The Canadian stock market said goodbye to September with solid gains for the first three quarters of the year. But October can be a difficult month for stocks and there’s no telling whether it’ll serve up tricks or treats for Halloween.
We’re handing out treats early this year with the addition of two extra stocks for each of the seven Canadian dividend and value stock portfolios we follow at The Globe. The idea is to include the two runners-up for each portfolio to cater to investors who want a couple of extra ideas to choose from – or for those who want alternates for a couple of the higher ranked stocks.
In their original form, six of the seven portfolios hold 10 stocks. The Stable Dividend portfolio is the exception with 20 stocks. As a result, adding two stocks to create expanded versions of the portfolios might change their long-term returns for good – or ill.
The expanded portfolios are put to the test to see how they stack up against the originals.
The average annual returns of the original and expanded portfolios are shown in the accompanying chart based on data over the 27 years through to the end of August. For comparison, the Canadian stock market – as represented by the S&P/TSX Composite Index – climbed at a 9.1 per cent average annual rate over the same period.
(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.)
Overall, adding two extra stocks changed the average annual returns of the portfolios by 0.8 of a percentage point, or less, over the 27-year period. The additions were slightly beneficial for three portfolios and slightly detrimental for four.
Adding the extra stocks might not have changed the portfolios’ long-term returns much, but it did reduce their volatilities in every case but one. The exception being the Stable Dividend portfolio, which became just a touch more volatile than the original.
The extra stocks are found by relaxing the final requirement used by each portfolio’s stock picking strategy. For instance, the original Stable Dividend portfolio starts with the largest 300 stocks on the Toronto Stock Exchange, narrows in on the dividend payers, and then picks the 20 with the lowest volatilities over the prior 260 days. Two stocks are added by relaxing the low-volatility requirement to allow for 22 rather than 20 stocks.
The stocks held by each portfolio – and the two runners-up – can be found via this link, which includes pointers to past articles detailing the strategies used by the portfolios.
The extra stocks can also be used to replace stocks in the original portfolios that investors don’t like.
For instance, many investors avoid thinly traded stocks because they’re relatively hard to buy – or sell – in a cost efficient and timely manner. Others avoid companies that are in the process of being taken over because they usually have limited upsides and are better addressed by merger specialists.
Laurentian Bank (LB-T) offers a timely example because it’s in the Stable Dividend portfolio this week. The company agreed to be acquired by Fairstone Bank with National Bank (NA-T) picking up some of Laurentian’s operations. Shareholder and regulatory approvals for the takeover have been obtained and – barring the unexpected – the transaction is targeted to close on Nov. 1.
Laurentian’s shares shot up when the deal was announced last December and they’ve been generally inching higher since then. (Disclosure: I owned a few of the bank’s shares before the deal was announced, but sold them in recent months.)
In most cases, a company that’s in the process of being taken over isn’t a great candidate for quantitative methods like those followed by the portfolios. While they aren’t excluded from the portfolios because they also appear in the backtests, investors should think about skipping them when making new investments and consider the runners-up instead.
Enjoy the extra stocks as an early Halloween treat. With a little luck, the portfolios will continue to do well over the long term. Mind you, they are far from risk free and are not suitable for every one.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.