Top 10 Lowest Correlation Dividend Aristocrat Pairs

The following is a post from Ben Reynolds, who blogs at Sure Dividend
Those who have invested in Dividend Aristocrat stocks have done well in recent years.  Over the last decade, the Dividend Aristocrat Index outperformed the S&P500 by 2.88 percentage points per year.  Deciding which Dividend Aristocrat stocks to invest in goes beyond examining stocks individually.  Viewing investment decisions from a portfolio level helps investors to make better selections.

 

Correlation

The current Dividend Aristocrat stocks cover a wide variety of businesses.  Businesses whose returns are dependent on different factors increase diversification better than businesses that are in the same field.  The more closely related a stocks returns are to another stock, the higher the correlation.  Stocks that moved exactly the same way every day would have a correlation of 1.  Similarly, stocks that moved exactly opposite each other every day would have a correlation of -1.  A correlation of 0 implies the stocks returns are not related at all; they come from different factors.


Dividend Aristocrats & Correlation

There are currently 54 Dividend Aristocrats.  Of these, 53 have price data going back 10 years or more.  AbbVie is the only Dividend Aristocrat that does not have a long price history due to its recent spinoff from Abbott Laboratories.  The average correlation coefficient of the 1,484 pairs of Dividend Aristocrat stocks with 10+ years of price history is high at .81. While the average is high, there are several stocks that exhibit very low correlation to one another.  The 10 lowest correlation pairs of Dividend Aristocrats are:
  1. .12 – McDonald’s & Medtronic
  2. .18 – Family Dollar & Medtronic
  3. .19 – Cintas & Nucor
  4. .21 – Consolidated Edison & Medtronic
  5. .24 – Leggett & Platt Co., & Nucor
  6. .25 – HCP, Inc. & Medtronic
  7. .27 – Family Dollar & Nucor
  8. .27 – Coca-Cola & Medtronic
  9. .29 – Nucor & Medtronic
  10. .30 – Sigma-Aldrich & Medtronic
There are several companies that recur repeatedly on the lowest correlated pairs list above.  Medtronic & Nucor in particularly come up over and over.  Medtronic has an average correlation to other Dividend Aristocrats of just .49.  Similarly, Nucor has an average correlation of .49 to other Dividend Aristocrats over the last 10 years.

 

Quality & Correlation

The correlation coefficient is a useful tool in determining what businesses to add to your portfolio.  The lower the correlation between a stock and your total portfolio, the higher the diversification gains will be.  Diversification is not the goal of investing.  I believe investing for long time periods in high quality businesses that have a history of rewarding shareholders through dividend payments will result in solid investment returns.  It is more important to find high quality businesses than it is to find businesses that are uncorrelated with one another. High quality businesses have strong competitive advantages that allow the business to grow earnings and dividends consistently and continuously.  These businesses are likely to have strong operational performance even during recessions. Given the choice between a portfolio of high quality businesses that are highly correlated to each other, and a portfolio of uncorrelated businesses that did not have competitive advantages, I would chose the high quality portfolio every time.  Once you have identified high quality businesses, then examine how well the business fits into your overall portfolio.

 

Where to Find High Quality Businesses

An Excellent place to find high quality businesses is the Dividend Aristocrats index.  A business that has paid increasing dividends for 25+ years either has or at one point had a strong competitive advantage.  I use quantitative rules backed by academic research such as The 8 Rules of Dividend Investing to further determine what businesses are likely to make sound investments over the next several years.

 

Conclusion

Minimizing correlation between your stocks will reduce portfolio standard deviation.  Standard deviation is not risk in itself; it is merely a proxy for risk.  With that being said, stocks with low volatility bounce around less, making it easier to sleep at night.  Even better, low volatility stocks have historically outperformed the market. A portfolio of high quality dividend stocks that seeks to reduce the correlation between each holding will likely provide capital and income appreciation in addition to the safety and peace of mind that comes with knowing you hold high quality businesses in a portfolio designed to reduce volatility.
About the Author:  Ben Reynolds runs the Sure Dividend which focuses on high quality dividend growth stocks suitable for long-term investing

Chatter Around the World – 50

Chatter Around the World is a weekly link update of economics, investing, dividends and personal finance articles that have caught my eye. In these weekly updates, I also capture my blog updates and news related to my holdings.

