Systematic Relative Strength

Dividends are nice. Lately, they have become downright popular with the investing masses. So here is Geoff Considine, writing in Advisor Perspectives, to remind us:

The financial crisis showed that traditional metrics, such as a stock’s dividend history and its payout ratio, failed to warn investors of impending dividend cuts.

Standard and Poors’ Dividend Aristocrats index provides a well-known list of companies that have at least a 25-year track record of raising dividends every year. Even among these firms, however, there is a real risk that dividends may fall. Pfizer (PFE) and General Electric (GE), two firms that had previously been on the list of Dividend Aristocrats prior to 2009, dramatically reduced their dividends in that year, as did several other firms on the list. In all, ten of the Dividend Aristocrats were removed from the list at the end of 2009, 20% of the total.

Is nothing sacred? Apparently not-even Dividend Aristocrats can go to the dark side. Mr. Considine proposes using volatility to warn of impending problems, but I think the real key is paying attention to price. Stocks that cut their dividends almost always have poor price performance leading up to the cut because the market tends to anticipate the event. Paying attention to relative strength is usually a great way to avoid dividend danger.

RESEARCH NOTE: For example, three companies were deleted from the Dividend Aristocrats list at the end of December 2010: LLY, SVU, and TEG. All were on RS sell signals. Notably, LLY has been on a point & figure RS sell signal since 4/19/1999; SVU has had the same status since 11/14/2002. JP Lee tracked down the deletions from 2009 and 2008 for me, and when I examined them I discovered that all of them spent much or all of the deletion year on an RS sell signal. Some of the long-standing RS sell signals were in titans of American industry like GE (RS sell 9/20/2001) and PFE (RS sell 7/12/2001). Some, like 2009 deletion GCI, had a complete RS collapse while the stock went from $62 to $4. We use a much more sophisticated measurement of relative strength for our managed accounts, but even a blunt instrument like buy and sell signals on a point & figure RS chart may have promise in identifying potential dividend problems.