What are we looking for?
Stocks with strong cash-flow momentum and dividend yield in their respective industries, and a history of long-term dividend growth.
The screen
Today I use Morningstar CPMS to look for stocks that, when, compared with their peers, provide attractive dividend yield with positive cash-flow momentum.
Companies with healthy cash-flow characteristics are more likely to have the ability to pay and increase their dividends. Stocks also scored better if they have higher cash-flow revisions and long-term dividend growth, which would indicate they will continue to provide stable income.
The specific factors used to rank stocks in this strategy include:
- Industry-relative dividend yield (the difference between the stock’s expected yield versus the median yield in the stock’s industry);
- Five-year dividend growth (annualized);
- Industry-relative annual cash-flow momentum (the difference between the stock’s annual cash-flow momentum versus the median annual cash-flow momentum in the stock’s industry);
- Three-month cash-flow revisions (change in the median cash flow estimates from three months ago).
To qualify, stocks must have a market float of at least $50-million and a positive three-month cash-flow estimate revision. Also they must also have an expected dividend yield of 2 per cent or greater to provide income. Finally, stocks must not pay more than 80 per cent of their cash flow in dividends in order to help ensure they have a manageable and sustainable payout ratio.
More about Morningstar
Morningstar Research 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.
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 February, 2001, to April, 2016. During this process, a maximum of 10 stocks were purchased and equally weighted with a maximum of five stocks a sector. Stocks would be sold if they fell outside the top 45 per cent of the ranked universe, if the stock pays more than 100 per cent of its cash flow or if three-month cash-flow estimates are revised downward more than 10 per cent. The strategy is rebalanced on a quarterly basis.
Over this period, the strategy produced an annualized total return of 13.5 per cent while the S&P/TSX composite total return index produced a 6.3-per-cent return. Today, 10 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.