Dynamic Income & Dividends
A Simple Strategy for Excess Returns DIAD
Philip A. VenanziDuquesne MBAClass of 2015
Factors Driving Returns
Fama-French 5 Factor Model
1. Risk Stocks with a higher beta typically yield higher returns than lower beta stocks
2. Market Cap Small stocks typically outperform large stocks
3. Value & Growth Value stocks usually outperform growth stocks.
4. Profitability (higher future earnings) Stocks with higher future earnings will outperform stocks that will lower future earnings
5. Investment (momentum) Stocks with high momentum outperform stocks with low momentum Highly correlated with the value and profitability factors
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http://www.forbes.com/sites/phildemuth/2014/01/20/whats-up-with-fama-frenchs-new-5-factor-model-the-mysterious-new-factor-v/
Factors Driving Returns
“Warren Buffett on the Stock Market”
1. GDP Growth Does it correlate to growth in stock markets?
2. Interest Rates PV of future earnings:
Higher when interest rates are lower Lower when interest rates are higher
3. Valuation Finding stocks that are undervalued based on valuation of future cash flows
These are the “value stocks” that outperform growth stocks in the Fama-French model Market Cap to GDP – Long-term valuation indicator of the market as a whole
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Manager’s Philosophy
Dynamic Income and Dividend (DIAD) model The philosophy is centered around two main themes:
1) Income Generation2) Consistency
Follow a simple strategy to achieve consistent excess returns over the long-term (20+ years)
Focus on stocks generating consistent:1) Net positive income2) Dividend payouts
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Strategy Objectives
Follow a simple strategy to: Achieve consistent excess returns over the long-term (20+ years) Take advantage of the inefficiencies in the following factors:
1. Small-cap vs. Large Cap performance2. Value vs. Growth performance3. Momentum
Also looks to find stable sources of returns through income
Focus on stocks generating consistent:1) Excess net positive income
2) Dividend payouts
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Screening Criteria
The criteria below was used to achieve these objectives:1. A market capitalization minimum of $125 million
2. A return on investment (ROI) minimum of 12%
3. A previous year dividend yield minimum of 3%
4. A stock price minimum of $1
5. A rank of the 9 highest dividend yielding stocks from the previous year remaining Various screens of 25 and 15 stocks shows less diversification improves returns Additionally, a screen of 5 stocks shows even higher returns, but more down periods
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Screen Input
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Base Set Size Formula Min Max Passed
$C+$R 29866 29866$1 29866 mkval 125 5159$2 5159 roi 12 750$3 750 dvydc[-1] 3 127$4 127 prccm 1 127$5 127 @RANK(dvydc[-1],$) 1 9 9
Criteria Rationale
Price Minimum ($1 per share)
Used to eliminate penny stocks
Market Capitalization Minimum ($125 million)
Used to eliminate micro-cap stocks
However, this screen is meant to capture both large and small caps depending on their income and dividend characteristics Although small-caps typically outperform large-caps, there are inefficiencies in regards to
total returns when accounting for dividends. This screen is meant to capture the inefficiencies between large and small stocks in the
pursuit of excess returns.
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Criteria Rationale (continued)
Return on Investment Hurdle (12%)
Used to screen stocks that have extraordinary income and extraordinary return compared to other investments It is a simple measure that gauges an investments ability to generate return Additionally, it shows the consistency of a stock’s ability to generate income
Previous Year Dividend Yield Hurdle (3%)
In concordance with the ROI criteria, this ensures that investors receive at least 9% capital appreciation return and an additional 3% for reinvestment This screen also ensure the stocks in the portfolio show a consistent ability to generate
income and provide shareholders with additional cash payouts
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Criteria Rationale (continued)
Rank 9 Stocks by Highest Previous Year Dividend Yield
Of the stocks that remain, ranking the stocks with the highest previous year dividend yield has proven to deliver higher returns
Screens of 25 and 15 highest ranked previous year dividend yields show that diversification hurts returns.
Although 5 stocks results in an even greater return, it begins to open up the portfolio for larger drops in down periods and less frequent beats of the major indices.
9 stocks was considered the optimal amount of diversification because beyond the range between 5 and 9 stocks, the marginal decrease in returns typically becomes more consistent, while the jump between 15-25 to 5-9 is substantial. The graph on the next page illustrates this point.
