Group Investment Insight from NDR's Custom Solutions Team ... · U.S. investable market universe2,...

NDR Solutions Quarterly

MARCH 2016

Investment Insight from NDR's Custom Solutions Team

Ned DavisResearch

Group

LUCY LIU, CFA Senior Research Analyst, Custom Research SolutionsSTEPHANIE O'BRIEN Research Analyst, Custom Research Solutions

INVESTMENT STRATEGIES FOR NON-DIVIDEND PAYERS

Please see important disclosures at the end of this report.

NED DAVIS RESEARCH GROUP NDR Solutions Quarterly | MARCH 31, 2016

www.ndr.com | Periodical | Issue #CRS201603311

TABLE OF CONTENTSExecutive Summary ....................................................................................................................................................... 1

Introduction ...................................................................................................................................................................... 1

Overview of U.S. and International Non-Dividend Payers ......................................................................... 2

Non-Dividend-Paying Stocks Are More Common in the U.S. ............................................................................ 2

The Same Sector Can Have a Very Different Proportion of Non-Dividend-Paying Stocks .................. 3-4

Examining the Performance of Dividend Payers over Non-Payers ........................................................ 5

Dividend Payers Have Outperformed Non-Payers Over the Long Run ......................................................... 5

The Relative Performance Varies in Different Periods .......................................................................................... 6

Explaining the Outperformance Under the Fama-French Framework ............................................................ 7-8

Investment Strategies for U.S. Non-Payers ........................................................................................................ 9

Strategy A: Mimicking Dividend Payers .................................................................................................................... 9

Strategy B: Investing in Companies That Have Justifiable Reasons to Not Pay Dividends ............ 10-11

Comparing the U.S. Non-Payers' Strategies .................................................................................................... 12

Both Strategies Have Outperformed the U.S. Market ........................................................................................ 12

Both Strategies Exhibit Robust Performance Across Most Regimes ............................................................. 13

Both Strategies Have Slightly Better Risk Profiles Than the U.S. Market ...................................................... 14

Holdings Comparison .................................................................................................................................................... 15

Conclusion ........................................................................................................................................................................ 15




This edition of NDR Solutions Quarterly discusses investment strategies for non-dividend-paying stocks, which can be help-

ful for investors with taxable investment accounts. As originally stated, the goal of this publication is to provide our client base

with unique investment ideas, tools, and analytical frameworks each quarter. Through this publication, the NDR Solutions team

can showcase the varied skill sets and diverse experience we regularly provide to clients with direct engagement, customized

output, and tailored solutions. As always, we welcome any feedback, as well as questions about our services, and hope that you

find this publication insightful, unique, and useful.

EXECUTIVE SUMMARY

� In the past two decades, dividend payers have outperformed non-dividend payers over the long run.

� However, after taking away some of the key qualities of dividend-paying stocks, such as lower market beta, higher market cap, and cheaper valuation, the outperformance of dividend-paying stocks over non-dividend paying stocks may be sub-dued, especially for the U.S. market.

� In the U.S., the percentage of stocks that are non-dividend-paying is much higher than it is in the rest of the developed world. Because of this, the U.S. market provides greater opportunities to form non-dividend-paying stocks’ investment strategies.

� Two investment strategies for non-dividend-paying stocks are discussed in this publication. The first strategy aims to select non-dividend-paying stocks that resemble dividend-paying stocks, and the second strategy screens for companies with justifiable reasons not to pay a dividend.

� The two strategies are quite different in nature, but both are able to generate comparable or better returns than an equal -weighted portfolio of dividend-paying stocks.

INTRODUCTION

Income-oriented investments have been quite popular given the U.S. demographic and the low interest rate environ-ment. However, those investments may not be tax efficient for investors using taxable accounts.

In reality, investors can have a good amount of investments in taxable accounts for various reasons. For individual in-vestors, tax-deferred investment accounts, such as 401(k) and IRA are great investment vehicles. However, those accounts typically come with restrictions, such as early withdrawal penalties and contribution limits. For investors who prefer higher liquidity and flexibility of their wealth, they may not be willing to or be able to invest all their savings in those accounts. For institutional investors, some institutions such as foundations and endowments may enjoy tax-exempt status, but others may need to pay tax on investments too.

Given the tax situation, it makes sense for investors to allocate as much high-yielding investment into tax-exempt or tax -deferred accounts, and keep low-yielding or non-yielding investments in the taxable account. In terms of stock investing, creating investment strategies for non-dividend-paying stocks can be just as important as creating investment strategies for dividend-paying stocks.

