Retirees seeking high-dividend stocks should remember what happened to General Electric GE, +13.02% last year.
The stock’s yield at the beginning of 2018 was high enough—at 2.75%—to qualify in some stock screens as a high-yielding stock. GE was a member of the famous Dogs of the Dow strategy, for example, which calls for investing each New Year’s in the 10 highest yielding stocks within the Dow Jones Industrial Average DJIA, -0.25%
A funny thing happened on the way to the bank, however: GE’s stock fell by more than 55% in 2018. But for two other stocks, GE was the worst performer of the year of any within the S&P 500 SPX, +0.66%
To be sure, GE’s spectacular fall from grace is unusual. But it’s not unprecedented. The Achilles’ heel of any dividend-stock strategy is that a high-dividend company’s dividend yield comes down not because its price rises but because the company cuts its dividend.
The best-performing dividend stock newsletter among services tracked by my Hulbert Financial Digest therefore suggests that we not focus on dividend yield alone when deciding the dividend stocks in which to invest. This newsletter is Investment Quality Trends, edited by Kelley Wright. It is in first place for risk-adjusted performance over the last 30 years, having produced an 11.0% annualized return since 1989, versus 9.9% for the dividend-adjusted Wilshire 5000 index W5000FLT, +0.66% Even better, this market-beating performance was produced a 9% less volatility, or risk.
Wright believes there are two fundamental problems with approaches that mechanically skew toward the highest-yielding stocks:
•A given yield may indicate undervaluation in the case of one stock and overvaluation in another. Each stock has its own unique range of historical dividend yields, and in order to assess whether it represents good value you need to compare its current yield with that range. To illustrate, consider American Express and Arthur J. Gallagher AJG, +1.55% Even though the latter yields significantly more than the former (2.2% versus 1.6%), Wright considers American Express to be undervalued and Arthur J. Gallagher to be overvalued.
•The second problem with automatically favoring the highest-yielding stocks, according to Wright: It leaves you vulnerable to what happened to GE last year. To protect clients from that possibility, Wright only considers stocks that satisfy a demanding set of financial strength criteria.
To appreciate how big a difference Wright’s approach makes, consider that just two of the 10 current Dow Dogs appears in his “Lucky 13” portfolio of top dividend stocks for 2019: Exxon Mobil XOM, +0.24% and IBM IBM, -0.39%
The remaining stocks on Wright’s “Lucky 13” list are:
•AbbVie ABBV, +1.91%
•Altria Group MO, +1.76%
•American Express AXP, -0.29%
•Cummins Inc. CMI, +0.07%
•Eastman Chemical EMN, -1.77%
•Lockheed Martin LMT, -0.74%
•Public Storage PSA, +0.58%
•Raymond James RJF, -0.82%
•TJX Companies TJX, +0.19%
•Texas Instruments TXN, -0.85%
•Whirlpool WHR, +0.34%
As you can see from the accompanying chart, the superiority of Investment Quality Trends’ approach over the Dogs of The Dow is incremental, adding up to a significant difference only over long periods. On an annualized basis, the difference in their returns over the last 20 years is between 9.0% and 7.9%.
But, due to the power of compounding, that translates into a big difference: $100,000 invested in the Dogs of The Dow would have grown to $454,594 over the last 20 years, versus $563,108 for Investment Quality Trends.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com.