25 stocks with high relative dividend yields
The income stream offered by dividends provides some comfort in volatile market conditions. Treasury yields have started to rise from all-time lows seen throughout 2020. As of March 14, 2022, the yield on the 10-year note was above 2% for the first time since 2018. While Treasury yields Treasury exceed the average dividend yield of stocks in the S&P 500 index, some investors may flee individual stocks for low-volatility investments. However, dividend-paying stocks can offer comparable returns with the potential for dividend growth and capital appreciation. In this article, I present AAII’s strategy which uses the dividend yield approach to investing in volatile markets. Our High Relative Dividend Yield selection model has shown strong long-term performance, with an average annual gain since 1998 of 8.8%, compared to 6.3% for the S&P 500 over the same period.
Dividends help returns in any market situation, while the income attraction of dividend-paying stocks helps limit large losses in a downturn. A dividend yield strategy can help you find potentially undervalued stocks with reduced downside risk, provided the dividend is secure.
However, not all dividends are created equal. Many companies have reduced or eliminated their dividends since 2020. Therefore, it is important for investors to pay attention to management’s commitment to guaranteeing the payment of dividends and whether the payment of dividends has increased, remained the same or has been reduced.
High relative dividend yields
A stock’s dividend yield is calculated by taking the stated dividend – the dividend expected over the next year – and dividing it by the stock’s price. For most stocks, the dividend shown is the most recent quarterly dividend multiplied by four. If a stock pays an indicated dividend of $1 per share and trades at a price of $40, its dividend yield is 2.5% ($1 ÷ $40 = 0.025, or 2.5%). If a stock’s price is rising faster than its dividend, the dividend yield will fall, indicating that the price may have been too high and may be ready for a decline. Conversely, if the dividend yield reaches a high level, the stock may be poised for a price increase if the dividend can be sustained. However, very high yields, especially relative to historical levels, may be a warning of a cut or suspension of dividends.
AAII follows a high yield filter that looks for companies with characteristics such as:
- An established history of rising dividends,
- A high dividend yield compared to its historical norm,
- Earnings growth above industry norm and
- Liabilities below industry standard.
A history of rising dividends implies that management has always been focused on providing an increasing level of income to shareholders.
The relative dividend yield is a measure of valuation. It is used to signal if a company is trading at a discount to its historical range. Higher yields signal a lower valuation, although other metrics such as price-earnings ratio should also be considered. A higher return may also signal concerns about the company’s business or financial condition; therefore, extensive research is required.
Earnings growth above the industry average suggests the company’s profitability should be able to support higher dividends going forward. These two characteristics increase the possibility that dividends will be increased in the future, but they do not guarantee it. Lower debt levels allow more cash for dividend payments because less cash has to be used to service debt. Comparing debt levels with the industry median allows the strategy to adapt to different capital needs.
Like all basic value techniques, the dividend yield strategy attempts to identify investments that are not popular. Screening is the first step in this process and involves analyzing a group of securities to find those that deserve further analysis. Absolute or relative levels can be used in screening for high yielding stocks. For example, a screen requiring an absolute level might seek a minimum dividend yield of 3% before an investment is considered.
Screens based on relative levels compare the return to a benchmark that can fluctuate, such as the current dividend yield for the S&P 500. In this case, the investor does not require the return to reach a minimum level, but rather than maintaining its history. relation to the reference figure. Common screens examining relative returns include comparisons to an overall market level, industry level, historical average, or even a benchmark interest rate. This screen is performed using a historical average as a reference.
The first filter excludes companies that trade on the over-the-counter (OTC) market. This filter makes it possible to establish minimum levels of liquidity.
The screen then requires a company to have seven years of price and dividend records. When selecting against a historical average, remember to include a time period that covers both up and down periods of a market and an economic cycle.
Selecting a time frame is a balance between using a time frame that is too short and captures only a segment of the market cycle and a time frame that is too long and includes a time frame that is no longer representative of current company, industry or market. Periods of five to ten years are the most common for these types of comparisons.
The screen then searches for companies that have paid a dividend in each of the last seven years and have never reduced their dividend.
Dividend levels are set by the Board of Directors based on current company, industry and economic conditions. Because dividend cuts amount to an announcement that the company is in financial trouble, dividends are set at levels that the company should be able to afford throughout the economic cycle.
A lack of dividend growth or a decline in the rate of dividend growth can also be troubling, especially after a period of steady annual dividend increases. Investors such as Benjamin Graham demanded that stock dividends at least keep pace with inflation. The screen is even more aggressive and requires an annual increase in the dividend per share for each of the last six years.
The following filter requires that the company’s current dividend yield be greater than its seven-year average dividend yield. This filter looks for companies whose dividends have increased faster than share price increases, or whose current share price has recently fallen.
The payout ratio
Although it may seem that the selection process should be completed with this last filter, before a company can be considered for purchase, the security of the dividend must be considered. A high dividend yield can be a signal that the market expects the dividend to be cut soon and has driven the price down accordingly. A high relative dividend yield is only a buy signal if the dividend level is expected to hold and rise over time.
There are measures that help identify the security of the dividend. The payout ratio is perhaps the most common of them and is calculated by dividing the dividend per share by the earnings per share. Generally, the lower the number, the safer the dividend. Any ratio above 50% is generally considered a warning. However, for some industries, such as utilities, payout ratios of around 80% are common. A payout ratio of 100% indicates that a company pays out all of its earnings in the form of dividends. A negative payout ratio indicates that a company pays a dividend even though earnings are negative. Businesses cannot afford to pay more than they earn in the long run. The screen requires a payout rate between 0% and 85% for utilities and between 0% and 50% for businesses in other sectors.
Dividends are paid in cash, so it’s also important to look at a company’s liquidity. Financial strength helps indicate liquidity and provides a measure of safety for the dividend payment. Consider both the company’s short-term obligations and long-term liabilities when testing financial strength. Common measures of a company’s longer-term obligations include debt-to-equity ratio (which compares the level of long-term debt to equity), debt as a percentage of capital structure (long-term debt divided by capital, which includes long-term funding sources such as bonds, capitalized leases and equity) and total liabilities to total assets.
The screen uses the ratio of total liabilities to assets because it takes into account both current and long-term liabilities. Acceptable debt levels vary from industry to industry, so the screening looked for companies whose total liabilities to assets were below the norm for their industry. The higher the ratio, the greater the financial leverage and the higher the risk. Financial stocks and utilities that pass have much higher values than stocks in the consumer sectors.
It is also important to review the history of earnings. Dividend growth cannot deviate from the level of earnings growth for very long, so the earnings growth model will help confirm the stability and strength of the dividend. Ideally, income should increase steadily. The final screen requires earnings growth over the past three years to be above the industry norm.
This High Relative Dividend Yield screen identifies companies with strong dividend credentials that trade at relatively high yields. Selecting a relatively high dividend yield is based on the age-old rule of buying low and selling high. Examining a stock’s dividend yield provides a useful framework for identifying potential candidates.
To be successful with this strategy, you need to develop a set of tools to not only identify stocks that have relatively high dividend yields, but also which of those stocks have the strength to rebound.
As with any screen, the list of passing companies is only a starting point for further analysis.
Stocks passing the high relative dividend yield screen (ranked by dividend yield)
Actions meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to do due diligence.
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