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Is This Popular Investing Myth Hurting Your Portfolio?

By Meb Faber, co-founder, Cambria Investment Management
Thursday, May 11, 2017

Today, we're taking a look at the damage that one popular investing myth may be doing to your portfolio...
 
A comparison is only as good as the universe you decide to include. For example, it's easy to believe one type of investment or investing strategy beats all the others. But if your comparative analysis leaves something out, you might not realize a better option is out there. And you might fall prey to investing myths.
 
It's crucial that you apply all appropriate comparisons when evaluating a strategy. In today's essay, I'll apply this point to a common investing belief involving a certain group of stocks...
 
I'm talking about dividend-growth stocks. If you're not already familiar, these are shares of companies that raise their dividends steadily over time.
 
A quick search for "dividend growth" on Google returns some impressive-looking graphs. Here's a breakdown of one of the first that comes up from investment-management firm Ned Davis Research. Ned Davis looked at the hypothetical performance of $100 invested in each of five strategies, from 1972 to 2013...
 
Type of Stock
Percent Return
Dividend Growers and Initiators
5,897%
All Dividend-Paying Stocks
4,031%
Dividend Payers With No Change in Dividends
2,099%
Non-Dividend Payers
164%
Dividend Cutters or Eliminators
-1%
Source: Ned Davis Research, 12/31/13

The takeaway is simple: invest in dividend-growth stocks, right?
 
Usually, this kind of chart is tied to marketing for one of the hundreds of dividend exchange-traded funds or dividend mutual funds available to investors.
 
So what's wrong with this picture? After all, dividends have a great brand and tell a great story...
 
The problem is that it's incomplete.
 
I partnered up with my good friends at asset-management firm Alpha Architect, and had CFO Jack Vogel run some simulations on dividend stocks for us. Here's what we found dating back to 1982:
 
1982-2015
Top 3,000 Stocks
All Dividend Stocks
Dividend Growers
Mkt Cap Weight
11.6%
11.9%
11.5%
Equal Weight
11.6%
13.6%
13.6%

Hmmm – sort of at odds with the first table. Where's all that towering outperformance of dividend growers?
 
It turns out that Ned Davis (whom we love more than any quant shop on the planet) had been calculating the returns in a different way than what we're currently used to. The Ned Davis statistics were based on geometrically weighted indices. When they created them over 15 years ago, geometric indices were common. However, the industry has since shifted to arithmetic indeces. One of the reasons is that geometric means suppress the performance of outliers. Two years ago, Ned Davis introduced arithmetic-weighted dividend charts.
 
Now, with updated return calculations going back to 1973, Ned Davis shows dividend growers returning 12.9%, all dividend stocks returning 12.8%, and the S&P 500 Equal Weight Index returning 12.4%!
 
So an entire generation of funds was sold on the premise of dividend-growth outperformance. The problem is, it's misleading because it doesn't tell the whole story.
 
If you did a simple sort on high dividend yielders (say, the top 20% of the highest-yielding stocks), you would find they outperform dividend-growth stocks...
 
1982-2015
Top 3,000 Stocks
All Dividend Stocks
Dividend Growers
High Yield
Mkt Cap Weight
11.6%
11.9%
11.5%
13.0%
Equal Weight
11.6%
13.6%
13.6%
14.0%

A recent piece by asset-management firm O'Shaughnessy adds detail to the same conclusion: Dividend investors would do better by focusing on dividend yield rather than dividend growth. From the report...
 
Our research confirms that investors should focus on dividend yield rather than dividend growth rates... High dividend yields are a strong indicator of future outperformance. Paying a dividend forces management to invest cash flow only in opportunities with the most optimal risk/reward tradeoff.

So simple high-yield stocks beat the growers. That's interesting enough as it is. But remember, this essay is about making sure to include all appropriate comparisons when evaluating a strategy. So what are the various marketing pieces of all these dividend-growth funds ignoring?
 
They're all ignoring how corporate culture has changed in past years, such that companies now distribute more than HALF of their cash flows to investors – through buybacks. Once you take a more holistic view of cash distributions, what we call "shareholder yield," the picture changes yet again...
 
Note the significant outperformance in the table below achieved through a shareholder-yield approach...
 
1982-2015
Top 3,000 Stocks
All Dividend Stocks
Dividend Growers
High Yield
Shareholder Yield
Mkt Cap Weight
11.6%
11.9%
11.5%
13.0%
15.4%
Equal Weight
11.6%
13.6%
13.6%
14.0%
15.3%

We recently put out a new white paper "Think Income and Growth Don't Exist in This Market? Think Again" documenting this outperformance, but anyone who has followed me for a while has known about this outcome for far longer.
 
So next time you see a marketing piece – for any strategy – think to yourself... "What better comparison are they omitting?"
 
Good investing,
 
Meb Faber
 
Editor's note: Meb offers expert insights into the market that others overlook. To read more of his strategies and learn how they can make a significant difference in your portfolio, visit CambriaInvestments.com. And don't miss Meb's free podcast, The Meb Faber Show, which has featured both Steve and Porter as guests.




Further Reading:

"Meb Faber is one of my heroes in the investment world," Steve says. Recently, on Meb's podcast, the two discussed a range of topics – including how to learn from your worst mistakes and losing investments. Read Steve's essays covering the podcast here and here.
 
"The go-nowhere investments loitering in your portfolio are a very real opportunity cost (and many times, real dollar cost) to your wealth," Meb writes. "The challenge is viewing our assets with genuine objectivity..." Learn a simple method that will re-focus your portfolio and boost your investment gains right here: The Zero-Budget Portfolio.

Market Notes


VIDEO GAMES ARE AS POPULAR AS EVER

Today, we'll look at the power of investing in addictive products...
 
In the past, we've highlighted the benefits of investing in physically addictive products – like soda, coffee, and alcohol. But what about psychologically addictive products? These aren't things that people physically need... But many crave them nonetheless. Think about Apple iPhones or Nike Air Jordan shoes. People often wait hours, if not days, to get their hands on the newest types of these products. Another great example is video games...
 
For proof, we'll look to three video-game makers: Electronic Arts (EA), Take-Two Interactive Software (TTWO), and Activision Blizzard (ATVI). These companies produce some of the most popular game series in the world – like Call of Duty, Grand Theft Auto, and Madden NFL Football. Customers eagerly await the release of each new game... which, for most of these series, is at least once per year.
 
In the chart below, you can see the steady uptrends in EA, TTWO, and ATVI shares. All three stocks are hitting all-time highs today. As long as people want to play new games, it's a trend that's likely to continue...
 

premium teaser


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