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Dividend Aristocrats & the Sharpe Ratio: Part 1 of 4


Published March 14th, 2015

The Dividend Aristocrats Index is composed of 52 businesses with 25+ years of dividend payments without a reduction. A business must have a strong competitive advantage to raise its dividend payments for 25 years in a row. It is no surprise that the Dividend Aristocrats has outperformed the S&P 500 by over 2.5 percentage points a year, according to S&P themselves.

Interestingly, the Dividend Aristocrats Index has outperformed the S&P 500 while having a lower price standard deviation than the S&P 500. Over the last decade, the Dividend Aristocrats Index had an annualized standard deviation of 13.69% versus 14.76% for the S&P 500. The table below shows the risk and return characteristics of the S&P 500 and the Dividend Aristocrats Index over the last decade:

Index Name Annualized Total Return Annualized Standard Deviation Sharpe Ratio
Dividend Aristocrats 10.75% 13.69% 0.79
S&P 500 7.99% 14.76% 0.54

Source: S&P 500 Dividend Aristocrats Fact Sheet
Note: Sharpe ratio is calculated as Total Return / Standard Deviation, risk-free rate is not subtracted

Over the last decade, investors would have seen both higher returns and lower risk from investing in the Dividend Aristocrats Index. Not all stocks in the Dividend Aristocrats Index are created equal. This article explores what Dividend Aristocrats have had the highest Sharpe Ratio over the last decade.

Methodology

The Sharpe Ratio for each current Dividend Aristocrat is calculated as the annualized total return over the last 10 years divided by the annualized standard deviation over the last 10 years. The table below shows the annualized total return for 51 of the 52 current Dividend Aristocrats over the last decade. AbbVie (ABBV) is excluded as it only has about 2 years of price data.

Ticker Standard Deviation Total Return Sharpe Ratio
HRL 19.65% 15.50% 0.79
SHW 28.08% 21.98% 0.78
MCD 19.82% 14.14% 0.71
VFC 28.64% 20.22% 0.71
CL 18.72% 12.46% 0.67
ECL 23.76% 14.69% 0.62
SIAL 27.43% 16.91% 0.62
BF.B 23.16% 14.10% 0.61
GWW 25.89% 15.45% 0.60
ADP 21.02% 12.38% 0.59
BDX 19.98% 11.06% 0.55
PPG 28.03% 14.94% 0.53
ABT 19.81% 10.51% 0.53
KMB 17.30% 9.02% 0.52
GPC 22.52% 11.47% 0.51
KO 18.52% 9.35% 0.50
ED 16.67% 8.34% 0.50
BCR 20.73% 10.27% 0.50
PEP 17.31% 8.51% 0.49
CLX 18.45% 8.97% 0.49
MKC 19.04% 9.11% 0.48
CB 26.91% 12.24% 0.45
JNJ 16.12% 6.81% 0.42
APD 27.95% 11.58% 0.41
MMM 22.46% 9.18% 0.41
PG 17.59% 7.16% 0.41
T 22.14% 8.49% 0.38
ITW 26.29% 10.08% 0.38
LOW 31.39% 11.32% 0.36
WMT 19.09% 6.59% 0.35
CAH 32.67% 11.18% 0.34
DOV 29.83% 9.96% 0.33
CVX 27.26% 8.90% 0.33
SWK 31.90% 10.08% 0.32
CTAS 25.78% 8.02% 0.31
TROW 39.67% 12.16% 0.31
WBA 27.15% 8.11% 0.30
MHFI 34.35% 10.25% 0.30
LEG 30.62% 9.05% 0.30
EMR 28.98% 8.06% 0.28
BEN 37.38% 9.90% 0.26
HCP 40.81% 10.58% 0.26
ADM 34.53% 8.15% 0.24
MDT 24.12% 5.34% 0.22
XOM 25.34% 5.32% 0.21
CINF 30.16% 6.24% 0.21
TGT 29.98% 5.87% 0.20
SYY 22.05% 4.22% 0.19
PNR 31.58% 6.02% 0.19
NUE 42.22% 7.62% 0.18
AFL 43.39% 6.90% 0.16

 

Analysis of Data

The best performing Dividend Aristocrats of the last decade based on the Sharpe Ratio are Hormel (HRL), Sherwin-Williams (SHW), McDonald’s (MCD), VF Corporation (VFC), and Colgate-Palmolive (CL). The worst 5 performers have been AFLAC (AFL), Nucor (NUE), Pentair (PNR), Sysco (SYY), and Target (TGT).

Of these 51 stocks (again, excluding ABBV), 24 had an annualized total return over 10%. Interestingly, 40 out of 51 beat the S&P 500’s annualized total return of 7.99%. Before doing this experiment, I thought that close to half of the current Dividend Aristocrats would have outperformed the S&P 500 over the last decade. Seeing that 78% outperformed the S&P 500 is quite interesting and shows that investing in high quality businesses over long periods of time really does produce outsized returns.

Further Testing

Testing the current Dividend Aristocrats over the last decade introduces survivorship bias. Stocks that have fallen off the Dividend Aristocrats Index in the last decade have very likely done worse than those that are still on the list. This is because stocks are generally removed from the list when they cut their dividend; a sign the business is in trouble.

Additionally, total return numbers could be artificially boosted by unsustainable gains in a company’s price-to-earnings ratio or other valuation ratios. This would provide a boost to returns in excess of underlying business growth. Adjusting for valuation multiple changes would paint a clearer picture of underlying business growth. I believe that a business with a long history of consistent underlying business growth is likely to continue growing at a similar rate, so long as its competitive environment does not change significantly.

To this end, sorting stocks by their valuation adjusted sharper ratios could potentially lead to outsized investing returns.

Dividend Aristocrats & The Sharpe Ratio Guide

In part 1, I introduced the Dividend Aristocrats Index and the 10 year Sharpe Ratios of each of the current constituents of the Dividend Aristocrats Index.

In Part 2, the valuation adjusted total return of each current constituent will be calculated and the results analyzed.

In Part 3, a backtest will be done using the constituents of the Dividend Aristocrats over the last 10 years. The backtest will track a portfolio that invests in the top 10 Dividend Aristocrats sorted by the valuation adjusted 10 year Sharpe Ratio at the beginning of each year, and rebalances annually.

In Part 4, I will provide detailed analysis of the Top 5 current Dividend Aristocrats using the valuation adjusted 10 year Sharpe ratio and conclude the series.


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