Halloween is fast approaching and little ghouls and goblins will soon be roaming the streets searching for sweets and treats. I remember being fond of chocolate peanut butter cups in the time long ago before Halloween became haunted by food allergies.
The idea of combing two ingredients to make a more sumptuous treat also works in the market where investors combine multiple factors to find good stocks.
The Dividend Monster portfolio is a case in point because it starts with a solid dividend base and adds a layer of momentum in an effort to outperform. The portfolio enjoyed average annual gains of 15.4 per cent over the 25 years to the end of September, 2024. It handily beat the market, as represented by the S&P/TSX Composite Index, which climbed by an average of 7.9 per cent annually over the same period. (The returns herein are based on backtests using monthly data from Bloomberg that include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The Dividend Monster approach starts with the largest 300 common stocks on the Toronto Stock Exchange and narrows in on the dividend payers. It then sticks to the 50 per cent of dividend stocks with the highest yields before adding momentum to the mix by buying an equal-dollar amount of the 10 high-yield stocks with the highest returns over the prior year. The portfolio is rebalanced once a month.
The Dividend Monster generated big long-term returns, but it hit a rough patch in 2022 and proceeded to decline, in stages, by 24 per cent from its prior high to its low last fall. The decline was recently erased when the portfolio hit a new all-time high at the end of September, 2024 after climbing 31 per cent over the prior 12 months. (The market index climbed by 27 per cent over the same period.)
The portfolio’s worst showing of the past 25 years occurred during the financial crisis of 2008-09 when it plunged 52 per cent. The market held up better during the downturn with a fall of 43 per cent.
The Dividend Monster, like many momentum-based strategies, suffers from sharp downturns from time to time. It prompted me to try adding a low-volatility tilt to help smooth out its bumpy ride. But doing so could backfire and might be akin to taking a chocolate peanut butter cup and slathering it with sardines.
I tested my hypothesis by creating two variants of the Dividend Monster portfolio that are also equally-weighted and rebalanced monthly.
The first is an eight-stock variant, which begins with the regular Dividend Monster portfolio and keeps eight of its 10 stocks that have the lowest volatilities over the prior 260 days.
The second is a 10-stock variant that inserts the volatility test near the start of the process. It begins with the 300 large Canadian stocks on the TSX and cuts the list to 240 by removing the 60 stocks (or 20 per cent) with the highest volatilities over the prior 260 days. It then proceeds as normal by narrowing in on the half of dividend payers with the highest yields. The variant then picks 10 stocks from the remaining high-yield stocks that have the highest returns over the prior year.
Both of the experimental portfolios produced slightly better returns than the Dividend Monster’s average annual returns of 15.4 per cent over the 25 years to the end of September, 2024. The 10-stock and eight-stock variants gained an annual average of 15.9 and 15.8 per cent, respectively, over the same period.
The variants also performed a smidgen better than the original in the big downturns of the past 25 years and were a touch less volatile.
While adding volatility to the mix resulted in modest improvements at the expense of some additional complexity, there is a chance the gains might be ephemeral and the result of digging in a haunted data mine. Time will tell.
But I’ve high hopes the traditional Dividend Monster portfolio will continue to perform well over the long term despite the frights it will likely give investors along the way.
You can find a list of the stocks in the Dividend Monster portfolio 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.
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