Rate Sensitive Industries

New Blog Posts

Let’s dive into the links that caught my attention this week.

Updates from My Portfolio Holdings

General Reads

Dividend Reads

Dividend Stock Analysis

Have a wonderful weekend.

Image Source: BofA Merrill Lynch
 

The Importance of Diversification: Part 1

Talk to any investor or financial advisor, and the rule of thumb to protect your assets is: diversification. This is part 1 of a two-part series (part 2 available here) where I discuss the importance of diversification. In this post, we look at the importance of diversification in investments. There are various complex mathematical models to determine risks in investments, which are outside the scope of this article and blog. For a simplistic viewpoint of risk assessment from a diversification viewpoint, consider the following chart (Image source: Nasdaq) comparing the Portfolio RiskGrade and the Number of Stocks.
Risk Grade vs. Number of Stocks
Risk can be either Unique or Systemic. As most investors know, investing in a company comes with a risk of the company either going under or just losing value, which results in the investor losing part or whole of his/her capital. This is called Unique risk. While investors can preserve their capital and investment by picking better companies, it is almost impossible to find a good investment without any inherent risk; as the old adge goes “Without risk, there is no reward”. As illustrated in the graph above, studies have shown that risk can be mitigated by investing in as little as 12 companies, and close to elimination with approximately 50 companies.
Systemic risk may arise from common driving factors such as broad economic factors (for e.g., recessions), war, natural disasters etc. The broad markets move when such events occur. Note that even with a  globally diversified portfolio of stocks, there is still a risk-grade of 100 in the graph above. This is the systemic risk.

My ThoughtsWhen I consider diversification for my investments, I consider it on three different levels: diversification based on asset class; diversification by sector of the economy; and geographical diversification. Another old adage that investors should remember: “Never put all eggs in one basket”.

  1. Asset class diversification is important for investors as relying on one asset class such as stocks, bonds, real estate or commodities exposes risk immensely. Stock market crashes of the yesteryears remind us how investor’s fortunes were gained and lost.
  2. Sector allocation: Investors should try to mitigate risk by investing in all sectors of the economy. I current own 20 individual stocks and 5 funds, which provides me with pretty good diversification. However, I still do not consider my portfolio completely balanced as it is lacking in certain sectors of the economy and it is an ongoing project on getting that balance right. Once I get it to a state I want it in, I will be cycling through my holdings and investing additional capital in the relatively undervalued stock/fund.
  3. Geographical diversification: The type of diversification often overlooked by investors is the geographical diversification. A lot of investors believe in the mantra “invest in what you know”. This, I find is a double edged sword. Yes, it is good to invest in companies that you know well if you are familiar with the business model and know how the company actually runs and turns profits and if the company has good future prospects. However, it is important to not depend only on your local businesses, but invest globally – esp now that we have all the tools available at our fingertips making trades available and affordable. This way, any local disturbances such as recessions, wars, natural disasters will not take a toll on your investments and the risk is mitigated.
Our Portfolio
Our portfolio diversification as of Jun 2014

As things stand, our portfolio is not so bad on the sector-wise asset allocation, but geographical diversification is very skewed to our home country (Canada). This big skew occurred after my wife and I merged our portfolios and all of her investments were focused on the Canadian markets. As part of my 2014 goals, we intend to rebalance our portfolios with better diversification.

What’s Your Number?

I can think of a few finance bloggers who consider 40-50 stocks to be a number that makes them feel that their portfolio is well diversified. Dividend Mantra posted on this topic a couple of months ago where he makes the case for his portfolio to contain 50 stocks to achieve enough diversification. What are your thoughts? Do you have a number in mind? How many companies would you want to own before considering your investment portfolio diversified?Full Disclosure: My full list of holdings is available here.

 

Chatter Around the World – 49

Chatter Around the World is a weekly link update of economics, investing, dividends and personal finance articles that have caught my eye. In these weekly updates, I also capture my blog updates and news related to my holdings.

