What are we looking for?
Canadian dividend growth stocks with and without a stop-loss order.
The screen
No one enjoys losing money, so when one or more holdings seem to be spiralling downward, it can be very tempting to rid yourself of that seemingly “bad” company in order to replace it with a better one. But is that a good strategy to follow?
Today, I’m testing whether it’s beneficial to sell stocks on the basis that they’ve gone down across a short time-frame. Given the popularity of dividends, I’ve chosen to create a strategy that searches for dividend growing companies with a price stop-loss added as a sell criterion. Any stock that has lost 10 per cent or more in the past 30 days is excluded in today’s portfolio; in back-testing this strategy over a period of time, our stop-loss order meant that any stocks in the portfolio that had dropped more than 10 per cent over the previous 30-day period were sold.
This strategy ranks stocks based on:
- Five-year dividend growth – annualized dividend growth across the past five years, high values are preferred;
- Expected dividend growth – percentage change in the next four quarters of expected dividends (according to analysts' consensus) compared with the trailing four quarters of paid dividends, high values are preferred;
- Quarterly earnings surprise (not shown) – proprietary measure of the difference between actual and expected quarterly earnings according to analysts' consensus; high values are preferred.
In order to qualify, stocks must have a five-year dividend growth in the top third of peers (today this value is greater than or equal to 9.4 per cent); a positive expected dividend growth; a five-year standard deviation of returns in the bottom 50 per cent of peers (today this value is less than or equal to 43.44) in order to help manage swings in returns; a dividend payout ratio less than or equal to 75 per cent to ensure companies have excess earnings for growth purposes; and lastly, a five-year sales growth greater than or equal to zero.
More about Morningstar
Morningstar Research Inc. provides independent investment research in North America, Europe, Australia and Asia. Its research tool, Morningstar CPMS, provides quantitative North American equity research and portfolio analysis to institutional clients and financial advisers.
What we found
I used Morningstar CPMS to back test this strategy from Jan. 31, 2004, to Nov. 30, 2018. During this process, a maximum of 15 stocks were purchased. No more than five stocks per economic sector could be held at any time. Stocks were sold if their five-year dividend growth fell into the bottom third of peers, if their dividend payout ratio went above 80 per cent or – using stop-loss – if their price dropped more than 10 per cent over the previous 30 days.
When sold, the positions were replaced with the highest-ranked stock not already owned in the portfolio. Over this period, the strategy produced an annualized total return of 12.6 per cent while the S&P/TSX Composite Total Return Index returned 6.9 per cent across the same period.
The same strategy – but with no stop-loss – returned 12.5 per cent with a turnover (an annualized metric representing how often stocks are bought/sold each year) of 34 per cent, whereas the strategy with a stop-loss added had a turnover roughly double at 79 per cent. The results here seem to conclude that adding a stop-loss for this particular dividend model required investors to trade more but didn’t significantly affect the performance.
Stocks that qualify for purchase into the strategy today are listed in the accompanying table. As always, investors are encouraged to conduct their own independent research before purchasing any of the investments listed here.
Emily Halverson-Duncan, CFA, is a director, CPMS sales at Morningstar Research Inc.
Emily Halverson-Duncan, CFA