Craig McGee is a senior consultant at Morningstar Canada.
What are we looking for?
Dividend growth stocks.
Keeping up with the market has been a challenge for many Canadian investment managers and models so far this year. The CPMS Canadian Dividend Growth model portfolio has been able to keep pace, especially by avoiding much of the volatility seen in recent months.
Year-to-date, the S&P/TSX Composite Total Return index is up 13 per cent while the Dividend Growth model has edged higher than the benchmark, with a 14 per cent return. Growing income from dividends has helped significantly.
The screen
This screen looks at the Dividend Growth model, which emphasizes stocks with high expected dividend yields and dividend growth. Importance is also placed on stocks with increasing cash flow and higher profitability. Specifically, it looks for stocks with a good combination of the following metrics:
– current expected yield;
– expected and trailing dividend growth;
– trailing return on equity (ROE);
– annual change in cash flow.
Stocks are selected from the largest 250 equities in the CPMS Canadian database and no more than five stocks a sector are held.
More about Morningstar
Morningstar Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers.
CPMS data cover more than 95 per cent of the investable North American stock market. With more than 110 equity and credit analysts, Morningstar has one of the largest independent institutional equity research teams in the world.
What we found
Using CPMS, I back-tested the strategy to apply the same rules-based approach starting Dec. 31, 1991. A portfolio of up to 20 stocks was equally weighted and stocks would be replaced if their rank fell outside of the top 40 per cent of the subset of 250 largest stocks.
To help show how dividend growth can affect a portfolio, I displayed the final portfolio's dividend yields on its adjusted cost in addition to its current yields. (Since your cost is fixed, "yield on cost" represents the holding's real yield while the current yield is what you would expect if you started new today.) The average yield on cost for the portfolio is 5.7 per cent compared to the average current yield of 3.2 per cent.
Over the past five years, this strategy generated an annualized total return of 16.3 per cent while the S&P/TSX Total Return index came in with 10.7 per cent. For the full period starting Dec. 31, 1991, this approach would have posted an annualized return of 14.9 per cent versus 9.3 per cent for the index.
Investors are advised to do their own research before investing in any of the stocks shown here.