In this paper, we present the following:

� Differences between non-dividend-paying stocks and their major contributing sectors in the U.S. versus the rest of the developed world.

� The performance spread between dividend-paying stocks and non-dividend-paying stocks under the Fama-French framework.

� Two investment strategies to pick non-dividend-paying stocks.




OVERVIEW OF U.S. AND INTERNATIONAL NON-DIVIDEND PAYERS

Non-Dividend-Paying Stocks Are More Common in the U.S.

To distinguish established non-dividend-paying stocks from

those that eliminate dividends possibly due to temporary fi-

nancial conditions, we divide equity markets into the following

four1 mutually exclusive dividend categories based on compa-

nies’ previous and current calendar years’ dividend payments:

dividend payers, dividend non-payers, dividend initiators and

dividend eliminators. To qualify as dividend payers (or non-

payers), the dividend payments for both previous and current

calendar year need to be non-zeros (or zeros).

For the U.S. stock market, which is represented by the MSCI

U.S. investable market universe2, about 48% of the stocks are

non-dividend-paying on average, as is shown in the chart be-

low. For the international market, which is represented by the MSCI World ex. U.S. investable market universe, about only 18% of the stocks are non-dividend-paying on average. Namely, non-dividend-paying stocks are more common in the U.S. than in the international market.

The top three contributing sectors for U.S. non-dividend-paying stocks historically are Information Technology, Health Care, and Consumer Discretionary, while the top three contrib-uting sectors for international non-dividend-paying stocks are Industrials, Materials, and Financials.

1. This approach is different from NDR’s SBOX_202_SP5 product, where dividend eliminators are considered non-payers and dividend initiators are considered divi-dend payers.

2. The MSCI investable market universe includes large-, mid-, and small-cap stocks.

© Copyright 2016 Ned Davis Research, Inc. Further distribution prohibited without prior permission. All Rights Reserved.See NDR Disclaimer at www.ndr.com/copyright.html For data vendor disclaimers refer to www.ndr.com/vendorinfo/

NSQ2016Q1_01

U.S. vs International Non Dividend Payers and Top Contributing Sectors 1994-12-31 - 2015-12-31


NSQ2016Q1_01

U.S. vs International Non Dividend Payers and Top Contributing Sectors 1994-12-31 - 2015-12-31

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016-0.75-0.50-0.250.000.250.500.751.001.251.501.752.002.252.502.753.003.253.503.754.004.254.504.755.005.255.505.756.006.256.506.757.007.257.507.758.00

-- MaterialsNon-Payers (123, 2.8%)

-- FinancialsNon-Payers (130, 2.8%)

-- IndustrialsNon-Payers (139, 2.9%)

World ex U.S.Non-Payers (833, 18.3%)

-- Consumer DiscretionaryNon-Payers (256, 8.8%)

-- Health CareNon-Payers (261, 9.2%)

-- Information TechnologyNon-Payers (404, 13.9%)

U.S.Non-Payers (1382, 48.2%)

MSCI U.S. IMI and MSCI World ex U.S. IMI universes are used for U.S. and international stocks.The numbers in the labels correspond to the average counts of non-payers through out the history ( absolute counts and % of all dividend categories ).

Source: MSCI




The Same Sector Can Have a Very Different Proportion of Non-Dividend-Paying Stocks

The chart below expands from the top three contributing sectors mentioned above, and shows all ten sectors’ contribu-

tion to non-dividend-paying stocks in the U.S. and the interna-tional markets.

It is true that the top contributing sectors for non-divi-dend-paying stocks in the U.S. and in the international market has something to do with sectors’ benchmark weights in the two markets. For example, as shown in the chart below, the Information Technology sector has a higher weight in the U.S. market, while the Industrials and Materials sectors have high-er weights in the international market. This could lead to the Information Technology sector being the top non-dividend-

payers' contributing sector for the U.S. and the Industrials and Materials sectors being the top dividend-payers' contributing sectors for the international market.

However, the sector benchmark weights alone cannot explain why some sectors, such as Consumer Discretionary, which have similar weights in the U.S. and in the international market, do not have similar shares of non-dividend-paying stocks in the two markets.

NSQ2016Q1_02

NSQ2016Q1_02




The chart below looks at non-dividend-paying stocks more

closely, by comparing the percentage of stocks in each sector

that are non-dividend-paying in the U.S. versus in the interna-

tional market.

Note that in the U.S., about 83% of the technology stocks are

non-dividend-paying, while in the international market, only

25% of the technology stocks are. In the U.S., about 80% of the

health care stocks are non-dividend-paying, while the number

is only 28% in the international market. For the consumer dis-

cretionary stocks, about 55% of the stocks are non-dividend-

paying in the U.S., while only 16% are non-dividend-paying in

the international market.

