What are we looking for?
Dividend-paying U.S. stocks to combat October's volatility.
The screen
As the first trading week of the fourth quarter ends, investors should be reminded that October typically brings more volatility to stock markets.
Even though the CBOE VIX index – which measures U.S. stock-market volatility – is hovering well below concerning levels, the index usually sees a noticeable uptick in the month of October. This is especially true in U.S. presidential election years.
Furthermore, the race for the Oval Office includes one of the most controversial candidates in history. The heightened uncertainty surrounding this election may bring significant stock-market swings from now through to Election Day on Nov. 8.
Prudent and risk-averse investors often choose stable income stocks to help protect portfolios from market instability while providing steady returns. When considering a long time horizon, dividend-paying blue chips should be a staple in any balanced portfolio.
Today I use Morningstar CPMS to look for stocks that provide attractive dividend yield, with low price volatility and stable earnings.
Our criteria included:
- Dividend yield of at least 2 per cent;
- A three-year price beta versus the S&P 500 index of less than one (a beta lower than one implies the stock’s price movement is less volatile than the index, while a beta of greater than one indicates price movement greater than the market index);
- Variability of earnings per share over the past five years (a lower value indicates more stability in the company’s earnings);
More about 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.
What we found
I used CPMS to back-test the strategy from April, 2004, to August, 2016. During this process, a maximum of 15 stocks in the S&P 500 were purchased and equally weighted. Stocks would be sold if their expected dividend yield fell below 1 per cent or if they fell below the top 20 per cent of the ranked universe. The portfolio is rebalanced monthly.
Over this period, the strategy produced an annualized total return of 13.4 per cent while the S&P 500 total return index advanced 7.8 per cent. Today, 15 stocks qualify for purchase into the strategy and are listed in the accompanying table.
As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Michael Pe, CFA, is an institutional product specialist for CPMS at Morningstar Research Inc.