Today we are revisiting the 10-year historic performance of one of our favorite strategies: Dividend Growth. More importantly, we are going to look at comparative performance averages across 4 major market capitalizations relative to their respective broad market indexes at five time periods: Most Recent Quarter, Year To Date (as of 6/30/2020), 1-year, 5-years, and 10-years.
The question we ask ourselves every quarter: Does the Dividend Growth Strategy continue to deliver better performance than its index peers in good and bad markets, across all market capitalizations, with LESS risk than the indexes?
As we all know, the market was hit by the COVID-19 freight train in Q1 2020 resulting in a -25% return in the S&P which knocked us all the way back to October 2017 market prices. Then, in Q2, the S&P bounced back 25% making the 2020 Year to Date picture a distinct V.
Interestingly, Q1 2020 was the 9th worst quarter in stock market history, and Q2 2020 was the 9th best quarter in stock market history. What a roller coaster!
In the first quarter of 2020’s unexpected sharp down market, Dividend Growth was extremely defensive, smashing the indexes by 652 basis points (Q1 Stats). In the equally unexpected rapid recovery of the second quarter of 2020, Dividend Growth, with one exception, lagged by an average of 508 basis points. Interestingly, across the V-shaped first half of 2020, Dividend Growth performed marvelously with Year to Date 412 basis points better performance than the indexes.
The summary stats here represent the average performance differential between gross performance of the strategy versus index performance, in an equally weighted distribution across all four capitalizations. The summary results are immediately below but keep scrolling to see the math for each of the four capitalizations!
A few quick observations:
In this quarterly commentary and all future versions, we will pinpoint the separate performance of each company size (capitalization) against its benchmark (see chart below). In so doing, one can see both the relative gross performance of each capitalization across various timeframes and one can verify numbers in the aggregate performance reporting (above). Additionally, publishing the performance of the individual capitalizations will enable us to spot anomalies within the strategy such as observing that in Q2, the average of the four capitalizations was lagging by 508 Basis Points, but Large Cap actually BEAT its index by 153 basis points! Large Cap, at least in this quarter, was a hero!
The Story Capital thesis or conviction is that Dividend Growth is a strategy for all seasons, not just an alternative strategy to “turn to” at specific times. Dividend Growth is evergreen; it is a profoundly beneficial, core strategy for all seasons. We further believe that the strategy delivers better performance with less risk than the index peers. Please see the 5-year Standard Deviation table below. Note that at every capitalization, Standard Deviation (volatility/risk) is lower for each Dividend Growth capitalization size than its index peer. Interesting question: if this perspective is consistently demonstrated, then we have discovered a strategy, or stock selection and monitoring process, wherein active management outshines an indexed approach. If true, then we will also be so bold as to suggest that this strategy consistently delivers ALPHA. For an interesting and expanded understanding of Alpha and Beta (risk) please see the discussion at Investopedia.
The Rest of the Story:
Here are the performance numbers we used to determine the average relative returns above:
As in all strategies there are Yin and Yang moments, but across reasonable time frames like 3 or more years, we believe this is a great core strategy in the diversified portfolio if you like smoother rides and great tax-preference dividend cash flow even in down or range-bound markets, and better overall performance relative to applicable broad market indexes (Alpha)!
Here are a few other measures for those that really want to dive into the details:
Review of the average standard deviation tells us that the returns in the Dividend Growth strategy are less volatile than their benchmark indexes. Special Note: If you thought adding Small Cap stocks comes with MORE risk, then think again! The volatility of Small Cap Dividend Growth is 13.24% less volatile than its Large Cap cousin’s index. By way of practical example, since most of our clients have a single security concentrated risk in a Large Cap stock, we enjoy looking for spots to add Small Cap Dividend Growth to improve diversification and risk-adjusted return across the portfolio. In other words, adding Small Cap Dividend Growth lowers portfolio risk and enhances diversification, whereas merely adding a broad market Small Cap Index strategy would increase portfolio risk which our clients, generally, do not desire. Who would have imagined that? Small Cap lowers risk?
The “secret” to Dividend Growth success is revealed again in up-capture/down-capture statistics. The average up/down capture here tells us that in the last 5 years, Dividend Growth captured 101.93% of the upside and only 74.90% of the downside. The thesis is that Dividend Growth consistently wins by matching index performance in up markets and by dramatically outperforming the indexes in down market periods while still delivering consistent, increasing dividend cash flows. This means that our clients enjoy double compounding in down or range-bound markets because during these times, consistent, increasing dividends purchase more shares of these wonderful companies at more favorable prices, thus enhancing long-term performance as markets regain growth momentum!
For definitions, click here.
A few key observations:
- 5-Year EPS Growth: A company cannot increase dividend payments to shareholders at two-to-three times the rate of inflation without growing Earnings Per Share by that amount. During retirement, our clients generally switch from reinvesting dividends to taking the tax preferred dividend flow in cash like an inflation-hedged, growing income source regardless of market direction!
- Debt/Capital: Servicing high levels of debt can impede management’s ability to grow dividends. Debt to capital ratios around or below 50% are considered responsible capital allocation.
- Yield: Though we use some variants of Dividend Growth that have yields in excess of 5-6% for those seeking solid cash flow with less emphasis on growing the underlying capital base, most of our younger clients enjoy the Dividend Growth strategy that brings balance to growing BOTH the capital base and compounding the dividend as noted in our Coke Blog.
- Turnover & Holdings: It flows naturally that a portfolio with a higher number of individual securities would see a larger turnover of names in the portfolio, thus a greater flow of undesired realization of capital gain via portfolio management which creates tax drag.
- Note the low number of positions in our Dividend Growth portfolios and the resultant low-to-ultra-low portfolio turnover.
- When deploying multiple Dividend Growth capitalization strategies within the portfolio, where possible, we generally put higher turnover capitalizations in tax-free or tax-deferred accounts and ultra-low turnover capitalizations in the taxable portfolio.
- Please note: Story does not utilize mutual funds or ETFs. All Dividend Growth capitalizations are executed by using individual securities traded in a dedicated account titled in the name of the client or their IRA/401k/Roth account. This method is most frequently referred to as “Separate Account” investment management but it is often confused with being a fund. Our clients maintain full tax control.
We look forward to bringing you another Dividend Growth update after the third quarter. Give us a call if you have any questions or want to start utilizing Dividend Growth in your portfolio!
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