The same sectors can have a very different makeup of div-

idend-paying vs. non-dividend-paying stocks in different mar-

kets. This can also lead to different levels of sector contributions

for non-dividend-paying stocks in different markets.


NSQ2016Q1_03

% of Stocks in Each Sector That Are Non-Payers ( Historical Average ) Monthly Data 1994-06-30 to 2016-02-29


NSQ2016Q1_03

% of Stocks in Each Sector That Are Non-Payers ( Historical Average ) Monthly Data 1994-06-30 to 2016-02-29

Energy Materials Industrials ConsumerDiscretionary

ConsumerStaples

Health Care Financials InformationTechnology

Telecommunication Services

Utilities

0.02.55.07.5

10.012.515.017.520.022.525.027.530.032.535.037.540.042.545.047.550.052.555.057.560.062.565.067.570.072.575.077.580.082.585.087.590.0

57 44 26 26 46 14 55 16 31 11 80 28 14 15 83 25 65 34 7 12

MSCI U.S. IMIMSCI World ex U.S. IMI

Note: MSCI IMI Universe includes small caps.Source: MSCI

NSQ2016Q1_03




EXAMINING THE PERFORMANCE OF DIVIDEND PAYERS OVER NON-PAYERS

Dividend Payers Have Outperformed Non-Payers Over the Long Run

As shown in the charts at right and be-low, dividend payers have outperformed non-dividend payers in both the U.S. and the international ex. U.S. markets since 6/30/19943, in terms of both absolute and risk-adjusted returns. This is consis-tent with our U.S. strategy team’s findings for the S&P 500 stocks (SBOX_202_SP5), where dividend payers have outper-formed non-payers, dividend growers have outperformed dividend non-chang-ers, and dividend non-changers have out-performed dividend cutters.

3. This is the earliest date of MSCI IMI universe in our database.


NSQ2016Q1_04

Returns of MSCI World ex U.S. IMI Stocks by Dividend Policy Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)


NSQ2016Q1_04

Returns of MSCI World ex U.S. IMI Stocks by Dividend Policy Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

354045505663717989

100112126141158178200224251282316355398447501562631708794891

1,0001,1221,2591,413

354045505663717989

100112126141158178200224251282316355398447501562631708794891

1,0001,1221,2591,413

Payers ( Gain/Annum: 6.5%, Std Dev Ann: 16.2%, Sharpe Ratio: 0.24, Turnover :36.5%, Avg # Stocks: 3324 )---- Growers ( Gain/Annum: 8.7%, Std Dev Ann: 15.5%, Sharpe Ratio: 0.39, Turnover :147.3%, Avg # Stocks: 1209 )---- Non-Changers ( Gain/Annum: 4.3%, Std Dev Ann: 17.1%, Sharpe Ratio: 0.10, Turnover :155.7%, Avg # Stocks: 1745 )---- Cutters ( Gain/Annum: 3.9%, Std Dev Ann: 17.9%, Sharpe Ratio: 0.07, Turnover :172.3%, Avg # Stocks: 370 )Non-Payers ( Gain/Annum: 1.9%, Std Dev Ann: 24.3%, Sharpe Ratio: -0.03, Turnover :75.8%, Avg # Stocks: 851 )Initiators ( Gain/Annum: 4.5%, Std Dev Ann: 19.9%, Sharpe Ratio: 0.10, Turnover :202.2%, Avg # Stocks: 168 )Eliminators ( Gain/Annum: 2.9%, Std Dev Ann: 25.2%, Sharpe Ratio: 0.02, Turnover :218.1%, Avg # Stocks: 74 )

Portfolios are Equal Weighted, Rebalanced Quarterly. Total Returns are in USD.The Major Dividend Categories Listed in the Chart are Mutually Exclusive.Dividend Payers Include Dividend Growers, Cutters and and Non-Changers.Dividend Growers are Stocks with Positive Change of IDC ( for International Stocks ) or Compustat ( for U.S. stocks ) Indicated Annual DPS from the Previous Year End ( in Local Currency ).

