In my post of May 23, 2010, I argued that regardless of whether or not we were headed for a double-dip recession, investing in companies with secure dividends would be prudent. I identified 22 companies listed on the Dow 30, S&P 500, and Nasdaq 100 indices with a minimum dividend yield of 4% and with at least 40% excess levered free cash flow compared to the amount of money paid out as dividends. I contended that these were companies that would be able to continue to pay their dividends through difficult economic times.
I suggested that, for a long term investor, market conditions would not ultimately matter for these stocks. If the market fell, investors would earn dividend income while they waited for a recovery. If the market rose, investors would earn the dividend and benefit from a potential capital gain on the price appreciation of the stock.
A return to market lows has not reoccurred. In fact, the S&P 500, the usual proxy for US equity returns, realized a total return of 15.06% in 2010. Did the high dividend companies that I identified keep pace with the general market?
Of the 22 companies that I identified, 16 outperformed the S&P index while six fell short. The average return of these stocks was 27%, or approximately 12% higher than the S&P 500 index. Interestingly, even without the dividend payments included in the stock returns, the average return was still 21.65%. Results were slightly skewed by Qwest’s massive return of 98.1%, but even when this stock was removed from the calculations, returns still exceeded 25%. Even though high dividend stocks are often considered to be conservative, they outperformed the S&P 500 index in a strong stock market environment. Note, however, that I have not adjusted the returns of the S&P 500 index or the returns of these 22 stocks for any measurement of risk. The average beta for this group of stocks was 0.87, suggesting relatively low volatility. However, I did not calculate the covariance of volatility compared to the index stocks.
Just as important, dividends for these 22 companies prove to be secure. In fact, 10 of the 22 companies raised their dividend payments during the year. The rest remained the same, except for Cincinnati Financial, which dropped its annual dividend very slightly from $1.60 per share to $1.58. Note that the average return of 27% for this group of 22 stocks does not include the increase in dividend payments that companies made during the year.
Have I discovered a new means for selecting stocks that will outperform the market year after year? Not likely. This “portfolio” did well in conditions when many of these companies were undervalued given their impressive cash flow. As economic recovery continues, more growth oriented stocks may perform substantially better than these secure dividend stocks. However, in times of economic uncertainly, this method of identifying suitable stocks may have some merit.
At the time of my original post, I mentioned that identifying these companies based on dividend yield and levered free cash flow was just the first step in analyzing whether these stocks are appropriate investments. More in depth analysis would be necessary prior to investment. Personally, on the basis of additional research, I invested in three of the companies in the list (Verizon, AT&T, and Phillip Morris), which produced an average return of 24.2% for 2010. The irony is that my extra research produced a slightly lower return than investing equal amounts in each of the 22 companies that my criteria produced.
In my post, I also mentioned that I purchased GlaxoSmithKline, a company that met the same criteria as the 22 companies, but was not listed on the indices I analyzed because it was a UK-based company. So far, on an annualized basis, that stock has returned 23.3%, including its 5.5% dividend payments.
I intend to produce another list of stocks that meet these dividend and levered free cash flow criteria for 2011 in order to observe how they perform in this changing market environment.
