The enhanced dividend yield strategy was developed by Jim O'Shaughnessy to provide a fixed income strategy based on stocks instead of bonds. O'Shaugnessy argued that while bonds appeal to investors because of their inherent principal protection advantage, they have a number of important disadvantages.
- First of all, bond yield remains fixed, i.e. you will receive the same coupon over the entire period until maturity. This is ok in periods of low inflation, but between 1970 and 2010 inflation has on average been at 4,45%. That means that something that cost 1 dollar in 1970 costs $5,75 in 2010.
- Secondly, with bonds your principal doesn't depreciate, but it also won't appreciate. When the bond matures, you will get back the principal amount, and due to inflation this will be worth a lot less.
To remedy these issues of the traditional fixed income strategies, O'Shaugnessy designed a quantitative investing strategy based on stocks, with as primary objectives a growing yearly income combined with capital appreciation. The results of his study show that by implementing the enhanced dividend yield strategy, yearly income would have increased by 10%per annum and between 1962 and 2009, the principal increased by 5538%. What's more, this strategy never had a five-year period in which it lost money, very enticing for risk-averse investors.
How does it work?
O'Shaughnessy created a dividend yield strategy with a twist. Sometimes high yielding stocks are value traps and this strategy tries to get rid of these stocks in 2 ways.
- First he limits the stock universe to market leading companies, that accourding to O'Shaughnessy have the
Shares outstanding > dataset average
Cash flow > dataset average
Sales > 1.5 times dataset average
- Next he excludes the bottom half of these stocks ranked by their EBITDA/EV. This way he only keeps the 50% of market leaders with the best financial conditions.
Finally, he builds a portfolio in which he overweights the stocks with the highest dividend yield, in the following manner:
- 25% of stocks with highest yield get 1.5 times the weight,
- the next 25% by yield get 1.25% the weight,
- the next 25% get 0.75 the weight,
- and the final 25 get 0.5 times the weight
The portfolio should be rebalanced every year.
You can read more about this strategy and the results by clicking on this link. This strategy is quite cumbersome to calculate for small investors, but with our screener it becomes a breeze. Just select the high dividend yield template screen, select your countries, and the screener will show the list of stocks for the dataset of the selected countries.