Source: MSCI


NSQ2016Q1_04

Returns of MSCI U.S. IMI Stocks by Dividend Policy Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)


NSQ2016Q1_04

Returns of MSCI U.S. IMI Stocks by Dividend Policy Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

16

20

25

32

40

50

63

79

100

126

158

200

251

316

398

501

631

794

1,000

1,259

1,585

1,995

2,512

3,162

3,981

5,012

16

20

25

32

40

50

63

79

100

126

158

200

251

316

398

501

631

794

1,000

1,259

1,585

1,995

2,512

3,162

3,981

5,012

Payers ( Gain/Annum: 12.1%, Std Dev Ann: 15.5%, Sharpe Ratio: 0.62, Turnover :27.9%, Avg # Stocks: 1347 )---- Growers ( Gain/Annum: 12.4%, Std Dev Ann: 13.7%, Sharpe Ratio: 0.72, Turnover :152.0%, Avg # Stocks: 501 )---- Non-Changers ( Gain/Annum: 11.5%, Std Dev Ann: 16.3%, Sharpe Ratio: 0.55, Turnover :137.4%, Avg # Stocks: 794 )---- Cutters ( Gain/Annum: 4.6%, Std Dev Ann: 21.8%, Sharpe Ratio: 0.09, Turnover :175.7%, Avg # Stocks: 52 )Non-Payers ( Gain/Annum: 9.2%, Std Dev Ann: 25.1%, Sharpe Ratio: 0.27, Turnover :49.7%, Avg # Stocks: 1385 )Initiators ( Gain/Annum: 7.8%, Std Dev Ann: 17.8%, Sharpe Ratio: 0.30, Turnover :221.7%, Avg # Stocks: 38 )Eliminators ( Gain/Annum: -0.9%, Std Dev Ann: 36.2%, Sharpe Ratio: -0.09, Turnover :235.3%, Avg # Stocks: 18 )

Portfolios are Equal Weighted, Rebalanced Quarterly. Total Returns are in USD.The Major Dividend Categories Listed in the Chart are Mutually Exclusive.Dividend Payers Include Dividend Growers, Cutters and and Non-Changers.Dividend Growers are Stocks with Positive Change of IDC ( for International Stocks ) or Compustat ( for U.S. stocks ) Indicated Annual DPS from the Previous Year End ( in Local Currency ).

Source: MSCI, S&P Capital IQ Compustat

NSQ2016Q1_04

NSQ2016Q1_04

http://www.ndr.com/group/ndr/content-viewer/-/v/SBOX_202_SP5




The Relative Performance Varies in Different Periods

The chart below provides a more detailed view of the rela-tive performance of dividend payers versus non-payers in the U.S. and the international market.

The green relative performance line represents the U.S. mar-ket, and it is a ratio of U.S. equal-weighted dividend payers total return index to the U.S. equal-weighted non-payers total return index, starting at 1:1. Over the long run, U.S. dividend payers have outperformed non-payers, as evidenced by the relative performance line rising from 1:1 to around 1.8:1. Most of the

outperformance of U.S. dividend payers is concentrated be-tween 1994 and 2002. After 2004, U.S. dividend payers exhibit relatively flat performance over the non-payers.

The orange relative performance line represents the interna-tional market, and for the international market, most of the divi-dend payers’ outperformance is concentrated in recent years. For the periods 1994 to 2000 and 2002 to 2008, the internation-al non-payers outperformed the international dividend payers.


NSQ2016Q1_05

Dividend Payers vs Non-Payers Relative Performance Monthly Data 1994-06-30 to 2016-02-29


NSQ2016Q1_05

Dividend Payers vs Non-Payers Relative Performance Monthly Data 1994-06-30 to 2016-02-29

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

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2.0

2.1

2.2

2.3

2.4

2.5

2.6

2.7

MSCI U.S. IMI Dividend Payers / Non-PayersMSCI World ex U.S. IMI Dividend Payers / Non-Payers

Relative performance is measured by the dividend payers total return index divided by non-payers total return index (in USD).Start at 1:1

Source: MSCI

NSQ2016Q1_05

http://www.ndr.com/vendorinfo/#msci




Explaining the Outperformance Under the Fama-French Framework

Dividend payers tend to have lower beta, larger market cap, and cheaper valuations than non-payers. When taking these divi-dend payers' features away, the excess returns of U.S. dividend -paying stocks over non-payers may no longer look significant.

The tables below use the Fama-French three-factor model to examine the statistical significance of the monthly excess re-turns of dividend payers over non-payers. Monthly returns of the MSCI IMI growth index4 over the MSCI IMI value index are used to represent the growth minus value factor, and monthly returns of the MSCI small cap index over the MSCI large cap in-dex are used to represent the small cap minus large cap factor. The negative coefficient estimates for the "MSCI IMI", "Small Cap Minus Large Cap" and "Growth Minus Value" factors indicate that dividend payers in general have lower beta, larger market cap, and cheaper valuation than non-payers. The zero p-values

of those estimates indicate that those dividend payers' features are not negligible.

