Dividends are the surest, safest building block of a comfortable retirement. And you needn’t just “settle” for retiring on dividends. You can even pick dividend stocks that’ll double your money or better, too.
All you need is a little quality.
What’s is “Quality”?
Quality isn’t some nebulous idea. It’s a “factor,” and it’s defined by a set of attributes or characteristics that the Wall Street “quants” are increasingly affectionate for.
Factor-based investing has become quite the rage in recent years. It’s a way to slice and dice the stock market by numbers. Yield, value, momentum, and other metrics are the ingredients. Money managers mix ‘em together with the goal of a market-beating meal.
The definition of quality can change from provider to provider, but to get an idea, here’s how S&P Dow Jones Indices—which is responsible for the S&P 500 and numerous other indices—determines quality:
- Return on equity (ROE): Indicator of a company’s profitability. ROE is computed as (trailing 12-month earnings per share/book value).
- Accruals ratio: Indicator of a company’s operating performance. It is computed as (change of net operating asset over past 1-year/average of net operating assets over past two-year period).
- Financial leverage ratio: Indicator of a company’s capability in meeting its financing obligations. It is computed as (total debt/book value).
A focus on quality alone can make a stock portfolio more durable over time and improve returns. Meshing quality and dividends, however, can really add a jolt to performance. These are two factors that play very well together.
These Numbers Don’t Lie
As Wall Street intensifies its focus on factor investing, the research community keeps finding increasingly more data revealing the strength of a quality-dividends tag team.
Consider this analysis from S&P Dow Jones Indices, which compares quality and high dividends against numerous indexes, including the S&P 500 and Dividend Aristocrats:
Source: S&P Dow Jones Indices LLC data from 12/1994-12/2018
The major takeaways? For one, every dividend-oriented strategy outperformed the S&P 500 in overall and risk-adjusted returns. But leading the way was quality + dividends, which outperformed the S&P 500 by more than 5 percentage points annually.
Better still: “The quality and dividend strategy held up relatively well in all market environments, with an average monthly excess return of 0.28%, which was the highest among all the strategies.”
Yield + Quality > Yield + The Rest
Factor Research produced a report in 2018 studying six different factors—dividend yield, value, momentum, quality, growth and dividend growth—from 2001 through 2017. This study tinkered a bit by studying long-short portfolios and comparing a combination of each factor plus dividend yield versus just dividend yield.
Here’s a look at the best chart of the bunch:
Source: Factor Research
For what it’s worth, every combination produced better risk-return ratios than dividend yield alone. But high yielders with strong ROE and low debt-to-equity (quality) were both the most consistent and rewarding:
Source: Factor Research
WisdomTree (WETF), which has made a name on its international funds, dug into a slightly different dividend theme—dividend growth—paired with equity, across both U.S. and international stocks.
“A key to lighting a fire under dividend growth—future dividend growth, not past growth—is high return on equity (ROE),” WisdomTree’s research claims.
The evidence it finds when examining its quality international dividend growth index is somewhat compelling. The implied dividend growth and payout ratio aren’t breathtaking, but it also has a massive yield advantage. “The MSCI USA Index, yielding barely 2%, would need to grow rapidly for years on end to catch up.”
The case for applying quality to dividend yield internationally, however, is crystal clear:
Yes, WisdomTree is selling its own product here. These indices are attached to three of its funds: the WisdomTree U.S. Quality Dividend Growth Fund (DGRW), the WisdomTree International Quality Dividend Growth Fund (IQDG) and the WisdomTree Dynamic Currency Hedged International Quality Dividend Growth Fund (DHDG).
But it finds what so many other researchers are discovering: that the quality factor boosts every strategy it’s applied to, including dividends.
The Cream Rises to the Top
What kinds of stocks make the grade, fulfilling the dividend-and-quality mandate?
- T. Rowe Price (TROW, 2.3%): The investment manager has more than $1.2 trillion in assets under its umbrella, and a bulletproof balance sheet to boot. It currently boasts $2.2 billion in cash against a mere $146 million in debt.
- Lockheed Martin (LMT, 2.3%): The defense contractor is responsible for military weapons such as F-35 Lightning fighter jets, Sikorsky Black Hawk helicopter and Trident ballistic missiles. Its return on equity is frequently in the triple digits, and currently sits at 242.4%.
- Cisco Systems (CSCO, 2.9%): Cisco has long been a leader in networking and telecommunications equipment, though it’s trying to modernize by adding arms such as cybersecurity. It has plenty of ammunition, with $8.4 billion more in cash than it has in debt.
These three high quality dividend stocks have all beaten the broader market in recent years:
Dividend + Quality Beats Mr. Market
“Perfect” Retirement Income: Start 2020 By Quadrupling Your Yield
Quality? Absolutely. But high yield? Far from it.
Cisco’s 2.9% yield might be better than what the broader market has to offer, but it’s still a pitiful amount of income. You’d need to have millions invested in CSCO to live comfortably off those dividends!
Put “just” a million bucks in Cisco and you’ve got $29,000 in annual dividend income. That’s barely above the new minimum wage out here in California!
I’ve long looked for quality factors when selecting income investments for my retirement portfolio, too. However, I explore where these supposedly safe indexes can’t: away from overcrowded, overpriced blue chips—and as a result, I’m able to target sky-high yields that quality-focused funds will miss every single time.
Remember: There’s nothing “safe” about not making enough income to take care of your most basic needs.
“Safe” is being able to afford your mortgage, your utilities, and all the extras that are supposed to make your retirement years the happiest ones … without gambling on crazy bull markets like we got in 2019.
And you can lock up that level of safety from the dividend-rich stocks in my “Perfect Income Portfolio.”
This is 2020, not 2000. 10-year Treasuries don’t pay 6.6% anymore—they pay 2.6%. The 2%-3% yields on most Dow stocks just won’t cut it, either.
Instead, investors (especially those with more modest nest eggs) need roughly 3x to 4x the yield of the broader market. Also, you have to look much farther down the road than 2021 or 2012; these income checks need to keep coming for literally decades down the road.
Enter my Perfect Income Portfolio.
Every couple of weeks, I get to read the most satisfying type of email I’ll ever receive: A reader telling me this portfolio has literally doubled, tripled, or in a few cases, actually quadrupled their annual income.
This is simple buy-and-hold investing. You don’t have to figure options or perfectly time a swing trade. I provide you with a set of tickers from under-the-radar, contrarian income plays that can quickly build your wealth without piling on the extra risk of gambling on newspapers and dying retailers. If the stock is below the buy-under price, you pull the trigger. It’s that simple.
Too good to be true? Look at this strategy’s past 10 years of returns, and you’ll see why I call it the “Perfect Income Portfolio”:
What really makes this group of stocks stand out is that it’s so much more than high headline yield. This portfolio checks off a bundle of vital retirement boxes:
- It gives you a safe, secure, and steady income of $10s of thousands per year in cash—not just ‘paper gains.’
- It pays out more than enough to live on from dividends without drawing down your savings or assets.
- You avoid overly complex, high-risk investments that can wipe out decades of hard-earned money in a matter of weeks or months!
- You’re not involved in any risky options, spread-bets, or day-trading.
- It’s simple to set up and simple to manage. That way you’re not glued to your screen all day. Go out. Enjoy life. Your check’ll be in the mail.
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