What Works With High-Yield Stocks

1/10/2011


When it comes to dividend yields, the rich really are different.

High-yield stocks don't act like other stocks. Historically, the top-yielding stocks have outperformed stocks with smaller yields, but the difference is most notable at the very top and bottom of the spectrum.

We divided the dividend-paying stocks in the Dow Jones Broad Stock Market Index into 33 equal-numbered baskets based on yield. The four baskets with the highest yields — containing mostly stocks yielding 6% or higher, have averaged 12-month returns of at least 13.6% since 1992, with the highest-yielding basket averaging a return of nearly 15%.

Baskets 4 through 31 averaged returns of 11.5% to 13.2%, while the four lowest-yielding baskets managed returns of less than 11.1%.

Since 1992, financial and utility stocks have accounted for an average of more than 75% of the stocks in the highest-yielding basket. The top-yielding baskets also tend to contain smaller, riskier stocks.

Today, 25 of the 35 stocks in the top-yielding basket (71%) are financials, including 21 real estate investment trusts (REITs). The basket features just one technology stock and no industrials, materials, or health-care stocks, limiting its profit-growth potential. Thirty of the stocks have market values below $3 billion. While the highest yielders have averaged superior returns in our back-tests, such concentrated portfolios take on a lot of risk — substantially more than is wise for most income-oriented investors.

High-yielders also act differently when it comes to our Quadrix® stock-rating system. Quadrix still works, but not quite as well as it does with a broader selection of stocks, and the drivers of outperformance in the high-yield universe are not the same.

For example: In a back-test of 12-month returns since 1992, the top one-fifth of Dow Jones Broad Stock Market Index as measured by the Overall score outperformed the average stock in the index by an average of 3.4%. In contrast, among the top one-fifth of stocks as measured by yield, top Overall scorers delivered 2.2% outperformance.

While stock yields fluctuate over time, since 1992 the two top deciles have generally contained the bulk of stocks yielding more than 4.5%.

Among the six category scores used to calculate the Overall score, Value is most effective for the Dow Jones Broad Stock Market Index, as it is for most broad indexes. However, among high-yielders, Value delivers the least amount of outperformance.

Many of the most effective statistics for high-yield stocks are Earnings Estimates and Quality variables. The comparisons aren't perfect, as our data for Earnings Estimates stats (and Value variables based on estimates) only go back to 2004. However, most Value variables don't work as well for high-yielders as they do for the broader index.

Historically, the Forecasts has not recommended many stocks with very high yields — in part because such stocks tend to be concentrated in a small number of industry groups, and in part because few offer the profit growth we seek. We believe the best way to obtain market-beating returns without taking on excessive risk is to own a diversified portfolio of high-quality, reasonably valued stocks selected for total-return potential, not yield. We like higher dividend yields and we like yields high relative to historical norms, but we don't want to sacrifice expected total return for a higher yield.

That said, we realize many investors feel more comfortable with stocks that pay a nice dividend. Such investors may want to check out the table below, which contains five A-rated stocks with yields of at least 2% and Overall, Earnings Estimates, and Quality scores above 70. For a list of high-yield stocks with decent Quadrix scores, visit our Web site at www.DowTheory.com/Go/Yield. We don't recommend the purchase of any of those stocks, but they may interest income-oriented investors willing to take on extra risk.

HIGH-YIELD LEADERS
The five A-rated stocks below are the only ones in our Monitored List that yield at least 2% and earn Quadrix® Overall and Earnings Estimates scores above 70. Of them, only Exxon Mobil ($75; XOM) and Wal-Mart Stores ($55; WMT) are recommended for purchase.
--------------- Quadrix Scores * ---------------
Company (Price; Ticker)
Div.
Yield
(%)
Quality
Earns.
Ests.
Perfor-
mance
Overall
Industry
Chevron
($92; CVX)
3.1
78
97
59
97
Oil & Gas
Exxon Mobil
($75; XOM)
2.3
71
96
53
95
Oil & Gas
Applied Materials
($14; AMAT)
2.0
77
90
44
97
Semiconductors
Du Pont ($50; DD)
3.3
76
97
70
82
Chemicals
Wal-Mart Stores
($55; WMT)
2.2
79
74
19
87
Gen'l Merchandise
* Quadrix scores are percentile ranks, with 100 the best.

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