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I doubt you've ever heard of John Wightkin.
He's the Director of Equity Research Applications of the
Schwab Center for Financial Research. Sure that's a fancy
title, but John is doing some very important work in the
field of income investing.
In fact, John Wightkin just confirmed what I've been telling
my readers for years. But he also uncovered an exciting way
to add a shot of capital gains to income investing by
predicting the next high-yielding winners.
The New Study that Leads to Capital Gains
John just published a study last month where he asked the question "Should income investors
purchase the highest-yielding stocks they can find?" His
answer was a resounding "No!"
I've been telling readers this for years -- suspiciously
high yields are typically warning signs -- but John's
study was second to none.
He derived his conclusion by dividing the 1,500 largest
stocks by market cap into five groups based on yield and
studying these groups over a 20-year period. Group 0 paid no
dividends, groups 1, 2, and 3 paid progressively higher
dividends, and group 4 was composed of the highest yielders.
 As
you can see from the chart, Groups 2 and 3 handily beat the
performance of group 4 (the highest yielders) on an annual
total return basis. That's right -- stocks with lower
dividends outperformed the higher yielders on a total return
basis.
The reason: Group 4 stocks had twice as many dividend
cuts as stocks in other groups. Instead of unusually high yields being
a sign of fundamental health, it was the opposite. In many
cases, a large drop in the share price had occurred and the
stock had not cut its dividend -- yet.
But should you completely avoid high-yield stocks? Wightkin
rightly points outs it's foolish to avoid them in entirety.
The secret is to find those winners among this group --
those that pay safe high yields. These are the ones
that will provide the tasty combination of income and price
appreciation.
His key to identifying the best of the best: Look to the
stock's price momentum over the last six months.
Momentum itself was measured by a simple formula:
(Price Today/Price Six Months Ago) - 1
If, for example, "High-Yield Darling" is trading at $15 a
share now and was $10 six months ago, its momentum would be
50% (($15/$10) -1 = 0.50 or 50%).
John's study showed that high-yield stocks in the top fifth
of their peers in terms of six-month momentum returned
+11.5% annually over the last 20 years. Those in the lowest
fifth returned only +7% annually.
There are many possible explanations why these stocks
typically outperform the market going forward. Wightkin's
favored hypothesis is that investors often "under react to
information about a firm's short-term prospects and often
over react to information about long-term prospects -- which
provides opportunities in the intermediate term."
Whatever the reason, the point is clear -- stocks that have
outperformed in the past six months have a reasonable
probability of continuing to outperform over the next year.
Further, stocks with the highest momentum and yields had
superior fundamentals to those with lower momentum. These
fundamental strengths showed up over time in providing more
dividend increases and fewer dividend cuts along with more
increases in analysts' earnings estimates and fewer
decreases.
Despite John Wightkin's study, I'll always continue drilling
down into the nuts and bolts of a company's dividend before
investing -- there's simply no substitute for due diligence.
But using his metrics does give investors a good place to
start their income search.
Good Investing!
Carla Pasternak's Dividend Opportunities
P.S. -- In my October issue of
High-Yield Investing I ran a screen for high-yield
stocks that were also showing strong momentum over the last
six months.
Of my 10 winners, one interesting name that made the list
was DTE Energy (NYSE: DTE). You may remember that DTE was a
finalist for
The Safest Dividend in the S&P a few weeks ago. The
stock has returned +30%in the last six months and still
yields 6.0%.
To see the rest of my list, including my highest-yielding
momentum stock (which pays 9.2%), please
visit this link to subscribe. Remember, your
subscription comes with a 90-day money-back guarantee!
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