Seeking attractive dividend growers of the future, not the past
Author: Stephen Duench
October 30, 2018
It’s no surprise that the appetite for dividend growth stocks is intensifying now that bond yields are on the rise. After all, there’s plenty of research out there — including our own — that shows dividend growers tend to hold up better in rising rate environments than companies with more static payouts.
But making the decision to add more dividend growth to a portfolio may not be as important as figuring out which companies will actually increase their dividends into the future. For many investors, there is often too much reliance on a company’s past history of payouts and not enough focus on the factors that can help predict ongoing dividend growth as well as overall market performance.
To counteract this common oversight, we have built a quantitative strategy for identifying dividend growers that begins by researching upwards of 500 factors, before whittling that number down to those that have a combination of the most predictive power for generating alpha (i.e. better-than-market returns), and also projecting dividend growth over time.
From there, a smaller list of factors is culled even further by weeding out ones that exhibit strong positive correlations to each other. In doing so, we are left with a select list of uncorrelated factors that are optimized through our quantitative modelling techniques to ensure each is appropriately weighted within a portfolio. These weightings tend to be stable over time, owing to the difficulty of factor timing, but they can be adjusted periodically to reflect changes in market conditions.
Dividend growers tend to hold up better in rising rate environments
All indices are unmanaged and unavailable for direct investment
Source: Bloomberg LP; AGFiQ as of Sept 30, 2018. Data based on quintile rankings of average factor returns during six-month periods when the U.S. 10-year treasury was rising/falling.
While many of the factors identified in this process are consistent across market, sector or industry, the number and variety of factors that are needed to best predict alpha and dividend growth in our four dividend models within Canada vary greatly.
For instance, there are currently 24 factors being analysed for Canadian cyclicals. These factors range from industry relative forward dividend growth and consecutive years without a dividend cut, to others like capital expenditures as a percentage of depreciation expense and free cash flow interest coverage.
While the model allocation to each of these factors can be uneven, it’s important to note that they are managed within broader factor groups (i.e. dividend, value, growth, quality and risk), that are equally weighted based on our research that doing so lowers volatility and turnover over a full market cycle.
These same factor groups also inform our other models, but, in comparison, there are only 17 factors in the Canadian financial model, 13 in the defensive model and 8 in the Canadian real estate income trust (REIT) model.
Again, there is a minimal amount of factor overlap across these models. However, even more interesting perhaps is the fact that none of the typical metrics associated with dividend growers (i.e. dividend yield, dividend growth, payout) are present in our REIT model, since historically they do not provide enough predictive power to be included.
Granted, this isn’t very intuitive. However, it does highlight one of the advantages that an experienced quantitative manager may have versus someone who is unable to examine these stocks from an unbiased viewpoint. Familiarity in applying and interpreting quantitative methods is paramount for the origination of ideas and a thorough evaluation of these factors and models.
That’s not to say our way guarantees a portfolio chock full of the best dividend growers out there, but we do expect an increased hit rate so that odds of getting the outcomes we seek are improved.
Stephen Duench is a vice president and portfolio manager with High Street Asset Management Inc.. He is a regular contributor to the AGF Perspectives blog.
AGFiQ Asset Management (AGFiQ) is a collaboration of investment professionals from Highstreet Asset Management Inc. (HSAM), a Canadian registered portfolio manager, and of FFCM, LLC (FFCM), a U.S. registered adviser. This collaboration makes up the quantitative investment team.
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