Strategy
Correlation between U.S. and Foreign Stocks
I have written earlier about some of the reasons for investing in foreign stocks. Despite the synchronized crash of both foreign and U.S. stocks in the recent bear market, investing in foreign stocks still offer diversification benefits.
The chart below shows the correlation between U.S. and foreign stocks during the rolling 12-month periods from December 1970 to August 2009:
Source: Fidelity Investments
The chart shows that correlations increased and declined over time. Global stocks (including U.S. stocks) tended to fall during periods of extreme market or economic stress (i.e. correlations moved up), just as they did during the recent global financial crisis. However historically, U.S. and foreign returns generally diverged after the crisis passed (i.e. correlations fell down).
So the fact that foreign markets also fell in tandem with US stocks during the recent crisis is not unusual. Moving forward, the correlations between them should decline based on historical trends. Hence adding foreign equities to one’s portfolio should continue to provide diversification and reduce volatility.
Some related ETFs:
iShares MSCI EAFE Index Fund (EFA)
iShares MSCI ACWI ex US Index Fund (ACWX)
iShares MSCI Emerging Markets Index Fund (EEM)
Vanguard FTSE All-World ex-US (VEU)
Vanguard European ETF (VGK)
Study: Growth Stocks Don’t Grow
Growth stocks which have high price-earnings (P/E) ratios don’t grow their earnings faster the market, according to a new research study by Cannon Asset Managers. The study was based on 10,000 global stocks over a 35 year period. The study analyzed two aspects of investment results namely the relationship between price-earnings ratios and investment returns; and the relationship between investment returns and earnings growth.
During the dot-com bubble times of the 1990s, investors bid up hi-tech stocks in the expectation that they will grow faster than the market. However that did not happen. Instead investors lost out big when the hi-tech bubble popped and tech stocks crashed wiping out billions in wealth.
The results of study contradict conventional wisdom on growth and value stocks. The two the main takeaways from this study:
- Growth stocks with high P/E ratios under-perform the market
- Growth stocks have earnings growth that are slower than the market but unloved value stocks deliver faster-than-market earnings growth
In the above chart, the left most Quintile 1 represents the basket of stocks with the highest P/E ratio while the right most Quintile 5 represents the stocks with the lowest P/E ratios. The green bar shows the average annual investment return, measured over five years, relative to the global equity market. Hence the expensive growth stocks in the Quintile 1 underperformed the market by an average of 4.7% per year. Similarly modestly expensive stocks underperformed by 4.3% per year. On the other hand, deep-value stocks in the Quintile 5 outperformed the market by an average of 9.8% per annum.
The grey bar measures the earnings growth relative to the market for each Quintile over five years. Value stocks have higher than the market average five year earnings than growth stocks.
Value shares outperform because of stronger-than-market earnings growth and growth shares under-perform because of poorer-than-market earnings growth.
This study conclusively proves that investors will be richly rewarded with value stocks as opposed to growth stocks. That does not mean investors ought to avoid all growth stocks. Some of them experience phenomenal growth and deliver awesome returns to investors. However such stocks are very few among the large pool of growth stocks and most investors fail to identify these winners.
Some examples of growth stocks are: Chinese internet search provider Baidu (BIDU) with a P/E of 97, online travel company Priceline (PCLN) with a P/E of 21, internet search giant Google (GOOG) with a P/E of about 20.
The Rising Dividend Strategy Applied To Canadian Bank Stocks
Some investors prefer dividend-paying stocks for long-term investment as opposed to those that pay no dividends. I believe it is better to pick not just dividend paying stocks but stocks that consistently pay dividends and also increase dividends year after after. One strategy that investors can use to identify such high quality stocks is called the Rising Dividend Strategy. In simple terms, it means that increasing dividends will ultimately will lead to higher stock prices. Or put another way, consistently increasing dividends will be followed by rising stock prices.
Statistically, in the long run price growth is highly correlated to dividend growth. To test this strategy I analyzed the five large Canadian bank stocks. This analysis proves that the rising dividend strategy is an effective idea to select wining stocks.While it is ideal to use data over many years, it must be noted that most of the Canadian banks were listed in the US markets only in the 90s. Hence data used is relatively for a smaller number of years.
1. Royal Bank of Canada (RY)
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In 1996, the stock price of Royal Bank closed at $4.53 and the dividend amount paid was $01.7 for an yield of 3.75%. Over the years as the chart above shows Royal Bank consistently increased the dividend payments except in 2009 where it decreased due to the global credit crisis.The stock price also tracked the dividend growth going from $4.53 in 1996 to $53.06 at the end of last year. The price plunged to $28.05 in 2008 but sharply recovered in 2009 as dividends were not slashed drastically. Clearly the graph shows that long-term investors of Royal Bank of Canada have been rewarded both with dividend growth and share price appreciation.
2. Canadian Imperial Bank of Commerce (CM)
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CIBC started trading on the US markets on 11/13/1997. The year-end price was $15.69 and the dividend yield was 1.34%. Unlike Royal bank of Canada, CIBC did not have a smoother dividend growth as the chart shows. However still an investment of $10,000 on 11/13/2007 with dividends reinvested would be worth $40,352.42 as of yesterday for a return of 303.52% according to the CIBC investor relations site.
3. The Bank of Nova Scotia (BNS)
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Just eight years of data is available for Bank of Nova Scotia’s US-listed stock. The stock price closed at $12.48 at the end of 2002. The last year’s closing price was $46.29. In eight years, dividends was reduced in only two.
