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Happy May 19th Weekend Folks.
It's been over half a year since I've updated this blog -- no real reason except "life". Much as occurred in my world (all good), and my time for writing my thoughts and results seems to be stabilizing. Hence, here I am again.
Today's scribbles will provide context on a strategy that many of you know I've been using / iterating / improving for years -- my Greenfield Stock strategy. There are many entries on this so I'll just hit the highlights today, and feel free to post questions (if you have a question I'm sure others will too). I prefer that you use the box at the bottom of this entry, but of course, you can send an email to GreekGodTrading [a t] g m a i l [d ot] c o m (intentionally made difficult for the bots to read and spam me -- so fix it as your intuition tells you).
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Greenfield Stocks Foundation
The premise of the Greenfield strategy is that I will only transact in stocks if the meet the following basic, minimum requirements:
1) Revenues must be increasing on a year-over-year (YoY), quarter-over-quarter (QoQ) compared to the same quarter a year ago, and trailing 12-months (TTM) must be positive growth compared to the one-year-ago TTM.
2) Earnings must be increasing on a year-over-year (YoY), quarter-over-quarter (QoQ) compared to the same quarter a year ago, and trailing 12-months (TTM) must be positive growth compared to the one-year-ago TTM.
3) Free-cash-flow (FCF) must be positive.
These three components are loosely tied to my adaptation of William O'Neil, Mark Minervini, and others of the IBD genre. I've done extensive backtesting and forwardtesting of these (and other related parameters) and my belief is that it all starts with proper stock selection.
Note that REV + EPS + FCF are linked in an "AND" statement -- all must be true or the stock is rejected.
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Applying the Greenfield Stocks in a Real Strategy
Many of you are aware that I use TradeStation as my platform and that I have a number of "scanners" that run on a daily basis, internally producing the Greenfield lists for me.
The large majority of you do not have these scanners, so there is another path that you can use -- the U.S. Dividend Champions List that is updated monthly and can be found here:
https://www.dripinvesting.org/tools/tools.asp
This is a free list, updated at the end of the month, and it produces a master list of all stocks meeting a certain dividend criteria, as well as individual lists that break down into the following names / criteria:
1) Dividend Champions: U.S. Companies with 25+ Straight Years Higher Dividends
2) Dividend Contenders: U.S. Companies with 10 to 24 Straight Years of Higher Dividends
3) Dividend Challengers: U.S. Companies with 5 to 9 Straight Years of Higher Dividends
If a company cuts their dividend then the stock is removed from the list. It's that simple.
The premise of the list is that if you are desiring self-funding through dividend replacement, that over a long period of time you can grow your nest egg using both the capital appreciation of this list as well as the dividend-reinvestment potential from this list.
The latest list has 879 stocks between the three categories, and this is quite overwhelming to pick/choose where to start.
Over the years I've had numerous discussions with many of you and there are as many ways to invest in this list as their are conversations. There is no "right" answer, so don't expect one here. This being stated, if I take the lists and apply my "Greenfield Strategy" to each of the lists, we can start to drop the numbers of potential stocks from 879 to something more manageable.
1) Dividend Champions: 37 stocks remain, list is here.
2) Dividend Contenders: 79 stocks remain, list is here.
3) Dividend Challengers: 186 stocks remain; list is here.
This process culls the 879 list down to 302. Still a large number, but slightly more manageable.
These 302 stocks have two characteristics that I think is relatively important: performance and volatility.
Historically, if we ignore dividends, the S&P 500 has returned 5.97% annually at an average volatility of 17.90%. There is a metric for this -- it's called the Sharpe Ratio (SR), and it is simply a ratio of the return that we receive vs. the risk taken. Higher numbers are better. The historical, long-term SR of the market is 0.3335. This is our benchmark. If a given portfolio that we are evaluating has a higher SR, then it probably is a better investment to go with the new portfolio. If lower, it is better to simply invest in an ETF that invests in the S&P 500, as over the longer term, the reward/risk ratio favors that the ETF will do better.
I have software that helps me build portfolios and determine the SR for a given portfolio. The software ignores dividends, so this these numbers are based purely on capital appreciation.
If I take the Greenfield lists above, and I crank them through the software, here is what I get in terms of historical performance and volatility:
1) Dividend Champions: 4.80% annual return, 11.45% annual volatility, SR = 0.21
2) Dividend Contenders: 5.16% annual return, 12.53% annual volatility, SR = 0.22
3) Dividend Challengers: 5.34% annual return, 12.77% annual volatility, SR = 0.23
Something should be obvious to you: the stocks that have been around the longest -- the Dividend Champions -- are generally big companies and do not have a large annual average return over their life; they also have lower volatility. Contrasting, the stocks that have been around the shortest time who have been paying constant dividends, the Dividend Challengers (5-9 years), have higher annual return but also higher volatility.
