Can dividends, past returns or ratios hint a future?

Summary:

• Investors should look at revenue dynamics while analyzing stocks

• Oversold stocks are not necessarily the best investment choice

• Companies that do not pay dividends tend to outperform S&P 500 the most

• There are 9 stocks meeting model criteria

Given how big the financial markets have grown it is impossible to keep track of and analyze in detail every listed company. In order to pick which stock to include in the portfolio investors need to develop a strategy of analyzing stocks that would allow them to browse through vast array of companies in an efficient way. In this report we provide you with results and methodology of our research aimed at developing reliable and time efficient strategy of picking stocks to portfolio.

Ratios

Top 20 stocks from the S&P 500 index in the 2014-2017 period had some common factors. Source: Bloomberg, XTB Research

In the first part of our research we took 20 stocks from the S&P 500 index that provided the highest rates of return in the 2014-2017 period and conducted a ratio analysis for these companies to see whether there is a common factor among them. We found out that almost all of this stocks held higher P/E ratio ( in contrary to common belief that overpriced stocks are poor investment choice) and lower debt-to-equity ratio than S&P 500 average. Moreover, these companies usually characterized with higher-than-average 1-, 2- and 3-year revenue growth.  

Dividends

Companies that did not pay a dividend in 2006-2007 period outperformed the S&P 500 index the most during the financial crisis. Source: Bloomberg, XTB Research

In the second part of our research we confronted common belief saying that companies that pay dividends are better investment opportunities. We analyzed all the stocks from the S&P 500 index to see whether stocks that were paying dividends in two previous years managed to outperform the benchmark in the next two year period. We performed this analysis for two different periods:

1. Dividends paid in 2006 and 2007, return in 2008-2009 period

2. Dividends paid in 2014 and 2015, return in 2016-2017 period

In both cases the results not only showed that companies paying highest dividend do not produce highest rates of return but also that the ones that do not pay dividend at all tend to provide highest returns for the investors. The first mentioned period was crucial as it covered the time of major economic downturn (financial crisis). Nevertheless, stocks that did not pay dividend in 2006 and 2007 managed to provide an average return of 19% over the S&P 500 index in 2008-2009 period.

In the second analyzed period, a period of a stable bull market, companies that were not sharing their profits with shareholders managed to outperform the equity benchmark by 15.1% on average.

Past Return

Stocks that performed similar to the S&P 500 index in a two year period outperformed the benchmark the most in the next two years. Source: Bloomberg, XTB Research

In the final part of our research we analyzed S&P 500 stocks to see if past rates of return could affected the future ones and if there is a correlation between two. The results showed that stocks which performance against S&P 500 index over two year period fell into one of these brackets:

• -30% to -20%

• -15% to -5%

• 0% to 10%

• Over 100%

...were most likely to outperform the benchmark in the next two year period. The 60%-100% range also looks promising but we decided not to include this bracket into the results as in the later time periods the average for this group was greatly biased by NVIDIA (NVDA.US). Taking a look at the results one can easily notice that the stocks that strongly underperformed against benchmark did not necessarily had to outperform it in the next two year period in contrary to belief saying that companies that has been oversold recently pose a chance to outperform the broad market in the upcoming future due to their attractive valuation.

Second quarter portfolio performance

Portfolio of stocks that have a chance to outperform the S&P 500 index in the Q2 2018-Q1 2020 period in accordance to our research. Source: XTB Research

We have combined all three above mentioned strategies and build a portfolio of stocks that have met criterias of each of three analyses. The resulting portfolio consisted of 12 companies and we decided it will be more reliable to use the average weighting as the size of the companies varied significantly and in case the market capitalization weighting was used 2 out of 12 companies would be responsible for more than a half of the index performance. In accordance to our research given portfolio should outperform the S&P 500 index in the Q2 2018-Q1 2020 period. So far the results look promising as the portfolio provided a return of 12.2% since the beginning of a second quarter while the S&P 500 rose by just 3.6% (data as of 05.07.2018). In mid-June the portfolio reached its highest value with a return of 17% while the S&P 500 advanced by 5%.

Model portfolio managed to greatly outperform the S&P 500 index in the second quarter of 2018. Source: Bloomberg, XTB Research

Stocks that meet model criteria at the end of June 2018

Source: XTB Research

Having all the above in mind we decided to look for stocks that meet model criteria looking ahead to the Q3 2018-Q2 2020 period. New “portfolio” is a bit less diverse than the previous one as it holds just 9 stocks. Moreover, some of the stocks from new “portfolio” have been included in the previous portfolio. Almost all of the stocks from the previous and new portfolio are available for you in xStation5 with Abiomed being the sole exception. You can hedge the exposure of these portfolios via S&P 500 CFD (US500 on xStation5).