The coefficient estimate of the intercept represents monthly excess returns of dividend payers over non-payers. For the period 20015 to 2016, the estimate of the excess returns of dividend pay-ers over non-payers in the U.S. market is positive; however, it has a p-value of 0.219, which is greater than 0.1, indicating the excess returns of the dividend payers versus non-payers are not very dif-ferent from zero. In the international market, the estimate of the excess returns of dividend payers has a p-value of 0, meaning the excess returns are considered different from zero and statistically significant in the international market, even after taking the beta, market cap, and valuation factors into account.

4. All indices are total return indices in USD.

5. MSCI small cap indices start in 2001 in our database.

REGRESSION ANALYSIS SUMMARY

Coefficient Estimate Std. Error T-Value P-Value

intercept 0.209 0.169 1.233 0.219

MSCI U.S. IMI -0.303 0.042 -7.279 0.000

Small Cap Minus Large Cap -0.310 0.064 -4.852 0.000

Growth Minus Value -0.874 0.073 -11.989 0.000

Ned Davis Research Group T_NSQ201603XX1.1

REGRESSION ANALYSIS SUMMARY

Coefficient Estimate Std. Error T-Value P-Value

intercept 0.728 0.179 4.061 0.000

MSCI World ex U.S. IMI -0.467 0.035 -13.388 0.000

Small Cap Minus Large Cap -0.296 0.089 -3.342 0.001

Growth Minus Value -0.576 0.108 -5.326 0.000





The chart below illustrates the statistical significance of ex-cess returns of dividend payers over non-payers in detail, using three-year rolling regressions instead of a single regression for the period from 2001 to 2016.

The green dots represent the excess returns of dividend payers over non-payers from the rolling three-year regres-sions ending on 12/31 each year for the U.S. market, and the orange dots represent the excess returns for the international

market. Statistically insignificant excess returns are grayed out in the chart.

For the U.S. markets, almost all excess returns throughout different rolling three-year timeframes in history are not sta-tistically significant, after removing the three key features of dividend-paying stocks. However, for the international mar-kets, the dividend payers’ excess returns in recent years are statistically significant.


NSQ2016Q1_07

Monthly Excess Returns of Dividend Payers Over Non-Payers Monthly Data


NSQ2016Q1_07

Monthly Excess Returns of Dividend Payers Over Non-Payers Monthly Data

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Year

-0.5

-0.4

-0.3

-0.2

-0.1

0.0

0.1

0.2

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0.6

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1.5

1.6

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1.8

Mo

nth

ly E

xc

ess

Re

turn

s (%

)

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1.7

1.8

Source: MSCI

Note: Fama-French three factor model is used to calculate monthly excess returns on a rolling 3-year basis ending on 12/31 each year.Excess returns with p values greater than 0.10 are considered statistically insignificant, and are grayed out.

MSCI U.S. IMI

MSCI World ex U.S. IMI

NSQ2016Q1_07




INVESTMENT STRATEGIES FOR U.S. NON-PAYERS

Given non-dividend paying stocks are more common in the U.S. than in the international market, and there is strong evi-dence showing that non-payers are not necessarily inferior to dividend payers in the U.S. market purely because they are not paying any dividends, we will be focusing on developing in-vestment strategies for U.S. non-payers in this publication.

Strategy A: Mimicking Dividend Payers

If one is happy with the performance of dividend-paying stocks, but the concern is paying tax on dividends, then why not create a non-dividend-paying portfolio mimicking similar features of the dividend-paying stocks?

As mentioned in the analysis above, dividend payers tend to have lower beta, larger market cap, and cheaper valuations than non-payers. By creating a scoring system that ranks non-payers based on these three features, one may be able to pick a basket of non-payers that resembles dividend payers.

The chart below shows a strategy that uses such a scoring system. The best tile (tile 5 in the chart) represents the strategy, namely the basket of non-dividend-paying stocks that match the three features of dividend payers most closely. The perfor-mance of this strategy has been quite impressive, with 14.3% gain per annum and 0.67 Sharpe ratio from 1994 to 2016.


