Looking for dividends? Here’s three twists on a popular approach

It’s time to indulge in Christmas movies, and revisiting Mr. Scrooge’s transformation from miser to mentor is high on the list.

When it comes to investing, Mr. Scrooge enjoyed his dividends, and his fellow income investors might be tempted to act like Oliver Twist by saying they want some more, please.

In the spirit of the season, I lend them a hand with three versions of my Stable Dividend portfolio. With a little luck, they’ll generate enough profit to provide a bounty of charitable donations in the future.

The three portfolios use a version of the Stable Dividend portfolio as a starting point. In its original form, the portfolio begins with the largest 300 common stocks on the Toronto Stock Exchange (TSX), selects the dividend payers and picks the 20 stocks with the lowest volatilities over the prior 260 days. As a result, it’s full of stocks many would consider to be suitable for widows and orphans.

The portfolio’s three variants start with the 300 largest stocks on the TSX, keeps the dividend payers and narrows in on the 50 stocks with the lowest volatilities over the prior 260 days. As a final step, each variant picks 10 low-ratio stocks from the remaining 50 low-volatility stocks using three ratios value investors appreciate.

The Frugal Dividend portfolio is the first of the three variants. It picks the 10 stocks with the lowest price-to-earnings ratios (P/E) and is regularly updated on The Globe and Mail’s website along with the Stable Dividend portfolio.

The Stable Cash portfolio is the second variant. It was highlighted last winter and picks the 10 stocks with the lowest price-to-cash-flow ratios (P/CF).

The Stable Free Cash portfolio is a twist on the Stable Cash portfolio because it selects the 10 stocks with the lowest price-to-free-cash-flow ratios (P/FCF).

The three portfolios provided prodigious profits over the long term. The Frugal Dividend portfolio climbed by an average of 15.5 per cent annually over the 25 years to the end of November, the Stable Cash portfolio advanced at a 13-per-cent annual rate and the Stable Free Cash portfolio climbed at a 16-per-cent annual rate. (In this case, all of the portfolios were rebalanced monthly.)

In comparison, the S&P/TSX Composite Index lagged with annualized returns of 7.8 per cent over the same 25-year period. (The returns herein are based on backtests using data from Bloomberg and equally-weighted portfolios. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)

The accompanying graph highlights the return history of the three portfolios along with those of the market index.

I hasten to add that opting for annual rather than monthly rebalancing also worked well. The 25-year compounded annual growth rate came in at 15.3, 14.1 and 13.7 per cent for the Frugal Dividend, Stable Cash and Stable Free Cash portfolios when they were rebalanced yearly.

The three portfolios performed similarly in downturns, but, to my eye, the Stable Free Cash portfolio enjoyed a slight advantage.

For instance, the worst downturn for the portfolios over the 25 year period happened in the financial crisis of 2008-2009 when the market index fell 43 per cent from its former highs. The portfolios held up better with declines of 35, 30 and 29 per cent for the Frugal Dividend, Stable Cash, and Stable Free Cash portfolios.

The volatility (standard deviation) of the portfolios over the 25 year period was 13.5, 12.8 and 12.5 per cent for the Frugal Dividend, Stable Cash and Stable Free Cash portfolios. Once again, the Stable Free Cash portfolio fared a bit better on this measure.

Mind you, the difference between the portfolios’ performance on the downside was modest and might not be similar in future downturns.

Overall, I tend to favour the Frugal Dividend and Stable Free Cash portfolios, but I hope that all three will continue to generate good returns over the long term. With a little luck, investors will keep Christmas in their hearts and share their good fortune.

You can find a list of the stocks in the three portfolios via this link, which also provides updates to many of the other portfolios I track for The Globe.

Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.