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Criteria Rationale (concluded)
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Results of the Model
Only one period where the portfolio does not beat the S&P 500
Worst period return was -26.4% and only experienced two down periods
An initial $10,000 investment at the end of 20 years:
$121,023,200DIAD
SummaryCumulative. Ret. Annualized Ret. Average Ret Best Period Worst Period
Portfolios 1210232.0% 60.0% 74.0% 372.6% -26.4%S&P 500 554.1% 9.8% 11.7% 37.5% -37.0%S&P MidCap 1021.8% 12.8% 14.4% 37.4% -36.2%S&P SmallCap 800.9% 11.6% 13.0% 41.3% -31.1%Beats S&P 500 19 out of 20 PeriodsBeats S&P MidCap 20 out of 20 Periods Number of Down Periods: 2Beats S&P SmallCap 20 out of 20 Periods
Results of the Model
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Index Returns Excess Returns vs. Individual Returns
Rebalance Date
Return thru12-month
Return90-Day T
BillS&P 500
S&P MidCap
S&P SmallCap
90-Day T Bill
Portf. Sharpe Ratio
Lowest Highest Avg. # Stocks%
TurnoverSTD
Dec13 Dec14 20.7% 13.7% 9.8% 5.7% 0.0% 7.0% 11.0% 15.0% 20.7% 0.85 -13.3% 37.5% 20.7% 9 66.7% 83.91%Dec12 Dec13 113.5% 32.4% 33.5% 41.3% 0.1% 81.1% 80.0% 72.2% 113.4% 0.87 -21.7% 373.2% 113.5% 9 66.7% 85.32%Dec11 Dec12 63.8% 16.0% 17.9% 16.3% 0.1% 47.8% 45.9% 47.5% 63.7% 0.83 13.8% 149.6% 63.8% 9 33.3% 87.25%Dec10 Dec11 4.0% 2.1% -1.7% 1.0% 0.0% 1.9% 5.8% 3.0% 4.0% 0.81 -54.7% 51.2% 4.0% 9 66.7% 89.91%Dec09 Dec10 107.2% 15.1% 26.6% 26.3% 0.1% 92.1% 80.5% 80.9% 107.1% 0.84 72.4% 207.6% 107.2% 9 44.4% 91.05%Dec08 Dec09 151.9% 26.5% 37.4% 25.6% 0.1% 125.4% 114.5% 126.3% 151.8% 0.80 60.6% 313.5% 151.9% 9 77.8% 93.88%Dec07 Dec08 -26.4% -37.0% -36.2% -31.1% 0.1% 10.6% 9.9% 4.7% -26.5% 0.73 -68.3% 17.0% -26.4% 9 55.6% 94.88%Dec06 Dec07 120.4% 5.5% 8.0% -0.3% 3.3% 114.9% 112.4% 120.7% 117.1% 0.81 -96.2% 377.6% 120.4% 9 33.3% 94.49%Dec05 Dec06 59.1% 15.8% 10.3% 15.1% 4.9% 43.3% 48.8% 44.0% 54.2% 0.75 18.0% 143.7% 59.1% 9 22.2% 97.88%Dec04 Dec05 49.8% 4.9% 12.5% 7.7% 4.0% 44.9% 37.3% 42.1% 45.8% 0.73 -5.0% 123.3% 49.8% 9 33.3% 102.46%Dec03 Dec04 76.4% 10.9% 16.5% 22.6% 2.2% 65.5% 59.9% 53.7% 74.2% 0.73 9.5% 201.4% 76.4% 9 44.4% 107.52%Dec02 Dec03 118.0% 28.7% 35.6% 38.8% 0.9% 89.4% 82.4% 79.3% 117.1% 0.69 23.6% 288.9% 118.0% 9 55.6% 114.03%Dec01 Dec02 -9.5% -22.1% -14.5% -14.6% 1.2% 12.6% 5.0% 5.1% -10.7% 0.61 -44.8% 38.3% -9.5% 9 33.3% 120.92%Dec00 Dec01 29.3% -11.9% -0.6% 6.5% 1.7% 41.1% 29.9% 22.7% 27.6% 0.68 -37.2% 157.2% 29.3% 9 44.4% 125.31%Dec99 Dec00 35.2% -9.1% 17.5% 11.8% 5.7% 44.3% 17.7% 23.4% 29.4% 0.71 -71.1% 209.2% 35.2% 9 55.6% 134.37%Dec98 Dec99 372.6% 21.0% 14.7% 12.4% 5.2% 351.5% 357.9% 360.2% 367.4% 0.74 -63.6% 2619.4% 372.6% 9 55.6% 145.82%Dec97 Dec98 24.6% 28.6% 19.1% -1.3% 4.4% -3.9% 5.5% 25.9% 20.3% 2.10 -55.3% 222.7% 24.6% 9 44.4% 20.92%Dec96 Dec97 76.4% 33.4% 32.2% 25.6% 5.2% 43.1% 44.2% 50.8% 71.2% 3.06 -28.5% 247.1% 76.4% 9 55.6% 16.89%Dec95 Dec96 48.2% 22.9% 19.2% 21.3% 5.1% 25.2% 29.0% 26.9% 43.1% 27.09 -34.5% 163.6% 48.2% 9 66.7% 1.55%Dec94 Dec95 45.9% 37.5% 30.9% 30.0% 5.0% 8.3% 14.9% 15.9% 40.9% -- -17.3% 106.9% 45.9% 9 --
Results of the Model
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Return ValuesFrequency: Annually
Return Bar Graph
-100.0%
400.0%
-80.0%-60.0%-40.0%-20.0%
0.0%20.0%40.0%60.0%80.0%
100.0%120.0%140.0%160.0%180.0%200.0%220.0%240.0%260.0%280.0%300.0%320.0%340.0%360.0%380.0%
Dec1994
Dec2014
Dec1995
Dec1996
Dec1997
Dec1998
Dec1999
Dec2000
Dec2001
Dec2002
Dec2003
Dec2004
Dec2005
Dec2006
Dec2007
Dec2008
Dec2009
Dec2010
Dec2011
Dec2012
Dec2013
DIAD S&P 500 Russell 3000 TR USD
Results of the Model
