Don’t underestimate pig smarts…
Purdue University’s Dr. Candace Croney once taught pigs to play video games. And the University of Bristol’s Dr. Michael Mendl showed that pigs can deceive one another.
In short, pigs aren’t as dumb as you might first believe… They can think and learn.
The humble pig even found praise in the world of finance many years ago. Legendary fund manager George Soros famously said, “It takes courage to be a pig.”
With that in mind, over the next two days, I’d like to teach you to be just like a pig. More specifically, I’ll cover how to become a “prudent yield hog.”
The reason is simple…
Educated hogs can chase high yields without being reckless.
This is darn important in today’s market… Nearly everyone is on the hunt for yield. And yet, with interest rates near all-time lows, it’s hard to find high yields with low risk these days.
For example, U.S. Treasury bonds are often considered one of the safest investments you can make. The U.S. government has never defaulted, so your money is in good hands.
Today, though, the yields on U.S. Treasury bonds just aren’t that attractive… The 10-year U.S. Treasury note, for example, yields about 1.5% right now. That’s better than this time last year when it was below 1%… But it’s still not going to grab your attention.
It’s a similar story in stocks…
You can see what I mean by looking at the SPDR S&P 500 Fund (SPY)… It’s a broad market exchange-traded fund (“ETF”) that tracks the benchmark S&P 500 Index.
The dividend yield on SPY is 1.2% today. That excites nobody.
Of course, many individual stocks offer much higher yields. In fact, you can almost always find some stocks with yields of more than 10%. But those are often “sucker yields”…
That’s because yields are expectations of future returns. And if investors were confident that the company could maintain the dividend, they would act… Buyers would bid the company’s share price up to the point when the yield would no longer stand out.
We can see this play out in real life… A portfolio holding the 20 highest-yielding stocks in the Russell 3000 Index yields 11.8% today. That’s enticing, but it’s best left for suckers…
You see, naïve yield hogs assume the market is wrong. They think investors have incorrectly pushed these stocks down, driving their yields up. (Remember, dividend yield is a ratio that shows how much a company pays in annual dividends relative to its stock price… So if the company’s stock price rises, its dividend yield will drop – and vice versa.)
As a result, naïve yield hogs will chase this basket of the highest-yielding stocks. That’s not a move that a prudent yield hog should make, though…
I simulated a portfolio built this way. Over the past 10 years, this portfolio’s annual total return would’ve averaged only 4.3%. That’s far lower than the initially expected 11.8% yield.
This discrepancy happens because many of these stocks’ expected dividends never materialize… And many of the stocks fall. They don’t live up to the expectations of future returns.
If you want to become a prudent yield hog, you could make a much better choice…
You could buy shares of the iShares Select Dividend Fund (DVY). It yields 3.2% today.
That 3.2% yield might not seem like much at first glance. But this ETF would’ve outperformed the basket of the highest-yielding stocks in a big way… In my simulation, the average annual 10-year rate of return on DVY was 12.2%.
You see, DVY uses simple, backward-looking criteria (over the past five years). It considers dividend consistency and dividend growth.
It requires that earnings are high enough to more than cover a company’s dividend payments. And it also requires “non-negative trailing 12 month earnings per share.”
In other words, DVY shows us that basic security analysis can help investors reach for more yield in a safer way… You don’t need to chase the basket of the highest-yielding stocks like the rest of the suckers.
The ETF would’ve easily earned more than the advertised 3.2%. Dividend payments among the companies within it often increase, and many of their shares produce capital gains as well.
This type of history-based analysis is common among thoughtful yield seekers. It’s the first step in becoming a prudent yield hog… Avoid the riskiest situations by eliminating the extremely high yields from the start.
Tomorrow, I’ll show you how we can take this idea a step further. We’ll use it to take on some of the brightest minds on Wall Street.
Good investing,
Marc Gerstein
