Your DI Questions Answered: Picking Stocks, Daily Returns and the Benchmark

March 28, 2025 | Get answers to common Dividend Investing questions, including stock selection tips, portfolio returns, and how free cash flow impacts payouts.

A few Dividend Investing (DI) subscribers have recently reached out with questions. Since many of you may have related questions, I answer them in this week’s commentary.

Here is quick summary:

• The DI Ideas list is a good place to start looking for stocks to add to your portfolio; it is suggested that investors focus on the stocks marked as held in the DI model portfolio.

• Daily returns for the stocks held in the model portfolio can be seen on the Performance tab of the Portfolio page.

• The DI model portfolio not only yields more than market, it also provides diversification and is less risky.

• The DI approach uses the free-cash-flow payout ratio in its analysis because cash is needed to pay dividends. (Earnings are just an accounting figure.)

Which Stocks Should I Target First?

There are 24 stocks currently held in the DI model portfolio. As stated in the DI User Guide, the more stocks you own, the greater the portfolio’s diversification and the lower the portfolio risk.

If you choose to hold less than 24 stocks, it is imperative that you divide your initial investment as equally as possible among stocks from different industries with an equal initial investment amount in each stock. You can select stocks by dividend yield, earnings growth rate or the date they were added to the DI model portfolio (newest to oldest). It is strongly advised that you hold at least 12 stocks, though holding more stocks will increase your portfolio’s diversification and lower its risk.

A good place to start looking for candidates to add to your portfolio is the DI Ideas list. This shows the stocks meeting the initial quantitative requirements as defined by the Dividend Pillars: valuation, growth and strength.

DI model portfolio holdings appearing on the DI Ideas list are designated by a check mark in the Held in Tracking Portfolio column on the right-hand side. These would be the first stocks to consider.

Where Can I See Daily Returns for DI Stocks?

The DI website’s Portfolio page contains seven tabs. The main Holdings tab shows you the total return for each stock since addition to the DI model portfolio. The next tab, Performance, shows you the daily change in the stocks’ prices (on a delayed basis) along with their price and total return since being added to the portfolio.

You can also see the risk index for each stock on this tab. The risk index shows how volatile each stock has been over the past three years relative to the benchmark iShares Dow Jones U.S. ETF (IYY). Values below 1.0 indicate that a stock’s price has been less volatile. Values above 1.0 indicate that a stock’s price has been more volatile than the benchmark.

An individual stock’s relative volatility matters much less than the overall volatility of the portfolio. This leads me to the next question.

Why Compare the DI Model Portfolio to the iShares Dow Jones U.S. ETF?

The iShares Dow Jones U.S. ETF is a market-capitalization-weighted fund that holds more than 1,000 U.S. stocks. It provides access to 95% of the domestic stock market’s capitalization. This makes it a good proxy to use as a benchmark for the market’s return.

While a market benchmark is useful for comparing returns against, there are key differences between the DI model portfolio and the iShares Dow Jones U.S. ETF.

The DI model portfolio emphasizes dividend growth and low to moderate valuations. The iShares Dow Jones U.S. ETF emphasizes market cap above all else. By design, the iShares Dow Jones U.S. ETF’s characteristics are significantly influenced by its largest stocks. These are mostly growth- and technology-oriented stocks.

This difference shows up in the R-squared values. R-squared measures how much of a portfolio’s returns can be explained by a benchmark. The DI model portfolio’s R-squared value was 0.54 for the 12-month period ending in February 2025. This shows that only about half of the DI portfolio’s performance can be explained by the iShares Dow Jones U.S. ETF’s returns over this recent time period.

Over a three-year period, the DI model portfolio’s R-squared is 0.81—a number that still represents a differentiated approach to stock selection. (A value of 1.00 implies that all of portfolio’s returns are explained by the market.)

I point this out because the DI model portfolio’s risk index is 0.97. This number indicates that over the past three years, the DI model portfolio has been less volatile than the iShares Dow Jones U.S. ETF. It also shows that the portfolio has been doing a good job in terms of diversification. When you combine different stocks in a portfolio with a focus on equal weighting, you end up with a less volatile portfolio.

To sum this up, the DI model portfolio yields more than the market portfolio (2.7% versus 1.0%), provides diversification against the market portfolio and is less risky. Such a comparison is only possible if we track a market benchmark like the iShares Dow Jones U.S. ETF.

How Is Free Cash Flow Calculated?

A subscriber recently asked about the free-cash-flow- per- share (FCFPS) payout ratio, which is reported on the Dividend Analysis tab of the Portfolio page. This metric shows the percentage of free cash flow paid out as dividends.

Free cash flow is cash flow from operating activities less capital expenditures (capex) and dividends. The DI approach modifies it to cash flow from operating activities less capex for the purposes of calculating the ratio.

The free-cash-flow-per-share payout ratio differs from the more commonly used earnings payout ratio.

The earnings payout ratio shows what percentage of earnings are paid out as dividends. It is a measure commonly used by companies. The downside of this ratio is earnings. Earnings are an accounting figure. Dividends are paid with cash.

A company can be profitable but not cash flow positive. This could happen if the company boosted its inventory over the past quarter or year, has yet to receive payment from customers, spent large amounts on facilities and machinery, etc. Free cash flow can be volatile due to timing issues or other reasons.

Over time, payout ratios based on earnings and free cash flow should both be positive and reasonable (especially below 100%). When analyzing each ratio, keep in mind that they differ among sectors and industries. Public utilities, in particular, have high payout ratios because their rate agreements allow for a certain return on assets.

Hello, Spring

Given all of the news headlines and stock market volatility, I want to remind you that spring has started. So has baseball; yesterday, was opening day for major league games played in North America. As a lifelong Baltimore Orioles fan, I am hoping their starting rotation of pitchers works out.