The recent U.S. election unleashed more pandemonium than usual. Cats and dogs living together – or maybe it was eating each other. It was all a little befuddling.
But the market jumped once the winner was crowned, which means it’s time to check in on the three U.S. portfolios I follow for The Globe and Mail. They’ve all provided outsized returns over the long term and gained ground over the past 12 months.
The portfolios pick stocks from within the S&P 500 index, which follows roughly 500 of the largest U.S. stocks. The first two portfolios start with the dividend payers in the index and the third seeks bargains by searching through the full list of stocks.
The U.S. Stable Dividend portfolio is the first and it buys an equal dollar amount of the 20 dividend stocks in the index with the lowest volatilities over the prior 260 days.
The U.S. Frugal Dividend portfolio starts with the 50 dividend stocks in the index with the lowest volatilities over the prior 260 days and then picks an equal amount of the 10 with the lowest price-to-earnings ratios.
The third, the U.S. Free Cash portfolio, is easy to describe but uses a fancy measure of value. It begins with all of the stocks in the S&P 500 and buys an equal amount of the 10 stocks with the lowest enterprise-value to free-cash-flow ratios.
As a quick reminder, enterprise value (EV) is equal to a company’s market capitalization plus its net debt. Free cash flow (FCF) is the amount of money a company can distribute to its shareholders while maintaining its operations. It is approximated by subtracting capital expenditures from cash flow generated by operations.
The accompanying graph shows the gains of the three portfolios (assuming monthly rebalancing) and the S&P 500 index for comparison. (The returns herein are based on backtests using data from Bloomberg. They include dividend reinvestment but not fund fees, taxes, commissions or other trading costs.)
The top performer was the U.S. Free Cash portfolio with average annual returns of 18 per cent over the 25 years through to the end of Nov. 11, 2024. The U.S. Frugal Dividend portfolio nabbed second spot with average annual gains of 12.2 per cent over the same period while the U.S. Stable Dividend portfolio climbed by an average of 10.6 per cent annually. The S&P 500 index trailed behind with average annual returns of 8.1 per cent over the same 25 years.
I hasten to add that the U.S. Free Cash portfolio’s giant returns were accompanied by bumps along the way and it was roughly twice as volatile as the S&P 500 index over the 25 year period.
On the other hand, the U.S. Stable Dividend portfolio was about 20 per cent less volatile than the index and the U.S. Frugal Dividend portfolio was just a touch less volatile than the index.
Turning to more recent times, the U.S. market index was particularly strong over the past year. The S&P 500 index advanced by 38 per cent over the 12 months through to Nov. 11, 2024 while the U.S. Stable Dividend and U.S. Frugal Dividend portfolios trailed with gains of 21 per cent and 23 per cent, respectively. But the U.S. Free Cash portfolio beat them all with a gain of 73 per cent, which exceeded my wildest expectations.
The portfolios also produced strong returns for investors who rebalanced annually rather than monthly. The U.S. Stable Dividend portfolio gained an annual average of 10.3 per cent when rebalanced once a year over the 25 years to the end of Nov. 11, 2024 while the U.S. Frugal Dividend portfolio gained an average of 11.4 per cent annually. I was somewhat surprised to see the U.S. Free Cash portfolio gain an average of 16.4 per cent annually when rebalanced yearly, but rebalancing in early November might have been fortuitous.
I’ve high hopes that all three portfolios will continue to do well over the long-term. Mind you, the overall U.S. market is unusually pricey these days based on Robert Shiller’s cyclically-adjusted price-to-earnings ratio, which makes it riskier than normal. We live in interesting times.
You can find a list of the stocks in each of the three U.S. portfolios via this link, which also provides updates to many of the other portfolios I track for The Globe and Mail.
Norman Rothery, PhD, CFA, is the founder of StingyInvestor.com.