Screening for Dividend Payers

Source: Capital Pixel

I'm an indexer.  I agree with Warren Buffet that most investors and individuals will do best by indexing the broad stock market.

Still, I belong to the "there is more than one way to skin a cat club" and, if an individual is willing to take the risk, has the time, expertise, emotional fortitude, and resources, he or she may outperform the market with a well-thought out/disciplined approach. Again, I would index at least 80% of the portfolio using it as an anchor for retirement assets and seek to outperform with the rest.

With this caveat in place, let's examine a popular theme and one way to approach it for investors.  The theme centers on the idea that a tsunami wave of retirees is just now beginning, and these retirees will move their assets to produce greater income, i.e. into the dividend sector.

McVey's Approach

Henry H. McVey heads up the asset allocation process at Kohlberg Kravis Roberts and incorporates this idea in what he calls his "Brave New World" thesis as described by Shirley Lazo in "Dynamic Duo."  He screens stocks according to the following criteria:  dividend yield between 2% and 5%, earnings growth between 5% and 15%, 12-month trailing return on equity rising, P/E below sector average, increasing payout ratio or a increasing dividends paid.  Thus, McVey is seeking dividend payers that should be able to increase dividends and offer value on a price basis.

Backtesting this approach achieved an average annualized  return of 11.2% versus 4.9% on the S&P 500 over the period 1/2004 - 11/2011.

The following table shows 10 of the stocks that made the screen (see the above article link for a more complete list):

Source 1/2/2012 Barron's

Click to Enlarge

I believe the approach has possibilities.  I would emphasize, however, that the results reported above were "backtested"!  Backtesting, as we know, can find the best coin flipper out of 30 people by running trials.  It doesn't help us, though, moving into the future.

A second caveat is that I am sensitive to the fact that I've seen companies implode over the past several years that I could never imagine having the problems they brought upon themselves.  These include GE, Ford, Fannie Mae, Merrill Lynch, and many others.  Some would, undoubtedly, have made this list in the past!  As a result, the backtested results suffer as well from what is called selection bias.

The bottom line is - proceed with caution.  This is an approach that has possibilities but has to be watched closely, IMHO!

Disclosure:  Post is for educational purposes only.  Investors need to do their own research before investing.  I hold some of the stocks mentioned above.