Thursday, March 8, 2012

Should You Be Buying Dividend Paying Stocks?

There has been a lot of press lately about the merits of buying dividend paying stocks.  The so called experts have decided that the next few years in the market are likely to be mediocre so why not get a return from dividends?  Setting aside the fact that nobody knows what the market is likely to do this post will compare a couple of different strategies:

1.       Buying a dividend stock ETF,  iShares Dow Jones Select Dividend Index (DVY)

2.       A relative strength strategy that rotates among a group of dividend paying stocks

3.       A relative strength strategy that rotates among asset classes—US Stocks, International, REITs, commodities, and bonds

I did a comparison of each of these strategies over the past 5 years ending 3/7/12.  The comparison does not include any fees, commissions, or taxes.  For the DVY I just assume you buy and hold it.  For the relative strength dividend stock strategy we start with a basket of 10 high yielding stocks---Verizon, AT&T, Merck, Pfizer, GE, Intel, Johnson & Johnson, Dupont, and JP Morgan.  Each month we use our proprietary relative strength analysis to buy the top five stocks in equal weights.  For the relative strength asset class strategy we have a basket that includes bonds, US stocks, international developed stocks, emerging market stocks, REITs, and commodities.  Each month we use our proprietary relative strength analysis to buy the top four asset classes in equal weights. 

Results are below:

5 yr   Avg Annual Return
5 yr Sharpe Ratio
2008 Performance
Buy and hold DVY
Relative Strength Dividend stocks
Relative Strength Asset Classes

Buying and holding the DVY was the worst of the three strategies, mostly because of the awful performance in 2008.  While the dividend stocks didn’t do as poorly as the S&P 500, losing over 32% still stinks.  The relative strength strategy did a little better but still lost a bunch in 2008.  The best by far was the strategy that rotated among asset classes.  The key take away from this simple study is that every asset class---dividend stocks, gold, bonds, etc--- has merit at different times.  A strategy of buying and holding any asset class can be extremely dangerous.  Instead, investors should stay in harmony with market trends and buy the asset classes that are in an uptrend and sell the ones that aren’t. 

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