Four New 4-Factor Strategy Portfolios

4 Factor Strategy

It was October 2022 when I accidentally stumbled on the 4 factor stock selection strategy during my research of SCHD. While studying the underlying index of SCHD, the Dow Jones U.S. Dividend 100 index, I was infatuated with its simple yet powerful process. While there are more steps involved, it was the final ranking process that caught my eye. To select the constituent stocks the index narrows down an initial universe of approximately 3000 companies to just the top 100. The final ranking process leverages four fundamentally based characteristics that aim to find companies that have high liquidity, strong dividend growth, pay an attractive dividend yield and generate a healthy return on equity.

I borrowed this stock selection strategy with a few modifications and applied it to my own tailored universe of high quality dividend stocks. My 4 factor strategy revolves around the following 4 metrics.

1. Free Cash Flow to Total Debt Ratio
2. 5 Year Dividend Growth Rate
3. Return on Capital
4. Forward Dividend Yield

Initially I applied it to a shortlist of about 174 dividend paying stocks that were focused on high dividend growth. More recently I expanded the 4 factor strategy to cover 3 additional subsets of dividend stocks and I have been accumulating monthly data to track the results.

Four New Strategies Tracked

I have been tracking 2 strategies monthly since June of 2023 and 2 additional strategies were started during the month of September. Here are the four new 4 factor strategies:

1. High Dividend Yield (since June 2023)
2. High Dividend Growth (since June 2023)
3. Dividend Aristocrats (since September 2023)
4. Dividend Kings (since September 2023)

The objective of this project is to determine if the 4 factor stock selection strategy can be leveraged to create a portfolio that will generate a healthy annual total return. Each month the top 20 ranked stocks will be selected for inclusion in the portfolio with an equal weight allocation. Each portfolio assumes a monthly rebalancing frequency. I will also measure 4 different frequencies of selecting new constituent stocks: none, semi-annual, quarterly and monthly. Below is a summary of the initial results for each strategy.

1. High Dividend Yield

The high yield 4 factor strategy uses the following 10 criteria to create the initial universe of companies that are included in the ranking process.

1. Dividend yield of at least 2.75%
2. Payout Ratio of less than 100%
3. Positive 3 year dividend growth rate
4. Positive 5 year dividend growth rate
5. Positive 10 year dividend growth rate
6. Positive 5 year revenue growth rate
7. Positive 5 year EPS growth rate
8. Wide or Narrow Economic Moat
9. Standard or Exemplary Stewardship Rating
10. Traded on NYSE or NASDAQ

Here is the count of companies included in the universe for each month since inception.

• June 2023 - 81
• July 2023 - 73
• August 2023 - 65
• September 2023 - 76

Here are the top 20 companies chosen for each month.

Here are the initial returns for each top 20 list and each constituent rebalancing frequency compared to the return for the SPDR S&P 500 Trust ETF (SPY).

Thus far the returns for each month and each constituent rebalancing frequency are more favorable than the return of SPY. Please note that September returns are price returns only (not inclusive of dividends) through 9/15.

One key observation thus far is that the more frequently rebalanced constituent portfolios are generating better returns. Each monthly top 20 list will be tracked for a duration of 12 months.

Here are the initial dividend yields for each monthly top 20 list.

• June 2023 - 4.60%
• July 2023 - 4.39%
• August 2023 - 4.41%
• September 2023 - 4.52%

2. High Dividend Growth

The high dividend growth 4 factor strategy is the original strategy that I used to launch my actual portfolio last November. I began tracking this strategy on a monthly basis at the end of May 2023. To determine the initial universe of stocks for this strategy I use the following 8 criteria.

1. Payout Ratio of 80% of less
2. 3 year dividend growth rate of at least 5%
3. 5 year dividend growth rate of at least 5%
4. 5 year revenue growth rate of at least 5%
5. 5 year EPS growth rate of at least 5%
6. Wide or Narrow Economic Moat
7. Standard or Exemplary Stewardship rating
8. Traded on NYSE or NASDAQ

Here is the count of companies included in the universe for each month since inception.

• June 2023 - 134
• July 2023 - 134
• August 2023 - 133
• September 2023 - 136

Here are the top 20 companies chosen for each month.

Here are the initial returns for each top 20 list and each constituent rebalancing frequency compared to the return for SPY.

Thus far only the top 20 stocks selected for the month of June are performing better than SPY. This strategy has been more volatile and I believe it will outperform during months where market returns are positive and underperform during months where market returns are negative. During June and July market returns were positive and the top 20 lists for both months generated superior returns compared to SPY. During August and September market returns were negative and we have seen all lists underperform SPY during these time periods. Given that over long periods of time there are far more positive return months than negative return months, I believe in due time this strategy will yield favorable results.

Similar to the high yield strategy, thus far a more frequent constituent rebalancing frequency has yielded better returns.

Here are the initial dividend yields for each monthly top 20 list.

• June 2023 - 3.15%
• July 2023 - 2.24%
• August 2023 - 2.05%
• September 2023 - 2.23%

3. Dividend Aristocrats

The 4 factor dividend aristocrat strategy was launched in September of 2023 and as such I have less data to report thus far. The starting universe for each months stock selection process is the full list of all dividend aristocrats, which for September included 66 unique companies.

Here are the chosen aristocrats.

Here are the initial partial returns for September.

In addition to comparing this strategy to SPY, I will also compare it to the ProShares S&P 500 Dividend Aristocrats ETF (NOBL).

Thus far the strategy isn't off to a great start as its trailing both SPY and NOBL as of mid September.

The starting dividend yield for the September top 20 list was 2.49%.

4. Dividend Kings

The 4 factor dividend king strategy was also launched in September. The original universe of companies will be the full list of all dividend kings as of each month.

Here are the chosen dividend kings for September.

Here are the initial partial returns for September.

Since there are no funds that invest solely in all dividend kings this strategy will only be compared to SPY. Thus far the September top 20 list is seeing a slightly better return than its benchmark.

The starting dividend yield for the September top 20 list was a flat 3.00%.

Final Thoughts

What I expect to learn from this project is whether a 4 factor stock selection strategy can be applied to various subsets of dividend stocks and yield better than average returns. I am measuring all strategies against SPY for comparison purposes but beating SPY is not necessarily the primary objective. I would be happy if the long term returns generated by these strategies are in excess of a 12% CAGR. It will take some time to collect enough data to truly judge how effective this stock selection strategy is. I launched a real portfolio based on this strategy back in November of 2022. The portfolio has been reviewed here on Seeking Alpha and is performing quite well thus far. More recently I funded another portfolio based on this strategy, one that will have its constituent stocks rebalanced more frequently.

Going forward I will summarize the results of this project here on Seeking Alpha each month.