When it comes to equities with a more moderate return, the general – albeit uneven – trend is to see higher total returns for those with higher returns. Opting for stocks with above-average but not extreme returns would have yielded an average annual yield of 11.2 percent, or 3.7 percentage points more than the market. This is based on averaging the results of the second to fifth highest yield group, which currently includes equities with returns of around 3 percent to 6.4 percent.

Although it is reckless to ensure that the past is a perfect guide for the future, it is hard to imagine that it goes too far wrong with a cheaper, broadly diversified portfolio of dividend payers. With a bit of luck, dividend stocks will continue to make a profit for investors.

Use dividend yield to beat the market

From 2001 to 2017

Avg. annual outperformance compared to S & P / TSX Composite (pp)

Yield from high to low (deciles)

THE INSIDE AND MAIL, SOURCE: bloomberg

Use dividend yield to beat the market

From 2001 to 2017

Avg. annual outperformance compared to S & P / TSX Composite (pp)

Yield from high to low (deciles)

THE INSIDE AND MAIL, SOURCE: bloomberg

Use dividend yield to beat the market

From 2001 to 2017

Average annual outperformance compared to S & P / TSX Composite (pp)

Yield from high to low (deciles)

THE INSIDE AND MAIL, SOURCE: bloomberg

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.


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