NSQ2016Q1_08

MSCI U.S. IMI Non Payers Strategy A Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)


NSQ2016Q1_08

MSCI U.S. IMI Non Payers Strategy A Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

10

18

32

56

100

178

316

562

1,000

1,778

3,162

5,623

10

18

32

56

100

178

316

562

1,000

1,778

3,162

5,623Quintile Portfolio Gain/Annum Std Dev Ann Sharpe Ratio Turnover Avg # Stocks

1 0.9% 38.6% -0.04 126.2% 231

2 3.8% 28.9% 0.04 175.9% 231

3 9.7% 22.7% 0.31 182.0% 231

4 13.2% 19.5% 0.55 160.3% 231

5 14.3% 17.5% 0.67 91.3% 231

Shaded areas represent NDR defined bear markets.Portfolios are Equal Weighted, Rebalanced Quarterly. Total Returns are in USD.The strategy is based on the overall scores of the following factors:3-Year Rolling Market Beta ( Small Values = Low Scores ),Market Capitalization ( Large Values = High Scores ),EBITDA to EV ( Large Values = High Scores ).

100

178

316

562

1,000

1,778

100

178

316

562

1,000

1,778Strategy A Best / Worst Quintile ( the Higher the Quintile Number, the Higher the Values, the Better )

Source: MSCI

NSQ2016Q1_08




Strategy B: Investing in Companies That Have Justifiable Reasons to Not Pay Dividends

Another approach is to think about when it makes sense for a company not to pay a dividend, and then invest in these types of companies.

When does it make sense for a company not to pay a divi-dend? One answer: when a company is very profitable and has great growth opportunities, it makes sense for it to plowback more to the business than distributing earnings to the share-holders.

In this strategy, we use return on equity (ROE) to represent companies’ profitability, and the past three years’ earnings per

share (EPS) growth trend6 to gauge if companies have good growth opportunities. In addition, we would like to avoid com-panies with high accrual ratios and avoid glamourous compa-nies with very high growth anticipation7 from The Street.

As shown in the chart below, this strategy (tile 5) has also shown impressive performance for the period 1994 to 2016, and the spread between the best and worst tile is even more consistent throughout the history than the first strategy.

6. Measured by rolling three-year z-score of trailing twelve months’ earnings per share.

7. Measured by estimated year-over-year sales per share growth.


NSQ2016Q1_08

MSCI U.S. IMI Non Payers Strategy B Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)


NSQ2016Q1_08

MSCI U.S. IMI Non Payers Strategy B Monthly Data 1994-06-30 to 2016-02-29 (Log Scale)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

1

2

5

10

18

32

56

100

178

316

562

1,000

1,778

3,162

5,623

10,000

1

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10

18

32

56

100

178

316

562

1,000

1,778

3,162

5,623

10,000Quintile Portfolio Gain/Annum Std Dev Ann Sharpe Ratio Turnover Avg # Stocks

1 -6.4% 33.5% -0.27 187.5% 203

2 5.1% 26.7% 0.09 258.6% 203

3 8.2% 23.7% 0.24 270.5% 203

4 11.2% 22.1% 0.39 256.6% 203

5 13.7% 21.1% 0.53 193.5% 203

Shaded areas represent NDR defined bear markets.Portfolios are Equal Weighted, Rebalanced Quarterly. Total Returns are in USD.The strategy is based on the overall scores of the following factors:Return on Equity ( Large Values = High Scores ),3-Year EPS Growth ( Large Values = High Scores ),Estimated Year over Year SPS Growth ( Small Values = Low Scores ),Accruals Ratio ( Small Values = Low Scores ).

56

100

178

316

562

1,000

1,778

3,162

5,623

10,000

56

100

178

316

562

1,000

1,778

3,162

5,623

10,000Strategy B Best / Worst Quintile ( the Higher the Quintile Number, the Higher the Values, the Better )

Source: MSCI

NSQ2016Q1_8




One explanation of the consistent spread between the best and the worst tile is that the factors used in this strategy have relative low correlation to each other, and some factors’ unde-sirable performance in certain years can be compensated by other factors’ desirable performance in those years.

The chart below shows each factor’s performance year by year, measured by the total returns of the factor’s best tile mi-nus the worst tile. In general, green means a factor performed well in a year, while red means vice versa. It is hard to find a year during which all the factors had undesirable performance

in any year from 19988 to 2015, and each factor seems to have

its own good versus bad performance pattern.

Using traditional correlation analysis for the full history, as

shown in the table below, the correlations among the four fac-

tors are quite low, ranging from -0.59 to 0.48.

8. 1998 is the earliest year when all the factors have performance stats. The ac-cruals factor starts in 1998, the estimated year-over-year sales per share growth factor starts in 1996, the return on equity factor starts in 1994, and the three-year earnings per share factor starts in 1994.

