CNS - Best High Growth Dividend Stocks - From The 4 Factor Strategy

2023-10-26 16:06:32 ET

Summary

• The 4 factor dividend growth strategy aims to blend the ease of investing in an ETF with the appeal of holding individual stocks.
• The strategy focuses on high-quality companies with above-average dividend yields to generate market-beating returns.
• The strategy has shown mixed results so far, outperforming the market in some months but underperforming in others.

4 Factor - High Growth Strategy

If you follow me here on Seeking Alpha you may be familiar with the 4 factor dividend growth strategy I published almost a year ago. I came up with this strategy last October, launched the first portfolio on November 1st and summarized the process in this article published on November 24th, 2022. Ever since I've been documenting how this portfolio has performed on a monthly basis, spoiler, it's been doing quite well and sits slightly ahead of the S&P 500 as we approach the 1-year mark.

A few months ago I started tracking the stocks this strategy finds on a monthly basis. The reason for this was twofold: to build a dataset that can be analyzed for correlations, and to test various re-constitution frequencies. A high growth focus has its advantages and drawbacks, the main being higher volatility compared to the broad market. The portfolios presented by this strategy should outperform during positive market periods but they may experience larger losses during negative market periods. Therefore, this should be viewed as a long term strategy best measured over a period of 5-10 years. Historically, the stock market had more positive return months than negative returns month. Theoretically, if a portfolio can outperform during months when the market is up while not giving up too much on the downside, such a portfolio should outperform the market in the long run, provided the stock market continues to experience more positive than negative return months in the future.

The high growth strategy is ideal for investors that have a long term mindset, favor growth over yield, and are looking for a simple actively managed portfolio strategy. The 4 factor strategy is a blend of automation with minor influence from the individual investor as to what subset of the investable universe to target. Explained below is the high growth focus of this strategy along with the initial results.

The objective of the 4 factor strategy is to automate the stock selection process by identifying high quality companies with the potential to deliver a market beating total returns. This is a passive style of investing where the process selects the top 20 stocks for inclusion in the portfolio.

It all starts with building the initial universe of stocks that all meet specific fundamental criteria. The criteria for inclusion in the high dividend growth universe are:

1. A payout ratio no greater than 80%.
2. A 3 and 5-year dividend growth rate of at least 5%.
3. A 5-year revenue growth rate of at least 5%.
4. A 5-year earnings per share growth rate of at least 5%.
5. A wide or narrow economic moat rating.
6. A standard or exemplary stewardship rating.
7. The stock must trade on the NYSE or the NASDAQ.

These criteria aim to identify businesses that have a history of operational growth, have an economic moat, are ran by competent management teams and have a commitment to paying and increasing dividends. There is no focus on the starting dividend yield in this strategy but I will share with you the starting dividend yields later on in the article.

The number of companies that pass this initial filter to be included in the universe of stocks varies from month to month. Between May and September there were as few as 133 stocks and as many as 136 stocks included in the screening process, not a very wide range.

Once the universe of stocks is set, the following step is to rank all of the stocks using the 4 factor stock selection process. As the name implies the process uses 4 financial factors to seek out the top 20 stocks. These 4 factors are:

1. Free Cash Flow to Total Debt Ratio.
2. 5-Year Dividend Growth Rate.
3. Return on Capital.
4. Forward Dividend Yield.

I borrowed this stock selection strategy from the Dow Jones U.S. Dividend 100 Index, the underlying index for the Schwab U.S. Dividend Equity ETF ( SCHD ). The Dow Jones Index starts with a much more broad initial universe of stocks and their 4 factor stock selection process includes the return on equity, unlike mine that favors the return on capital.

I started tracking this strategy at the end of May of this year, and I have done so every month since. I am also tracking the performance that each monthly top 20 stock list has attained thus far. And I have included 4 different rebalancing frequencies in the test to see if a more frequent re-constitution of stocks will lead to favorable results. The rebalancing frequencies are as follows:

• Annual (for taxable accounts).
• Semi-Annual.
• Quarterly.
• Monthly.

Under each rebalancing frequency the original list of stocks is rebalanced with the top 20 stocks selected for the upcoming month. Since more frequent rebalancing may create tax obligations it makes more sense to apply such strategies in tax-free or tax-deferred accounts. The primary reason why I am testing 4 different rebalancing frequencies is to see if more frequent re-constitutions lead to better outcomes.

Each month's top 20 list is tracked for a rolling 12-month window, which is the optimal holding period for this strategy. Let me share the initial results with you next.

