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The Dividend Monster portfolio

I was working in the lab late one night, when I brewed up the frightfully profitable Dividend Monster portfolio, which mixes momentum with dividend investing.

The concoction is an oddity, because most dividend investors take a slow and steady approach to the market while momentum investors try to leap from one hot stock to the next before the stocks flame out. But the strange brew performed remarkably well over the long term.

The Dividend Monster starts with the 300 largest common stocks on the Toronto Stock Exchange. It then distills out the dividend payers and keeps the half with the highest dividend yields.

Dividend investors will appreciate that the high-yield stocks performed well as a group, with average annual returns of 11.9 per cent from the start of 1995 through to the end of September, 2022. By way of comparison, the market as represented by the S&P/TSX Composite Index climbed by an average of 8.1 per cent annually over the same period. (The portfolios herein assume monthly rebalancing and equal weighting. The returns are based on data from Bloomberg and include dividend reinvestment, but do not include inflation, taxes or trading frictions.)

Momentum is used to boil down the high-yield group to the 10 stocks that performed the best over the prior 12 months, which form the Dividend Monster portfolio. The hope being the strong past performers will continue to do well for at least another month.

The dividend-momentum combination provided an elixir of returns, because the Dividend Monster portfolio climbed by an average of 16.6 per cent annually from the start of 1995 through to the end of September, 2022.

It handily beat the market, as shown in the accompanying graph. But there's a problem. Momentum stocks often topple over during downturns and the Dividend Monster is no exception, because it suffered from some frightening falls. You can see the downside in the second graph, which shows how far the portfolio fell, as a fraction of its prior peak, along with similar data for the S&P/TSX Composite Index.

The Dividend Monster bubbles up

The Dividend Monster dies in downturns

A couple of points stand out for me when looking at the downside graph. First, the Dividend Monster managed to hide in the shadows to avoid the internet downturn that began in the summer of 2000. Second, it wasn't so lucky in the financial crisis of 2008-09, when it was cut down to less than half its former size.

More recently, the Dividend Monster spluttered down 29 per cent in the COVID-19 crash of 2020, while the market gave up about 25 per cent. It's also faring poorly in the current downturn, with a loss of about 25 per cent versus a decline of about 15 per cent for the market index through to the end of September.

Alas, sudden reversals are a common feature of momentum-based strategies, and they should be expected to hit with distressing irregularity. It's also a big reason why most dividend investors shy away from momentum-based approaches.

These days, the Dividend Monster portfolio is packed full of oil and gas stocks. The portfolio's stocks climbed by an average of 63 per cent over the last 12 months, they pay an average dividend yield of 5.1 per cent and sport an average earnings yield of 16.1 per cent. (I own many of the stocks mentioned herein.)

Dividend Monster list: ARC Resources, Canadian Natural Resources, Cardinal Energy, Crescent Point Energy, Freehold Royalties, Paramount Resources, Peyto Exploration, Pine Cliff Energy, Suncor Energy, Surge Energy

The Dividend Monster offers investors long-term treats with a few tricks along the way. It'll be interesting to see how it fares as the market becomes a little less frightful.

First published in the Globe and Mail, October 23 2022.

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