Saturday, March 31, 2012

Blistering Returns on our Low P/E and Moderate Dividend Portfolio


Last year we discussed long term stock performance based on work of various authors including Ken Fisher. One book stood out and that is “What works on Wallstreet” by James O’Shaughnessy who discussed the performance of portfolios based on certain value investing parameters. James suggested to not only follow one strategy but to create several portfolios each based on its own strategy E.g. a Low P/E portfolio, a low Book Value Portfolio and a Portfolio combining momentum with moderate dividend paying stocks.
The idea to invest in a moderate dividend is that the 10% (decile) of dividend paying stocks with the highest yields say yields of 8% or higher, comprise companies that are often not in a position to maintain those dividends. But stocks in the 3rd decile paying dividend yields between say 2-6% are typically companies that are able to maintain their dividends and their long term performance (we’re talking annual returns measured over the last 6 to 10 decades) is 14.19% annually with the lowest risk (standard deviation).  Also a portfolio of low P/E stocks performed very well with an annual return of 18.23% and a modest risk level (S.D. = 18.45%).  So, how would a portfolio of Low P/E stocks combined with moderate dividend yield perform? According to O’Shaughnessy this was one of the best value investing combinations.

In December 2011 we scanned Canadian stocks tracked on Globe Investor Gold to find such stocks and we examined them further in regards to financial strength, debt, earnings growth and whether I already owned these stocks in other portfolios, e.g. Canadian Banks. The result was the Canadian Diversified Investor’s Low P/E and moderate Dividend Portfolio. We bought the 10 stocks that made up this portfolio and normalized it to a $100,000 initial value. The purchase costs include commissions as charged by one of Canada’s largest discount brokerages.
Click on table to enlarge
A spreadsheet with the first quarter results annualized is shown above. The annualized returns are calculated as appreciation on March 30, 2012 combined with the annual dividends. That means, these are the returns for this year provided the stock market valuation of the stocks in the portfolio do not change for the rest of the year. This is of course not realistic and we will review the portfolio again three months from now near the end of June.

First quarter results were stunning with an annual return on investment of 20.69%. That is to say that if the market valuation would not change during the remainder of this year. Something that is quite unlikely. We may experience a correction in the summer and fall, but I think the market could easily be up by another 10% at year’s end. If each stock in our portfolio would rise another 10% by year’s end ROI for the portfolio would be:  31.62%  (not counting possible dividend increases).  

Value stocks selected on shareholder yield (earnings, dividend and stock buyback combined) historically returned 19% annually according to O'Shaughnessy; our results are excessive compared to this average. However, coming out of the 2008-2011 turmoil and considering top returns of such a portfolio may be as high as 77%, today’s returns do not appear excessive.  Overtime our portfolio performance should revert to the 19% - not shabby. After all the dry number crunching, my conclusion is: “Wow what a portfolio and there is more to come!”

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