The icy cold of winter pushed many Canadians inside to defrost and to dream about summer days to come.
When it comes to the markets, investors might look forward to the returns of the lemonade portfolio, which is on fire thanks to its intoxicating blend of momentum and value.
The lemonade portfolio shot up by an average of 18.6 per cent annually over the 25 years through to the end of January. In comparison, the Canadian stock market, as represented by the S&P/TSX Composite Index, climbed by an average of 7.3 per cent annually over the same period. (The returns herein are based on back tests using monthly data from Bloomberg with monthly rebalancing. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The portfolio starts its search for value stocks on the upswing with the largest 300 common stocks on the Toronto Stock Exchange. It then focuses in on the minority of stocks that do not pay dividends, which narrowed the list to 90 candidates this week. The list is further concentrated by selecting the 20 stocks with the lowest price-to-earnings ratios (P/E) for a touch of value flair. It finally adds a dash of momentum by cutting the list of 20 stocks in half by buying an equal-dollar amount of the 10 stocks with the highest returns over the prior six months.
While the portfolio’s long-term returns have been grand, avoiding dividend stocks is a little unusual. But the idea is to design a portfolio for investors who prefer capital gains rather than dividends.
Mind you, many investors are happy to hold dividend payers. They might consider the pink lemonade portfolio, which doesn’t discriminate against dividend stocks. It starts with the largest 300 stocks on the TSX, picks the 20 with the lowest P/Es, and then buys an equal-dollar amount of the 10 with the highest returns over the prior six months.
The pink lemonade portfolio gained an average of 17.7 per cent annually over the 25 years through to the end of January, which is mighty fine but not quite as good as the original portfolio. You can examine the return history of both portfolios, and the market index, in the accompanying graph.
Notice that the pink lemonade portfolio led the return race for much of the 25-year period thanks, in part, to outperforming in the 2008-09 financial crisis, when the regular lemonade portfolio soured. The magnitude of the decline is demonstrated in the second graph, which shows how far the portfolios fell from their prior highs in hard times.
Generally speaking, the original lemonade portfolio suffered from larger and more prolonged downturns over the 25-year period than its pink sibling. The worst downturns for both occurred in the financial crisis when the original portfolio fell 64 per cent and the pink portfolio declined 44 per cent.
The COVID-19 pandemic served up the second worst downturn for the portfolios, with the lemonade portfolio falling 45 per cent and the pink lemonade portfolio dropping 40 per cent.
These days, investors can find good value and momentum in both portfolios. The stocks in the lemonade portfolio have a median P/E of 11.0 and a median return over the prior six months of 38 per cent. (The median is the point where half the readings are higher and half are lower.) In comparison, the stocks in its pink sibling have a median P/E of 5.8 and a median six-month return of 22 per cent. As a result, the former is more attractive to momentum investors but the latter has better value appeal.
Over all, I tend to favour the pink lemonade portfolio because of its better track record in past downturns, but both produce an interesting list of stocks. With a little luck, they’ll continue to warm the hearts of investors over the long term.
You can find the stocks in the lemonade portfolios via this link, which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.
Be smart with your money. Get the latest investing insights delivered right to your inbox three times a week, with the Globe Investor newsletter. Sign up today.