Victoria Day is nearly here, bringing with it dreams of lazy summer days spent fishing on the bay.
It’s also a reminder to catch up with the profitable Perch portfolio, which favours Canadian low-volatility dividend-payers trading at bargain prices.
The portfolio netted average annual gains of 14.4 per cent over the past 26 years through to the end of April. At the same time, the Canadian stock market (as represented by the S&P/TSX Composite Index) climbed at an average annual rate of 7.9 per cent.
(The returns herein are based on backtests using monthly data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs. The portfolios are equally weighted and rebalanced monthly.)
The Perch portfolio searches for bargains by starting with the largest 300 common stocks on the Toronto Stock Exchange by market capitalization. It then removes the largest 50 of the 300 companies from consideration to focus on the 250 smaller names. It further narrows the list to dividend payers (147 this week) and then to half of the remaining stocks with the lowest volatilities (standard deviation) over the prior 260 days. It finally buys the 20 stocks with the lowest, positive, price-to-earnings ratios (P/Es.)
The original 20-stock portfolio landed big returns but a 10-stock low-P/E version of it fared even better. It picks stocks in the same way as the original, with the exception of the last step, when it buys 10 stocks with the lowest P/Es instead of 20.
The 10-stock low-P/E portfolio gained an average of 15.3 per cent annually over the 26 years to the end of April.
Now let’s try a 10-stock high-yield version of the Perch portfolio. It buys the 10 stocks with the highest dividend-yields instead of the 10 with the lowest P/Es.
Alas, the 10-stock high-yield portfolio was a little disappointing with average annual gains of 13.3 per cent of the same 26 years. Mind you, it still beat the market.
You can examine the return history of all three portfolios, along with the market index, in the accompanying graph.
It’s easy to get carried away with the portfolios’ strong gains and to ignore their weak periods, which can be particularly important when deciding between the original 20-stock portfolio or one of the 10-stock variants.
Volatility gauges how rough the ride was for investors, and the 20-stock portfolio shone with a modest annualized volatility of 13.4 per cent over the 26-year period. Alternatively, the 10-stock low-P/E portfolio had a volatility of 15.1 per cent and the 10-stock high-yield portfolio a volatility of 16.5 per cent over the same period.
Diversification has its benefits and helped the 20-stock portfolio to a Sharpe ratio (think of it as a reward-to-variability ratio) of 1.01, which is pretty good. The 10-stock low-P/E portfolio sported a Sharpe ratio of 0.98 and the 10-stock high-yield portfolio posted a weaker ratio of 0.79 because of a combination of lower returns and higher volatility.
It’s also useful to see how the portfolios fared in past downturns, and the financial crisis of 2008-2009 was a big stress test. To set the stage, the market index fell 43 per cent from its former highs in the crash, but the 20-stock Perch portfolio fared better, with a decline of 37 per cent. On the other hand, the 10-stock low-P/E portfolio fell 49 per cent and the 10-stock high-yield portfolio dropped 45 per cent.
I have high hopes that the Perch portfolio will continue to serve up strong returns over the long term. But investors have to expect stormy periods along the way and there are no guarantees when it comes to future returns. So, enjoy the sunny days to come while they last.
Details on the stocks in the Perch portfolio and the others regularly followed at the Globe and Mail can be found via this link.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
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