Probably the most important -- note the relative stability of the reward/risk. There isn't a great deal of difference in the reward received vs. the risk returned between any of the three classifications, hence, the use of the the SR metric points to "doesn't matter" but since the return is bigger with Dividend Challengers, on a year-over-year basis, you are much further ahead in using the Dividend Challengers list than any other, simply because there is a bias upward that is larger than the Champions.
If nothing else, I personally focus on stocks that are on the Dividend Challengers list, only because they are more in a growth phase than those on the Champions list.
I can hear some of you right now: "Wait, the S&P 500 has returned 5.97% annually and yet you want me to invest in a large basket of companies that only pay for 5.34% on average?"
This is the argument about why over the long haul, most fund managers cannot beat the market average. The question here is whether you think you have a strategy that is better than the market, e.g. is more adaptable and can navigate in and out as necessary. The short answer is "yes", you should be able to beat the S&P 500 long-term averages, and the sections below start to give you a glimpse of how to accomplish this.
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Including Dividends
Note that above the analysis excludes dividends. This is because my software doesn't consider dividends -- it becomes the "value add" of investing in dividend-paying stocks.
The calculator link I provided above gives you the ability to include dividends. If you do this, the average return of the S&P 500 jumps:
Average annual return: 10.69%
Average annual volatility: 18.54%
SR: 0.5766
This presumes that each dividend was reinvested back into the stock, and those reinvestments compound over time.
Note the SR of the S&P 500 over a LONG time when we include dividends: 0.5766. Remember, SR is a measure of reward:risk, so if it is larger than some other comparison, we want the model that produced the higher SR value (more return per unit of risk).
Hence, you want stocks that pay constant to increasing dividends, which is not factored into the S&P 500 benchmark values above. The S&P 500 benchmark above presumes that you have bought and held every stock, good or bad for the duration of time, and this isn't what you will be doing in the Greenfield Dividend Contenders. These are above average dividend stocks, and they also are above average in terms of capital appreciation (share price growth).
To illustrate this, I pulled two different lists from May 2017 to show performance and dividend payments. The system presumes equal balancing into each position, with a quarterly rebalance, and the initial starting amount was $100,000.
The period of these graphs is June 2016 to May 2019.
In the top graph I have shown Annual Returns.
- For the 6 months of 2016, both dividend portfolios were positive and the S&P 500 was also up. The numbers are roughly 15% Portfolio 1, 22% Portfolio 2, and 8% S&P 500.
- Portfolio 1, shown in blue, had a great 2017 but poor 2018. 2019 is good. Contrasting, Portfolio 2, shown in red, had a great 2016, 2017, and 2018, and is doing well into May 2019. The differences between the two portfolios are only stock list creation and nothing else, so are quite arbitrary.
The bottom graph is Portfolio Income, and you can see that for a $100,000 portfolio, June - Dec 2016 returned about 1.3% dividends in income, and if we double, it would be about 2.6% or so. This was better than the risk free rate back then which was around 1% or less. I love my dividends.
You can see that Portfolio Income moved upward year over year, showing the impact of selection of stocks that pay constant to gaining dividends on a yearly basis. For the 5 months of 2019 we're at 1.25%; I have no idea if we'll beat 2018 or not.
A couple of important points:
- Dividend income is just that -- income. Share price does not matter. If you are retired, this can be a nice generator.
- None of these portfolios were "managed" -- I simply picked two lists from the past and forward tested. In reality, if a stock fails to maintain the Greenfield criteria (REV, EPS, FCF) I sell it, and if it is taken off the monthly U.S. Dividend Champions list because they cut the dividend, I sell it.
There simply is no reason to hold a dividend stock if they cut the dividend, and there is no reason to hold a Greenfield Stock if the fundamentals of the company change, causing a blurp in REV, EPS, or FCF.
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So, what have we done here? I assert the following:
- Consider only dividend paying stocks.
- Consider only Greenfield-Screened dividend paying stocks.
- Sell the stock if the company cuts the dividend.
- Sell the stock if the company has an earnings report that shows negative growth REV, EPS, or FCF on a QoQ, YoY, or TTM basis.
For those of you wondering, I combine the above with selling cash-secured puts (CSPs) and buying a covered call (CC). Doing so can add to your overall gains. It all adds up.
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That's all for now. If you have questions -- ask.
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As with all my ramblings, you are responsible for your own actions and I am not. Nothing I've written here is advice to buy or sell any security, so don't do it unless you absolutely take ownership for your actions.
Regards,
Paul
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