Huatai Securities: Middle East tensions disrupt market risk appetite; dividends still hold core position value

Haitong Securities’ research report states that in recent years, as global macro uncertainty has increased and domestic residents’ asset allocation demand has grown, along with the downward shift in the central threshold of broad-based investment returns for the whole society, dividend/“dividend yield” (bonus) strategies have attracted increasing attention from capital. Currently, dividend yield relative to growth valuations remains at a low level. Disruptions to the Middle East situation have affected market risk appetite, but dividend yield still has bottom-position value. Haitong Securities optimizes the dividend yield strategy from two aspects: stock selection and market timing: 1) from the stock selection perspective, based on dividend stability, earnings quality, and industry neutrality optimization, it builds a Haitong strategy high-dividend, industry-neutral portfolio. Based on free cash flow combined with growth and capital expenditure relative strength factors, it constructs the Haitong strategy free cash flow growth and stability portfolio; 2) from the timing perspective, it focuses on three types of excess-return environments: risk appetite decline, inflation rise, and the rise-in-volatility stage in a volatile market. Combined with Haitong’s Quantitative Investment Engineering (Haitong Gold Quant) team’s quantitative timing model, it currently remains bullish on dividend yield.

Full text as follows

Haitong | Strategy: Stock selection and market timing optimization for dividend yield strategies

Key takeaways

Re-explaining the long-term and short-term logic for dividend yield strategy outperformance

Considering dividend reinvestment returns, dividend yield strategies have been effective both overseas and domestically over the long term. The sources of their excess returns can be summarized as dividend reinvestment returns, low valuations and low volatility, and the “price fill-back” (“filling the rights”) effect. Over the long term, environments in which dividend yield strategies outperform include: 1) rising global macro uncertainty, with investors increasing demand for “safe assets” such as gold and dividend yield; 2) an interest rate downtrend or a long period of low interest rates— from an asset allocation perspective, the spread between dividend stocks and bond returns rises or stays at a high level, and funds flow into dividend yield assets through channels such as insurance, pension funds, and ETFs. In the short term, dividend yield also has both defensive and pro-cyclical characteristics: 1) dividend yield as a short-duration asset is relatively insensitive to risk premium changes on the denominator side and discount rate changes, and thus tends to hold up better during valuation contraction phases; 2) cyclical dividend yield tends to perform relatively better during inflation upswings.

Stock selection #1: Dividend stability, earnings quality, and industry-neutral optimization to form the dividend yield portfolio

We can enhance dividend yield strategies through methods such as multi-factor combination, refined factor processing, and weight optimization. Traditional dividend yield strategies face issues such as value traps, low growth potential, and overly concentrated industry distribution. To address these problems, in our 2023.3.30 report “High Dividend Yield Strategy Excess Return Environment and Stock Selection Ideas,” we constructed the Haitong strategy high-dividend industry-neutral portfolio and further optimized it as follows:

1) The sample universe is the entire A-share market (all A), rebalanced every May 1; 2) exclude ST stocks and stocks with market cap below 10 billion yuan; 3) stocks that have paid dividends continuously for the past three years, and whose five-year dividend yield average is higher than the median, with a coefficient of variation lower than the median; 4) calculate the forecast dividend yield based on consensus forecast net profit (if unavailable, use net profit TTM instead) and the average dividend payout ratio over the past 5 years. After removing outliers, the forecast dividend yield is not less than 2.5%; 5) compute a composite score by weighting based on the forecast dividend yield and ROA percentile, then rank; 6) select the top two stocks from each Shenwan一级 (Shenwan Level-1) industry based on score (if there are fewer, ignore) and build an equally weighted portfolio.

Within the backtest period (from May 1, 2016 to March 26, 2026), the portfolio’s annualized return is 11.7%, with an annualized excess return of 7.2% relative to the CSI Dividend Index (total return); annualized volatility is 17.0%, maximum drawdown is 23.1%, and the Sharpe ratio is 0.69—all of which are better than the CSI Dividend Index (total return). In terms of performance review, the portfolio only significantly underperformed the CSI Dividend Index (total return) in Feb.~Aug. 2022 and Jun.~Sep. 2025, while maintaining defensive characteristics and also capturing some portfolio resilience. However, it lost some of its exposure level to the dividend yield factor, and the portfolio’s dividend yield is clearly lower than that of the CSI Dividend Index.