S&P 500 vs Emerging Markets return since Jun 2011

New Blog Posts

Let’s dive into the links that caught my attention this week.

Updates from My Portfolio Holdings

General Reads

Dividend Reads

Dividend Stock Analysis

Have a wonderful weekend.

Image Source: Bloomberg
 

Recent Buy – General Electric Company (GE)

GE
I initiated a new position in General Electric Company (GE). GE is a conglomerate and hardly needs an introduction. The company is an industrial behemoth and has been around for over 120 years, with business in a broad array of segments serving over 100 countries.I have wanted to add a stock in the industrials sector for a while now, in order to have a better asset allocation. This position brings a bit of much needed balance to my portfolio. I initiated my position with 75 shares of GE at a price of $26.80 per share. This increases my annual dividend income by $66.

Corporate Profile (from Yahoo Finance)

General Electric Company operates as an infrastructure and financial services company worldwide. The company’s Power and Water segment provides gas, steam and aeroderivative turbines, nuclear reactors, generators, combined cycle systems, controls, and related services; wind turbines; and water treatment services and equipment. Its Oil and Gas segment offers surface and subsea drilling and production systems, equipment for floating production platforms, compressors, turbines, turboexpanders, high pressure reactors, industrial power generation, and auxiliary equipment. The company’s Energy Management segment provides electrical distribution and control products, lighting and power panels, switchgears, and circuit breakers; engineering, inspection, mechanical, and emergency services; motor, drives, and control technologies; and plant automation, hardware, software, and embedded computing systems. Its Aviation segment offers jet engines, aerospace systems and equipment, and related replacement parts for military and commercial aircrafts; and maintenance, component repair, and overhaul services. The company’s Healthcare segment offers medical imaging and information technologies, medical diagnostics, and patient monitoring systems; and disease research, drug discovery, and biopharmaceutical manufacturing services, as well as remote diagnostic and repair services. Its Transportation segment provides freight and passenger locomotives; diesel engines for rail, marine, and stationary power applications; railway signaling and communications systems; underground mining equipment; motorized drive systems; information technology solutions; and replacement parts. The company’s Appliances and Lighting segment home appliances and lighting products. Its GE Capital segment offers commercial loans and leases, fleet management, financial programs, credit cards, personal loans, and other financial services. The company was founded in 1892 and is headquartered in Fairfield, Connecticut.

Recent Buy Decision

General Electric has made it clear after the recent recession that the direction of the company lies in the original industrial roots of the business. The company has a backlog of $245B, and their revenues surpass $1B from 24 countries. Anyway you measure it, those are some impressive numbers. GE also expects increased spending in infrastructure projects around the world as more people move into the middle class in the emerging and frontier markets and is expected to be well positioned to benefit.
Recently GE announced that they are going to spin off the retail financial business, which will be a good move for the company overall. I am a fan of spin offs and believe that it creates immense value for shareholders.The following analysis from Trefis shows the current and expected growth in revenue in various segments.

 

The dividends paid by GE have been growing since 2009, after they were cut during the financial crisis. GE was a former Dividend Champion and now has a track record for raising dividends for 4 consecutive years at an annualized rate of 16%. GE will next year get upgraded to the Dividend Challengers list if they raise their dividend again. Current payout ratio stands at 62%.

Risks

The stock is not cheap. With a ttm P/E close to 19, the current stock price is quite expensive. In addition, the broader stock market is at all-time highs, so any correction will have repercussions and will be reflected in most components of the index.
GE also closely follows the performance of the global economy. If there are problems such as slow/stalled growth in US economy, a bigger slowdown in China and other emerging economies, that could spell trouble for GE. The other risk is in the spin off of the financial arm – it will be interesting to see how the new company will be managed and run. One advantage the shareholders have is: if that new entity isnt managed well, shareholders can unload the shares while still maintaining equity in GE.
A summary of the stock:

  • Symbol: GE
  • Quote: $26.89
  • 52-week Range: $22.76 – $28.09
  • P/E: 18.94
  • Yield: 3.30%
  • 5-yr average yield: 3.30%
  • 4-yr DGR: 16%
  • Graham Number: 20.50
Full Disclosure: Long GE. My full list of holdings can be found here.