Since May 2020, we’ve been having a friendly competition between a few popular valuation ratios. It all started as a battle between dividend yield and shareholder yield. Since then, I’ve been keeping track of these portfolios at M1 Finance(link to actual holdings).

For more information on how these portfolios are constructed, read last month’s breakdown and then come back. If you’re familiar with how things are, then let’s see how these things finished the year.

How has each of these portfolios performed through December 31, 2020?

#7: S&P 500 Index (as represented by SPY) +33.5%1

Last month: #7

Since the value ratios started performing well in November, literally every single ratio was beating the market-cap-weighted S&P 500 since May. That continued through December. From inception (May 4, 2020), the S&P 500 returned 33.5%. Dead last on this list.

#6: S&P 500 Equal Weight Index (as represented by RSP) +39.2%2

Last month: #5

The S&P 500 is a market-cap-weighted index. Since we are equal weighting all of our holdings at the start, the most representative benchmark is probably the equal-weight S&P 500. That index has actually performed nearly 6% better than the S&P 500 since May 4th.

Therefore, we should consider this to be the more appropriate benchmarks for our strategies. It’s a tougher hill to climb, but it’s definitely a more fair way to compare how successful our little experimental funds are.

#5: Highest Dividend Yield +39.5%3

Methodology: Trailing 12-month dividends per share / Price per share

Last month: #3

How has the highest dividend yield portfolio performed since May? Not bad, but it doesn’t look very impressive compared to some of the other portfolios. At year-end, it was dead last amongst the other valuation ratios.

As I said in my video when I started this list, dividend yield does not include as much information as you might think. Companies can do all kinds of things to pay big dividends while funding them in questionable ways (issuing equity, borrowing money, reducing future investment, etc.) so it’s not a great way to pick your stocks. You need to, at a minimum, consider other variables.

This analysis would, at least so far, suggest that was spot on. The dividend yield is an overrated metric.

#4: High Buffett Yield +43.4%4

Methodology: 10-year average free cash flow / enterprise value (5)

Last month’s rank: #4

Holding steady at the #4 spot is the Buffett Yield. It is now closing in on the #3 position and that’s been great to see. It has been the biggest surprise to see this metric struggle in the early months; it is one of my most interesting custom variables for determining value. If you want to read more about Buffett yield, you can check out December’s article.

#3: Lowest Forward P/E Ratio +43.8%6

Methodology: Current price / Forward 12-month earnings per share estimates

Last month: #5

I’ve long been critical of the price-to-earnings (P/E) ratio. It’s simple to calculate, intuitive, and widely referenced. However, I think it contains virtually no useful value information. It only captures one moment in time, which can lead to value traps or for stocks to look “expensive” which really are not. That’s not even to mention the substantial issues with GAAP earnings per share.

The P/E ratio has been struggling to keep up with other, more robust methods of valuation capture; things have been improving as of late though. It was the worst-performing metric we had last month but is now up to 3rd.

Maybe I’m wrong on P/E ratio… We’ll see. 😉

#2 High EBIT/EV Yield +44.5%7

Methodology: Highest operating income (EBIT) / enterprise value (EV)

Last month: #2

Research has shown impressive results for the EBIT/EV ratio. It’s one of my favorite single valuation metrics. It’s far better than the P/E ratio because it also incorporates the balance sheet into the ratio. For example, two stocks could have identical P/E ratios of 20. Yet, one company has 100% of its market cap in debt. The other has 0% in debt. Which is more attractive? The latter is obviously better.

The EBIT/EV ratio for these two companies would be wildly different. All else being equal, the highly indebted company would likely show an EV/EBIT ratio of 40; the other would show a ratio of 20. Now the lower debt company appears cheaper, which it should.

That’s why EBIT/EV is superior to P/E (and why I think it will show better long-term performance). That continues this week as it holds steady at #2 with P/E ratio hot-on-its-heels.

#1 High Shareholder Yield +49.0%8

Methodology: Highest shareholder yield (total dividends + buybacks (equity issuance) / market cap)

Last month: #1

Shareholder yield actually had a relatively tough month. Last week’s gap between it and the dividend yield portfolio was nearly 12%. That margin is now down to 10%. Still, it was doing so well that it doesn’t even matter. Shareholder yield is clearly the best-performing metric since our metric began.

It remains one of the most important single factors for dividend investors and investors, in general, to consider.

Why Shareholder Yield is Better Than Dividend Yield

If you’ve been watching my YouTube channel, you know that I’m not a huge fan of dividend yield. It is deceptive and alluring, which leads to a lot of investors into trouble. I’ve dedicated the last few months to combat this common myth amongst dividend investors.

However, there are certain cases where a high dividend yield is legitimate. Those situations are when a companies stock price has declined substantially, but they are still able to pay the dividend out of organic free cash flows. Even better is when that company can pay a dividend and buyback shares; that’s a double whammy. It’s like you getting both $20 bill and a $20 gift card to Amazon. Jackpot! 😃

Unfortunately, there are other cases where the company is borrowing money or, worse, issuing new equity to keep paying the dividend. This creates an illusion of a high dividend yield, but it is being offset by bloating the balance sheet or diluting shareholders. It’s essentially like paying you $20 in cash, but then requiring that you give them a $20 gift card to Amazon. Technically, they paid you $20; really, it wasn’t much different than $0.

Conclusion

We’re basically creating our own index fund with these strategies. So far, everything has been going quite well. The portfolios are nearly all beating the S&P 500, shareholder yield is trouncing dividend yield, and the stock market analysts and their precious P/E ratio is lagging. Life is (still) good. 🏝

As we move into 2021, we’ll see how these portfolios continue to perform. I plan to update them 12 months from the initial rebalance. There also may be some new strategies for 2021 that I’ll be rolling out over the next few months.

Nathan

DISCLAIMER: This is for educational purposes only and is not investment advice. It is not a recommendation to buy or sell any security. The author owns every stock mentioned above. All opinions are my own.

1. Morningstar “SPY” Total Return interactive chart.   ↩

2. Morningstar “SPY” Total Return interactive chart.  ↩

3. “M1 Finance - Free Automated Investing.” M1 Finance, https://dashboard.m1finance.com/d/invest/portfolio. Accessed 4 Jan. 2021.  ↩

4. “M1 Finance - Free Automated Investing.” M1 Finance, https://dashboard.m1finance.com/d/invest/portfolio. Accessed 4 Jan. 2021.  ↩

5. Calculated as total debt + market cap, which generally gives a more complete picture of a company. In essence, this is what the company would cost if you bought the entire thing and paid off all debts.  ↩

6. “M1 Finance - Free Automated Investing.” M1 Finance, https://dashboard.m1finance.com/d/invest/portfolio. Accessed 4 Jan. 2020.  ↩

7. “M1 Finance - Free Automated Investing.” M1 Finance, https://dashboard.m1finance.com/d/invest/portfolio. Accessed 4 Jan. 2021.  ↩

8. “M1 Finance - Free Automated Investing.” M1 Finance, https://dashboard.m1finance.com/d/invest/portfolio. Accessed 4 Jan. 2021.  ↩