DIADTime
Compound ReturnFrequency: Annually
Compound Return Graph
0.0%
1300000.0%
100000.0%
200000.0%
300000.0%
400000.0%
500000.0%
600000.0%
700000.0%
800000.0%
900000.0%
1000000.0%
1100000.0%
1200000.0% 1210232.0%
568.9%
Dec1994
Dec2014
Dec1995
Dec1996
Dec1997
Dec1998
Dec1999
Dec2000
Dec2001
Dec2002
Dec2003
Dec2004
Dec2005
Dec2006
Dec2007
Dec2008
Dec2009
Dec2010
Dec2011
Dec2012
Dec2013
DIAD S&P 500 Russell 3000 TR USD
Results of the Model
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Index Values (USD)Frequency: Annually
Index Line Graph
9,000.0
200,000,000.0
10,000.0
20,000.030,000.0
50,000.0
100,000.0
200,000.0300,000.0
500,000.0
1,000,000.0
2,000,000.03,000,000.0
5,000,000.0
10,000,000.0
20,000,000.030,000,000.0
50,000,000.0
100,000,000.0 121,033,200.5
66,762.9
Dec1993
Dec2014
Dec1994
Dec1995
Dec1996
Dec1997
Dec1998
Dec1999
Dec2000
Dec2001
Dec2002
Dec2003
Dec2004
Dec2005
Dec2006
Dec2007
Dec2008
Dec2009
Dec2010
Dec2011
Dec2012
Dec2013
DIAD S&P 500 Russell 3000 TR USD
Summary Statistics
• Over a 20 year period, the DIAD portfolio strategy achieves returns of more than 6x that of indices that measure aggregate market performance.
• On a risk adjusted basis, DIAD does offer above average risk-adjusted returns, but due to the high standard deviation, the Sharpe ratio remains under 1.
• Additionally, the risk of the portfolio is very high, but it has low correlation to the market. Thus, this portfolio has capitalized on the inefficiencies that exist in the market.
N Periods Geometric
Mean (%)
Arithmetic
Mean (%)
Standard
Deviation
(%)
Sharpe
Ratio
P/E Ratio Beta R-Squared N Positive
Periods
N Negative
Periods
DIAD 20 60.01 74.05 84.31 0.8783 0.0000 1.8803 0.19 18 2
S&P 500 19 9.65 11.64 20.14 0.5781 0.0000 1.0004 1.00 15 4
Russell 3000 TR USD 20 9.96 11.82 19.42 0.6087 0.0000 0.9880 0.99 16 4
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Conclusions This trading model is a simple, yet effective screening criteria that seeks out stocks that
generate consistent above average income and dividend distributions.
Beating the S&P 500 for 19 out of 20 periods and only 2 down periods (during periods of crisis in 2001-2002 and 2007-2008), this model exhibits return characteristics that consistently outperform indices that capture returns of the market in the aggregate.
Additionally, this model is consistent with traditional portfolio theory. The more diversified, the lower returns will be. Thus, if you are looking for more diversification and one fewer down period, you can increase your
number of stocks to 15 or 25. If you want to even higher returns but increased downside risk, you can reduce your number of
stocks to 5.
Lastly, this model has above average risk, but offers above average returns in excess of the risk taken. Additionally, the lack of correlation with the market is a characteristic that mitigates the downside risk when the market as a whole declines.
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Areas for Future Refinement Continue to reevaluate the optimal hurdle levels for:
Previous year annual dividend yield Return on investment
See if there are opportunities for even higher returns by focusing on: A model that switches between the number of stocks based on previous year returns:
Essentially, can previous year results indicate the raising or lowering the number of stocks the model should invest in the following year?
Find ways to lower downside risk without sacrificing the upside potential: Can additional asset classes beyond equities help achieve this goal?
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