Welcome to our second edition of the Dividend Growth Quarterly Update! While Story has been analyzing the Dividend Growth strategy for many years, given the massive market downturn in Q1 and the atypical recovery taking place in Q2 and now into Q3, we have decided to routinely share some of the key performance indicators we track in order to affirm that our thesis behind use of the strategy remains fully operational. We believe the effectiveness of the Dividend Growth Strategy is a lot like gravity; one can choose to deny it but, in the end, one will only succeed in confirming it.
Many of our clients carry extensive single security risk by holding a high concentration of their employer stock. In fact, C-suite and Named Executive Officers (NEO’s) have enforced “holding requirements” as well as peer pressure to hold concentrations in excess of their “holding requirement.” Story believes that one of the best equity diversifier of this single security concentration risk is the strategy of Dividend Growth, owned across multiple capitalizations.
Einstein had an intuition while ascending an elevator in 1909 that yielded (for him) a profound insight: acceleration and gravity are not just similar – they are the same thing! Our Dividend Growth intuition came to us in Lowell Miller’s book, The Single Best Investment (2006) and was refreshed in David Bahnsen’s book, The Case for Dividend Growth (2019). This quarterly synopsis of key performance indicators is an ongoing public confirmation of what we already believe to be true.
We compare performance averages across 3 major market capitalizations relative to their respective broad market indexes at five different time periods over the most recent rolling decade.
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 a reminder, the market was hit by the COVID-19 freight train in Q1 2020 which knocked equity markets all the way back to October 2017 market prices. Then, in Q2 and now Q3, equity markets unexpectedly bounced back in a distinct V-shaped market recovery to pre-COVID market highs. In Q3, two of the major indices hit record highs:
- S&P 500 hit 3,588 on September 2nd, 2020
- NASDAQ hit 12,074 on September 2nd, 2020
- The Dow Jones Industrial Average did not surpass its February 2020 high, but it got within 500 points on September 2nd, 2020
The ride was a little bumpier to the end of the quarter after these highs, but overall, the market has been on an upward trajectory since March (See S&P 500 Q1 2020 – Q3 2020). If you are a true believer in the capitalist system of effective corporate capital allocation, the markets have been on an upward trajectory since their founding (May of 1792 in the case of Wall Street)!
For additional context, the Wall Street Journal indicated that the second and third quarter of 2020 have wound up being the “best two-quarter performance since 2009.” We’ve certainly had a taste of everything in the market this year. From Story’s point of view, we are skeptical or ambivalent about market direction in the short run, but in the long run, we are “perma-bulls” (see Tip #1).
S&P 500 Q1 2020 – Q3 2020
|Tip #1: being a “perma-bull” underlies one of several ways of dealing with today’s zero-bound interest rate environment with its historically low yields. To sow a valuable mustard seed into your minds: If your family can afford volatility, and the 10-year treasury is hanging around 75bps while a solid Dividend Growth portfolio has a yield 3-7 times the 10-year treasury, how might one think about holding bonds versus the alternative as the opportunity cost of holding bonds has soared? Which is the greater risk? Next-to-zero yield with modest volatility, or superior yield with greater volatility? That question must be answered by each individual investor and their advisor.|
Dividend Growth Performance
The summary stats here represent the averaged performance of the Large, Medium, and Small Dividend Growth Capitalizations we track, minus the averaged performance of the indexes of these three capitalizations. This tells us broadly if the Dividend Growth Strategy is still beating their indexed performance, thereby delivering consistent Alpha. The summary is an equally weighted distribution across all three capitalizations. The aggregate results are immediately below but keep scrolling to see the math for each of the three capitalizations!
By Way of Review
The Story Capital thesis or conviction is that Dividend Growth is a strategy for all seasons, all market periods, and not just an alternative strategy to “turn to” at specific times in the economic or market cycle. Dividend Growth is potentially evergreen; we believe it is a profoundly beneficial, core strategy for all seasons; “to have and to hold until death do you part!” That’s no joke. Can you imagine getting a step-up in every security’s basis at death and then passing on a stream of inflation-beating, tax-advantaged, increasing dividend income to the next generation that is so precious, they would not even think of selling it? Within the family, a Dividend Growth portfolio is very much like an exquisite commercial building, a family farm, or a business. The Dividend Growth strategy remains an actively managed process that historically outperforms an indexed approach across a decade of tracking this strategy.
The Rest of the Story
Here are the performance numbers we used to determine the average relative returns above. Remember the math using Large Cap in Q3 2020 (orange text) as an example: Dividend Growth Manager performance of 6.36% minus Index performance 5.59% equals a positive relative return (or Alpha) of 0.77% for Q3.
What’s up with Small Cap?
As noted by any market commentator who represents the long-term interests of their clients: a portfolio without periodic underperforming elements will eventually displease overall! Having a properly diversified portfolio carries the prerequisite understanding that some element of your portfolio will always be under-performing. Were this not true, by definition, one’s portfolio would NOT be diversified.
For example, all capitalization sizes of dividend growing stocks were marvelously defensive going into the COVID-19 meltdown. However, high-quality dividend growing small caps were slower than large caps coming out of the meltdown in Q2 & Q3. By contrast, look at the 5 and 10-year numbers that demonstrate, in the long-run, markets come around to honor effective capital allocators.
|Tip #2: At the end of Q3, Small Cap Dividend Growth stocks were trading at an anomalous 19% DISCOUNT compared to the Russell 2000 Index. Yes, friends, Small Cap Dividend Growth was on sale. Isn’t it wonderful to know that clients who already owned Small Cap Dividend Growth bought MORE of the position at a discount by reinvesting their growing dividends back into the strategy during this market opportunity? Hmmm… buying the dips. Dividend reinvestment in down or range bound markets is double compounding. We will write a blog about this someday!|
Here are a few other Q3 measures for those that really want to dive into the details
One “secret” to Dividend Growth success is amplified in up-capture/down-capture statistics. They tell us that in the last 5 years, on average, Dividend Growth captured 101.93% of the upside and only 74.90% of the downside. This is an evergreen, defensive equity strategy our clients appreciate.
For greater context around these statistics please see our Q2 Dividend Growth Summary
Important note: Story does not utilize mutual funds or ETF’s. 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/Trust account. This method is most frequently referred to as “Separate Account” investment management, but separate accounts are often confused with being a mutual fund. Our clients and our team maintain full tax and security selection control with the separate account format.
We look forward to bringing you another Dividend Growth update after the fourth quarter. Give us a call if you have questions or if you would like to further explore the specifics of this evergreen strategy!
This report was prepared by Story Capital, LLC and reflects the current opinion of the firm, which may change without further notice. This report is for informational purposes only and is not intended to replace the advice of a qualified professional. Nothing contained herein should be considered as investment advice or a recommendation or solicitation for the purchase or sale of any security or other investment. Opinions contained herein should not be interpreted as a forecast of future events or a guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for a client's portfolio. Economic factors, market conditions, and investment strategies will affect the performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark.
Commentary regarding the returns for investment indices and categories do not reflect the performance of Story Capital, LLC or its clients. Historical performance results for investment indices and/or categories generally do not reflect the deduction of transaction and/or custodial charges or the deduction of an investment-management fee, the incurrence of which would have the effect of decreasing historical performance results.