Emily Halverson-Duncan: Welcome to Quant Concepts' virtual office edition. With kids heading back to school soon, or at least planning to, now may be a good time to sit down and teach your kids about the importance of saving and what it means to invest. Of course, investing can seem like a daunting subject to broach for the first time to a young investor. One way you can help make it more interesting and applicable is to focus on companies they'd be more likely to have heard of, in other words, larger names that have been around for a while.
Today, we'll be looking at a strategy that selects dividend paying stocks from the S&P/TSX Composite suitable for a newer investor. This video will be the first of a two-part series that explores different types of investing styles that may be of interest to the younger generation. So, let's take a look at the dividend model to start.
Jumping in here, first off, as you can see, our universe is the S&P/TSX Composite and as always, we're going to go through and rank the stocks within that universe. The factors that we're going to look out for ranking – dividend yield, so stocks that have a higher dividend yield will be listed higher than stocks with a lower dividend yield. Five-year dividend growth, so looking at a longer track record and again, wanting to see companies that have been growing their dividends over the long term. And then, five-year price beta versus the S&P/TSX. This is a measure of sensitivity. We want to see that on the lower side, which would indicate that a model or the model is less sensitive than the TSX.
On the screen side, once we've gone ahead and organized that universe, we're going to apply at the different screens you can see here. So, some of the ones that we've got listed – dividend yield, we want that to be in the top roughly half of peers, which today has a value of 3.17% or higher. Five-year dividend growth, we want that to be positive, so just indicating that they've been actually growing their dividends over the last five years on an annualized basis. Earnings per share payout ratio, we want that to be less than or equal to 80%. And the reason why we're capping that is, we don't want the company to be paying out too much of their earnings as dividends, but instead still retaining some leftover to go towards other projects, paying down debt, or any other use case they can have for that excess earnings. The beta metrics that we spoke about, we want that to be less than or equal to 1. Again, on a value of 1, a stock is as sensitive as the market. So, putting a cap there means we're keeping that sensitivity to market level or below. Lastly, five-year standard deviation of return on equity, we want that to be less than or equal to 4.16%. And what that's looking at is the volatility of the last five years' return on equity metrics and we're willing that to be on a lower side.
On the sell side, some of the factors we've got set here. Five-year dividend growth, if it drops below 0, then we're going to go ahead and sell the stock from the model. If that payout ratio goes above 100%, then there was thinking that they're paying too much of their earnings out as dividends and again, we're going to sell the stock from the model. And then, lastly, if that five-year beta metric goes above 1.2, that's going to be too sensitive for us, so we're going to get it out of the model.
Now, that's done. We can go ahead and take a look at the back test to see how the model did over the long term.
So, our back test here, we're running compared to the S&P/TSX Composite and the test period is from December 1990 until July 2020. Across that timeframe, the model returned 11.6%, which is an outperformance of 3.4% over the benchmark. Turnover was about 14%, which this particular back test was holding 10 different stocks or up to 10 stocks. So, a turnover at 14% indicates probably about one to two trades per year, which again is great for a newer investor that probably isn't going to want to be trading too often and really shows them the value of buying and holding.
Some other metrics I always like to look at – downside deviation, which is the volatility of negative returns, for the strategy is 6% and for the benchmark is 9.9%, so quite a bit more downside protection across the downside deviation. And then, lastly, my favorite green and blue chart here. In up markets, the model outperformed 40% of the time, but in down markets, it outperformed 74% of the time. So, again, for a newer investor or for a younger investor, something like this could be of more use to them or more interest because they might see some stocks that they know, that they recognize, but they're also not taking on too much excessive risk while getting exposure still to the market.
For Morningstar, I'm Emily Halverson-Duncan.