4. Bank of Montreal (BMO)
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Bank of Montreal has increased dividends consistently from 1994 thru 2008. The year-end dividend yield in 1994 was 4.49%. At the current price per share of $61.37, the yield is 4.44%.
5. Toronto-Dominion Bank (TD)
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Since 1996, TD Bank has also increased dividends for most of the years. After closing at $33.27 in 2008 the price sharply rebounded in 2009 and closed the year at $61.64. The average dividend yield in the last 14 years is 4.73%. Except for 2006, TD Bank’s dividend yield was at least 3% each year.
Note: Data used is known to be accurate from sources used. Please do your own research before making any investment decisions.
Disclosure: Long all five stocks mentioned above.
Equity Income Strategies with ETFs
In a recent article fellow blogger and portfolio manager, Roger Nusbaum noted that “it is very difficult to build an ETF portfolio that emphasizes dividend yield.” Update: Please note that Roger said the previous statement in the context of building a portfolio with ETFs at the sector level. My article below discusses about using dividend ETFs at the market/index levels.
I came across a paper that discussed this topic in more detail.
The ETF provider iShares(UK) has published a report on using dividend yield ETFs for income. The following are some of the key takeaways from this report:
a) ETFs provide the benefits of dividend investing, combined with the usual advantages of index investing: easy diversification, low costs, transparency and market representativeness.
b) Many factors are considered when building dividend indices.For example, STOXX and Euro STOXX Select Dividend indices screen companies based on dividend per share growth and earnings per share ratios whereas DivDAX uses one-year historic yields.
Methodologies followed by various dividend Indices:
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c) iShares offers country-specific and regional dividend ETFs to track the following indices:
d) “There are two key differences between the dividend yield of an index and the distribution yield of the ETF that is tracking that index.
1. The historical fund distribution yield is based on the last 12 months of fund distributions and therefore is NOT EQUAL to the future/expected fund distribution yield
2. The index dividend yield is NOT EQUAL to the fund distribution yield”
e) Dividend ETFs can be used to offset inflation, create regular inflows, enhance portfolio yield and reduce portfolio volatility
To download the Equity Income: Investment and Strategies with iShares ETFs paper, click here.
Related ETFs from iShares(US):
1. Dow Jones International Select Dividend Index Fund (IDV)
12-Month Yield: 3.85%
2. Dow Jones Select Dividend Index Fund (DVY)
12-Month Yield: 3.57%
3.S&P U.S. Preferred Stock Index Fund (PFF)
12-Month Yield: 7.41%
Investment Opportunities in PIIGS
For the past few months the Greek debt crisis has been the focus of investors worldwide as the major European countries try to figure out a solution to solve the crisis. Due to politics and the integration of many countries under the common currency, the crisis does not appear to end very soon. In addition to Greece, Portugal, Ireland, Italy and Spain (collectively dubbed as PIIGS by traders) are also suffering from high deficits.
Despite the current chaos in the European Union, some good investment choices can be found in these countries. An article in the latest edition of Bloomberg BusinessWeek lists a few stocks from PIIGS that are liked by fund managers.
The stocks listed in the article are noted below:
1. Portugal
Energias de Portgual (OTC: EDPFY) is an electric and natural gas utility with strong presence in Spain, Portugal, France and Belgium. Its alternative energy subsidiary EDP Renovaveis has wind energy projects in the early stages in Illinois, Indiana and Ohio. The current dividend yield is 5.15%.
Portugal Telecom (PT) offers telecom services in Portugal, Brazil and a few countries in Africa. PT pays a dividend of 7.10%.
2. Ireland
The holding company DCC which has interests in food, energy and health care. DCC is not traded on the US markets.
3. Italy
Ansaldo Sts Spa (OTC: ASDOF) is a builder of railways and subways. The company earns more than 50% of its revenues from outside of Italy and has a strong backlog of orders.
4. Greece
National Bank of Greece (NBG) does not pay regular dividends. The stock has fallen heavily in recent months and closed at $3.95 today.The bank’s deposits exceeds loans.
5. Spain
The telecom giant Telefonica(TEF) gets a significant portion of its revenues from Latin America. Telefonica’s current yield is 6.34%.
Banco Santander (STD) also gets more than 50% of its profits from outside the Euro zone. The stock pays a 5.26% dividend. Santander has large exposure in North and South America. In the US, it bought the Sovereign Bank during the credit crisis in 2008.
In another article titled The Pain in Spain falls Mainly on the Cajas, author Mark Scott notes that the main reason the Spanish banking giants Banco Santander (STD) and BBVA (BBV) remain strong despite the troubled economy is that bad real estate loans have hit mostly the the non-profit lending institutions known as Cajas. Hence investors need not totally avoid Santander and BBVA.
Why Diversification Still Matters
I posted The Importance of Diversification chart last year in an article on Callan charts. In 2008, diversification across countries did not work well for investors as the majority of stock markets fell. However that does not mean diversification is dead. Diversification still matters. One can diversify by not only investing in different countries but can also diversify picking various sectors within a country. The following charts show the importance of diversification:
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1. Periodic Table of Style Rotation — Why Diversification Matters
2. Periodic Table of Sector Rotation — Why Diversification Matters
3.Annual Returns for Key Indices - 20 Years (1989-2008)
The IFA Periodic Table of Investment Returns
For the pdf versions, click here and here.