Summary of Results

The table below shows the performance results for the June 2023 Top 20 High Growth Dividend Stocks.

The return shown for October is a partial price-only return as of market close on October 26th.

As you can see the top 20 high growth dividends stocks chosen for the month of June are thus far outperforming the SPDR S&P 500 Trust ETF ( SPY ) and SCHD, under every rebalancing frequency. The more frequent rebalancing periods are thus far not performing better compared to the not rebalanced portfolios.

A full list of the top 20 stocks for each month is shown in the next section.

The table below shows the performance results for the July 2023 Top 20 High Growth Dividend Stocks.

As you can see the top 20 high growth stocks chosen for the month of July are underperforming both SPY and SCHD, under every rebalancing frequency.

The initial observation has been that this strategy tends to outperform SPY and SCHD while the market is experiencing positive growth, and it tends to underperform both benchmarks while the market is declining. Since the last 2.5 months have seen equity valuations decline the strategy is not performing well overall.

Given that when measured over long periods of time the stock market has more periods of positive returns than negative returns, this strategy should perform well over the course of several years.

The table below shows the performance results for the August 2023 Top 20 High Growth Dividend Stocks.

The August top 20 list is also underperforming SPY and SCHD across all rebalancing frequencies, with all 3 months seeing negative overall returns. It is also important to note that the monthly rebalanced portfolio is performing the worst thus far.

The table below shows the performance results for the September 2023 Top 20 High Growth Dividend Stocks.

Similar to the August top 20 list, the chosen stocks for September are trailing SPY and SCHD across all rebalancing frequencies. All rebalancing frequencies have the same exact returns as the top 20 list remained unchanged between September and October.

The table below shows the partial performance results for the October 2023 Top 20 High Growth Dividend Stocks.

The October top 20 list is also not off to the best start as it trails SPY by 1.64% and SCHD by 0.79% with only 8 market days left in the month.

The 4 factor strategy is a long-term strategy with an intended minimum holding period of 12-months. While overall the initial results are not that great I intend to judge this strategy's success based on rolling 12-month returns.

Here are the initial success rates for the first 4 full months plus partial October, for each rebalancing frequency. As you can see the strategy is not off to the best start but I believe this strategy has the potential to outperform the High Yield 4 Factor Strategy I shared on seeking alpha previously. Thus far the high yield strategy is performing much better.

Top 20 Stocks by Month

Each month I follow the same process to update the list of the top 20 high growth dividend stocks for the upcoming month. From month-to-month, the list does not change by much but I have observed turnover on the list in 3 out of the last 4 months. This is expected, as the 4 factors are updated each month stocks move up and down in the rankings. Below are the top 20 stocks selected for each month thus far, in the original rank order, with new stocks bolded.

During the last 4 months there has been on average one new stocks appearing on each months top 20 list. This equates to a 5% turnover rate each month. This appears to be quite low and I expect to see this percentage tick up over the next few months.

Starting Metrics

Given that the focus of this strategy is to generate an attractive dividend growth rate it's prudent we take a look at the average metrics from each monthly top 20 list thus far. Below are the average metrics for each of the 4 factors, for each month:

The average starting dividend yield has ranged from a low of 2.05% in August to a high of 3.15% in June, with the average being roughly 2.40%. Not a bad starting dividend yield for a dividend growth oriented portfolio.

The average 5-year dividend growth rates also appear to be quite attractive, hovering right around 20%. With the exception of the dividend yield, the 4 factor metrics have remained rather consistent from month to month.

Final Thoughts

Investing is inherently risky and this rules based approach to investing carries risk of loss as well. While I don't recommend for anyone to adopt this strategy, I hope it can inspire you to create your own investing strategy that is tailored to your own goals and objectives. Thus far I have deployed two actual portfolios leveraging the 4 factor strategy, both have adopted this original high growth focused strategy. The first portfolio was launched on November 1st, 2022, this portfolio is approaching its one year anniversary at the end of this month. The second portfolio with a slightly higher asset value was launched on September 1, 2023, using the list provided in the tables above. As of today this portfolio is underperforming SPY and SCHD by roughly 2%.

The high growth 4 factor strategy is my personal favorite out of all the 4 factor strategies I am tracking. I have a very long outlook for my personal portfolio and therefore my primary objective is on long term growth and total return. While I like a high dividend yield as much as any dividend investor I realize that a more growth oriented strategy will increase my probability of maximizing my total return in the next few decades.

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