The goal of any investor is to either:
Investors in the accumulation phase tend to fall under the first constraint, while retired investors invest with the second criterion in mind.
There is a third approach – maximizing risk-adjusted returns.
This means that an investor has no cap on the amount of risk they will assume, as long as they are adequately compensated for this risk by excess investment performance.
So how do we measure risk-adjusted returns?
The Sharpe Ratio is the generally-accepted metric used to measure risk-adjusted returns.
Finding stocks with strong prospects for above-average risk-adjusted returns can be difficult. One way to identify these businesses is by looking at their historical risk-adjusted returns.
With that in mind, this article will use various time periods to analyze the risk-adjusted performance of the Dividend Aristocrats, a group of high-quality dividend stocks with 25+ years of consecutive dividend increases.
1-Year Risk-Adjusted Returns
A 1-year time period is generally too short to identify any meaningful investment trends.
However, this analysis still calculates 1-year risk-adjusted returns for Dividend Aristocrats, as there are important observations that can be made from this time period.
First, it’s important to understand the metric that we’re dealing with. For those unfamiliar with the Sharpe Ratio, it is calculated as follows:
For the risk-free rate of return, the 10-year government bond yield is generally used. That convention will be followed in this analysis. Right now, the 10-year U.S. government bond yield is 2.3%, which is the figure that will be used in our Sharpe Ratio calculations.
With all that in mind, here are the top 10 Dividend Aristocrats by 1-year risk-adjusted returns.
Source: YCharts
The first observation that can be made from this data is this: the Sharpe Ratios contained in the table above are far higher than what can be expected for equity securities over long periods of time.
These elevated Sharpe Ratios are caused by the unique characteristics exhibited by the broader equity markets over the past year: above-average returns combined with a volatility level that is much below historical norms.
In the table above, stocks rank highly because they either have very high returns, very low volatility, or some combination of the two.
Stocks with fantastic returns include:
None of these returns are sustinable over long periods of time, or else these companies would eventually grow to consume the entire global economy.
Stocks with extremely low volatility include:
These standard deviations are well below what investors can reasonably expect over long periods of time.
For context, the S&P 500 ETF (SPY) – a diversified basket of large-cap stocks– has had a 10-year annualized standard deviation of about 16%, much higher than some of the stocks in the table above.
Looking at the best-performing Dividend Aristocrats on a risk-adjusted basis over the past year gives insights into some of the hottest dividend stocks right now.
However, buying the ‘hottest’ stocks is not a winning investing strategy. It is important to have an element of contrarianism as an individual investor.