MSCI U.S. IMI NON PAYERS QUANT FACTORS CORRELATION (06/30/1994-02/29/2016)

Return on Equity 3-Year EPS GrowthEstimated Year over

Year SPS Growth Accruals Ratio

Return on Equity 1.00 0.48 -0.14 -0.59

3-Year EPS Growth 0.48 1.00 -0.11 -0.36

Estimated Year over Year SPS Growth -0.14 -0.11 1.00 0.07

Accruals Ratio -0.59 -0.36 0.07 1.00

Copyright 2016 Ned Davis Research Group. Further distribution prohibited without prior permission. All rights reserved.See NDR disclaimer at http://www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo.


NSQ2016Q1_9




COMPARING THE U.S. NON-PAYERS' STRATEGIES

The above section shows the performance of the two non-payers' strategies on their own. In this section, we will compare the two strategies’ performance with the broad U.S. market and with the dividend payers portfolio, and analyze the strength and weakness of those strategies.

Both Strategies Have Outperformed the U.S. Market

The charts below show the two non-dividend-paying strat-egies and the dividend payers portfolio’s performance relative to the broad U.S. market. For comparison purpose, the per-formance is calculated from equal-weighted, quarterly rebal-anced, total return indices.

From 1994 to 2016, both of the non-payer strategies have out-performed the customized U.S. market benchmark, in terms of both absolute and risk-adjusted returns. The two strategies have also outperformed the dividend payers portfolio in terms of the absolute returns, and achieved comparable risk-adjusted returns.

Note that the relative performance line for Strategy A, which tries to resemble the dividend payers portfolio, and the relative performance line for the dividend payers portfolio look corre-lated, while the relative performance line for Strategy B looks quite different. This confirms that Strategy B is quite different from Strategy A, and Strategy A succeeds in mimicking the divi-dend payers portfolio to a certain degree.


NSQ2016Q1_11

Relative Performance Against MSCI U.S. IMI Equal-Weighted Total Return IndexMonthly Data 1994-06-30 to 2016-02-29 (Log Scale)


NSQ2016Q1_11


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200MSCI U.S. IMI Non-Payers Strategy A Equal-Weighted Total ReturnMSCI U.S. IMI Non-Payers Strategy B Equal-Weighted Total ReturnMSCI U.S. IMI Payers Equal-Weighted Total Return

Name Gain/Annum Ann Std Dev Downside Dev Sharpe Ratio Max Drawdown (%)

MSCI U.S. IMI Non-Payers Strategy A Equal-Weighted Total Return 14.3% 17.5% 11.2% 0.67 -47.7%

MSCI U.S. IMI Non-Payers Strategy B Equal-Weighted Total Return 13.7% 21.1% 12.9% 0.53 -52.6%

MSCI U.S. IMI Payers Equal-Weighted Total Return 12.1% 15.5% 10.2% 0.62 -55.3%

MSCI U.S. IMI Equal-Weighted Total Return 10.8% 19.8% 12.9% 0.42 -56.2%

Source: MSCI




Both Strategies Exhibit Robust Perfor-mance Across Most Regimes

The historical period from 6/30/1994 to 2/29/2016 can be broken down into four dif-ferent pairs of regimes: equity bull market and equity bear market, commodity bull market and commodity bear market, high volatility market and low volatility market9, and rising real interest rates10 market and falling real in-terest rates market.

The chart on the top right shows the two non-dividend paying strategies' excess gain per annum over the U.S. market in different regimes, and the chart on the bottom right shows the excess gain per annum of the divi-dend payers portfolio over the U.S. market.

Both of the non-dividend-paying strate-gies have outperformed the U.S. market in most of the regimes, except that Strategy B has underperformed the U.S. market by about -1.2% per annum in the commodity bear market. The shapes of the two strategies look quite different: Strategy B has performed bet-ter than Strategy A in equity bull market, com-modity bull market, and high volatility market; while Strategy A has performed better than Strategy B in equity bear market, commodity bear market, and low volatility market.

The dividend payers portfolio has a more similar shape to Strategy A, except that it has performed better in the falling real interest rates market than in the rising real interest rates market, indicating one aspect of the dividend payers portfolio that Strategy A may not be able to fully replicate. Unlike the two non-dividend-paying strategies, the dividend payers portfolio has underperformed the U.S. market in equity bull markets by about -3.6% per annum and in rising real interest rates en-vironment by about -0.9% per annum.

9. VIX index is used to define high versus low volatility market. The historical average of the VIX index during the 6/30/1994 to 2/29/2016 period is 21.2. When the VIX index is higher than 21.2, the market is considered a high volatility market. Vice versa, for the low volatility market.

