Reality Shares launches dividend health strategy indices

Aug 24th, 2015 | By | Category: ETF and Index News

Reality Shares Advisors, a specialist index provider and exchange-traded fund issuer, has developed a new proprietary model, branded as “DIVCON”, that ranks firms based on expected probabilities of a change in dividend policy.

Reality Shares launch dividend health rating Index series

Eric Ervin, President of Reality Shares Advisors.

The model underpins a new suite of indices – the DIVCON Dividend Health Indexes – which ultimately could provide the basis for a new line-up of dividend-focused ETFs.

The DIVCON model assigns a rating of 1-5 to each firm, with a lower rating indicating a higher probability of a dividend cut and a higher rating indicating a higher probability of a dividend increase.

“We believe dividends are a crucial measure of the underlying value of companies and a strong indicator of their future performance, and our new DIVCON indexes are uniquely designed to track the companies our methodology determines are most likely to grow their dividends,” says Eric Ervin, President of Reality Shares Advisors. “DIVCON also gives investors tools to help them assess the dividend health of their portfolios, as well as shining a spotlight on the best- and worst-performing dividend-paying companies.”

Some of the factors that the model examines include analyst consensus of expected dividend levels, coverage ratios (free cash flow/dividend cash flow), EPS growth over the previous 12 months, the firm’s record of dividend changes, share repurchases, Bloomberg dividend health scores, and Altman Z-Scores (a measure of the probability of a firm going bankrupt).

These factors are assigned different weightings in the combined analysis, but together they generate a score between 1-100 for each firm, which is then standardised into the probability groups 1-5. This process has been applied to the S&P 500 and has resulted in the formation of three distinct tracking indices: The Reality Shares DIVCON Leaders Dividend Index, which tracks all firms with a DIVCON rating of 5; the Reality Shares DIVCON Dividend Defender Index, which tracks DIVCON 5 firms while shorting DIVCON 1 firms; and the Reality Shares DIVCON Dividend Guardian Index, which tracks DIVCON 5 companie and shorts DIVCON 1 companies only when the market is in decline, as decided by the Reality Shares Guardian Market Strength Indicator.

The model’s track record in correctly predicting changes to firm’s dividend policies has been impressive in back tests. During the period 2001-2014, DIVCON 5 firms did indeed increase their dividend 96.6% of the time within a year of being assigned the rating. Meanwhile, DIVCON 1 firms were 34.4% likely to slash their pay-out within a year of holding the lowest score. The difference in predictive power between the two extremes is understandable as firms are naturally reluctant to cut dividends owing to the negative signal this sends to the market.

As of 1 July 2015, there were 42 US firms from the S&P 500 that held DIVCON ratings of 5. Top of the list was Starbucks (75.5), followed by Stanley Black & Decker (70.3) and PACCAR (70.0).

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