Stock selection #2: From high dividend distribution to high cash flow, build a free cash flow enhanced portfolio

From the valuation model perspective, the essence of the dividend yield factor is the DDM model, while the essence of the free cash flow factor is the DCF model, which is more closely aligned with first principles. Compared with the traditional dividend yield factor, the cash flow factor (free cash flow rate, FCFF/EV) more effectively reflects companies’ ability to continuously and stably pay dividends. The selected stocks not only have strong profitability, healthy financial conditions, and high shareholder return capability (share buybacks and dividends), but also maintain some expansion capacity. Their position in the industry life cycle is generally more forward, balancing stability and growth. Free cash flow strategies are already relatively mature in overseas markets, and similar index products in the A-share market have also gradually become more abundant. Since their base date, most free cash flow index products have shown a significantly improved risk-return ratio compared with the CSI Dividend Index; in particular, the China Securities Free Cash Flow Index has a relatively superior risk-return ratio. We enhance it in two ways:

1) Combine with growth factors to build the Haitong strategy free cash flow growth portfolio: use free cash flow after smoothing treatment (TTM), combine with the growth factor (rolling 2-year free cash flow CAGR), remove outliers and then rank. Select the top 100 stocks, weight them by free cash flow rate, cap individual stock weight at 10%. Within the sample (from Jan. 2, 2014 to Mar. 26, 2026), annualized return is 18.0%, annualized volatility is 22.4%, and the Sharpe ratio is 0.83— all outperform the CSRC Free Cash Flow Index;

2) Combine with capital expenditure relative strength to build the Haitong strategy free cash flow stability portfolio: use free cash flow after smoothing treatment (TTM), and exclude stocks whose capital expenditure / operating cash flow is greater than 0.4. Select the top 100 stocks, weight them by free cash flow rate, cap individual stock weight at 10%. Within the sample (from Jan. 2, 2014 to Mar. 26, 2026), annualized return is 19.8%, annualized volatility is 20.7%, and the Sharpe ratio is 0.96— all outperform the CSRC Free Cash Flow Index.

The above portfolios’ annualized turnover rates are both around 125%, and their industry distribution is relatively balanced. Looking at changes in the portfolio’s industry structure since 2020, it can capture some clues about improvements in business conditions or supply-demand patterns.

Market timing: Three types of excess return environments and a quantitative timing system

From a strategy perspective, dividend yield assets have three typical excess return environments: 1) risk appetite declines— the excess return window generally starts within 1–3 months after the high point in the entire A-share market, and ends after liquidity widens or the economy weakens. Stable dividend yield tends to be relatively superior; 2) inflation rises— the timing signal is the upward movement in the average year-over-year PPI changes between China and the U.S., and cyclical dividend yield tends to be relatively superior; 3) in volatile markets during the rising-volatility phase— from the portfolio management perspective, when the trend is unclear, or downside risk is greater than upside risk, investors typically adopt a “barbell” strategy to deal with the increase in volatility, and dividend yield can also generate excess returns. From a quantitative perspective, in the Jan. 7, 2025 report “Dividend Factor Timing and 2025Q1 Industry ETF Investment Recommendations— ETF Smart Investing Series Research No. 3,” Haitong Quantitative Investment Engineering (Haitong Gold Quant) team constructed a timing model using dividend yield’s own trend, the term spread, and interbank market trading volume. From 2017 to this year, the annualized return is 16.5%, with an annualized excess return of 9.9% relative to the benchmark (50% CSI All Shares + 50% CSI Dividend). With PPI year-over-year rising and geopolitical developments disrupting risk appetite that may be under pressure at certain stages, the quantitative timing model’s signals also turn bullish on dividend yield. The relative attractiveness of dividend yield assets is assessed as high, measured by factors such as the spread between bond and stock yields, the public offering allocation coefficient, the share of trading amount, and turnover rate.

Risk warning: model failure risk; domestic and overseas fundamentals underperforming expectations; liquidity underperforming expectations.

（Source: Caixin/China Financial Information— Eastmoney? Financial Link News (财联社)）