10. Note that the real interest rates are used here instead of the nominal interest rates. The nominal yields of 10-year U.S. treasuries minus the U.S. inflation rate is used to represent the real interest rates. NSQ2016Q1_12

NSQ2016Q1_12


NSQ2016Q1_11



NSQ2016Q1_11


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188







Source: MSCI




Both Strategies Have Slightly Better Risk Profiles Than the U.S. Market

For the period from 6/30/1994 to 2/29/2016, the chart on the top right shows the maximum drawdowns of the two non-dividend-paying strategies minus the maximum drawdown of the U.S. market in the following regimes: equity bear market, commodity bear market, and high volatility market. A positive number indicates the maximum drawdown is smaller than that of the U.S. market, which is considered desirable.

As shown in the chart, the two non-dividend-paying strat-egies display less maximum drawdown than the U.S. market in equity bear market and the high volatility market. Howev-er, their maximum drawdowns are slightly higher, though not significantly higher, than the U.S. market in commodity bear market: Strategy A experienced 0.3% more drawdowns, and Strategy B experienced 1.5% more drawdowns in commodity bear market.

In general, Strategy A displays a slightly better risk profile than Strategy B, and has slightly fewer drawdowns than Strategy B in all of the three regimes.

As for the dividend-paying portfolio shown in the chart on the bottom right, it exhibits a less impressive risk profile in high volatility market, but shows a better risk profile in the commodity bear market than the two non-dividend-paying strategies.

NSQ2016Q1_12

NSQ2016Q1_12


NSQ2016Q1_11



NSQ2016Q1_11


1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188

200

63

67

71

75

79

84

89

94

100

106

112

119

126

133

141

150

158

168

178

188







Source: MSCI




Holdings Comparison

Last but not least, one may be interested in seeing those strategies’ sector exposure. Sector exposure analysis on portfo-lios’ holdings is a good and a common tool to use; however, the true nature of the portfolios may elude this type of analysis.

The chart below shows the sector weights of the current holdings of the two equal-weighted non-dividend-paying strategies' holdings, alongside those of the equal-weighted dividend payers portfolio.

Though the two non-dividend-paying strategies are quite different in nature, the sector breakdown of the strategies are more similar to each other: Technology, Health Care, and Con-sumer Discretionary sectors have higher weights in the two strategies’ holdings. For the dividend-paying portfolio, even though it shared a lot of common features with Strategy A, its sector exposure is quite different. Financials, Materials, and Industrials sectors have higher weights in the dividend payers portfolio’s holdings.

CONCLUSION

In summary, unlike dividend-paying stocks, non-divi-dend-paying stocks are more tax efficient for investors with taxable accounts. Investment strategies can be developed to enhance non-dividend-paying stocks’ performance and reach a comparable or even better returns than the divi-

dend-paying stocks. It is also possible to develop a strategy that resembles key features of the dividend-paying stocks.

For more information or requests for further re-search, please contact our custom research team at [email protected]

NSQ2016Q1_13

mailto:[email protected]




Wenjia ( Lucy ) Liu, CFA, Senior Research Analyst, is a member of the Custom Research Solutions group. She specializes in global markets, asset allocation, and investment strategy research, and was the lead developer of the ETF Asset Allocation Model. Lucy joined NDRG in 2010.

Prior to joining NDRG, Lucy worked at Boston Common Asset Management, where she conducted fundamental research on international stocks. Before coming to the U.S., she worked as an analyst for American International Assurance Company, where she conducted analysis for the bancassurance division and provided training for salespeople.

Lucy earned her Master of Business Administration degree with a focus in finance from Carnegie Mellon University, Tepper School of Business, in 2010. She received her dual bachelor degrees in Law and Economics from Peking University. Lucy is a CFA charterholder and is a member of the CFA Institute.

Stephanie O’Brien, Research Analyst, Custom Research Solutions, performs a variety of research projects for NDRG clients.

Stephanie joined the firm in 2008 and previously worked for Ned Davis, the firm’s President and Senior Investment Strategist, developing indicators, models, and studies, as well as building and maintaining charts and reports.

Stephanie graduated cum laude from the University of South Florida with a Bachelor of Science in Economics.

Senior Research AnalystWENJIA ( LUCY ) LIU, CFA

Research AnalystSTEPHANIE O’BRIEN

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such devices can impact the market in a way that changes the e� ectiveness of such device.

Further distribution prohibited without prior permission. For data vendor disclaimers, refer to

www.ndr.com/vendorinfo.

Copyright 2016 (c) Ned Davis Research, Inc. All rights reserved.

Ned DavisSenior Investment Strategist

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Joseph KalishChief Global Macro Strategist

Ed Clissold, CFAChief U.S. Strategist

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