Saturday, January 25, 2014

Todd Wenning on Finding Differentiated Dividend Ideas

One of the good things about dividend investing is also a challenge. Dividend investing forces you to screen out many stocks, because they do not pay a dividend at all. And really, for most dividend investors, you are going to want at least a 2 or 3% yield. This hurdle dramatically thins the herd and you tend to see a lot of the same companies and same industries in the companies that clear the hurdle. That simplifies the research process, but it can also be a bit limiting. A well trodden path leads to utilities, energy, MLPs, REITS, is that all there is?

Todd Wenning has a post on a topic that I spend a lot of time thinking about Where to Find Differentiated Dividend Ideas. Beyond the basic screen, what can you look for? Todd has four ideas:

"1. Firms that have cut their dividends"
Holy counter intuitive Batman! While Todd's first idea sounds like heresy (in his words) at first, in fact it is a place worth exploring. Look no further than financial institutions coming out of the crisis. Wells Fargo raised its dividend by 90% over the last year to a current yield of 2.6% and yet the payout ratio is only 28%. This means the dividend can easily double over the next couple of years. It not just Wells Fargo, AIG, Bank of America, JP Morgan, and many other survivors are in a similar postion to grow their dividend over the coming years.

"2. Firms that are in the final stages of a deleveraging process"
See point 1

'3. Small Caps"
Todd has a series on Morningstar that is well worth your time for hunting ideas in small cap dividend space. I have never understood why people would limit their holdings to large cap only. Lots of great businesses are small, and any of them are easier to analyze than large caps. Innophos has annualized dividend growth of 13% over the past 5 years. Its deeply embedded in many necessary industries' supply chains. Should its $1B market cap really keep you from thinking about investing in Innophos?

"4. Spin offs"
Right out of the Joel Greenblatt playbook, Spin Offs are very good candidates for mispricings. Recent examples here include Phillip Morris (4.6% forward yield) and Kraft (4%).

One thing I would add to Todd's list is to consider foreign stocks. Most US investors limit their holdings to US companies, but expanding the search horizon to include international markets can yield good results. Many countries have more investor friendly dividend policies than US companies with higher payout ratios. On the down side, some countries impose extra taxes on dividends for foreign investors so you have to consider this as well. Still going a bit further afield is a good way to find great companies with good yields. For example, Brookfield Infrastructure Partners was spun out of Brookfield Asset management (a Canadian company) and owns assets all over the globe, things like toll roads in Latin America, dams, and so on. They have excellent management, pay out a 4.6% dividend yield, and they have a global focus meaning their managers can hunt anywhere for bargains. Individual investors should too.

Friday, January 10, 2014

Lake Wobegon Investing

"Some luck lies in not getting what you thought you wanted but getting what you have, which once you have got it you may be smart enough to see is what you would have wanted had you known." - Garrison Keillor

Tim McAleenan points to a great interview with Don Yacktman of his eponymous fund.  Yacktman's son describes his approach in a way that is immediately recognizable to dividend growth investors - "Basically, what you are saying is, if you buy above average businesses at below average prices, then on average, it is going to work.

That's a very useful way to think about investing. The above average (Lake Wobegon) businesses is somewhat subjective, especially trying to sort which ones will remain so over a decade plus. To get the below average price, there are many ways to look at the price to determine relative cheapness.

Not that there are many bargains lying around these days. Yacktman mentions Procter and Gamble, Coca Cola, and Pepsi. Consuelo Mack rightly says these are a yawn for most people and no doubt this is true.

One thing that is not a yawn is the long term total return from businesses such as these. There was a time earlier in my career when I thought investing was about finding the next great tech or biotech company. Nowadays when I start to think that an idea seems to be boring, I think I am probably fishing in promising waters.

One thing that tends to make these "boring" stocks more exciting is to head over to Long Run Data and see what would happen if you hold these over the long haul

Annualized Total Return 10 yrs $1,000 invested 10 years ago Annualized Total Return 25 yrs $1,000 invested 25 years ago Annualized Div Growth 10 yrs Annualized Div Growth 25 yrs
KO 7.8% $2,113 13.5% $23,648 9.8% 11.4%
PEP 8.9 2,341 13.3 22,452 13.5 12
PG 7.7 2,098 13.9 26,025 10.6 11

Sure the companies that Yacktman mentions are boring, but the total returns are anything but.

In light of the above table,  the returns go from good to great in the 10-25 year window when the compounding really starts to kick in. Given that I will add one thing Yacktman's strategy - Basically, what you are saying is, if you buy above average businesses at below average prices, and hold them for a long time then on average, it is going to work.

Sure you can say there is hindsight bias in these examples, but I don't think anyone investing in Coca Cola, Pepsi or P&G, if they bought in 2004 or 1989 felt that they were taking inordinate risk or had a genius insight to pick these companies.

That's all the news from Lake Wobegon where the holding times are long, the yields are good looking, and the business models are all above average.

Thursday, January 2, 2014

Vaccinate Yourself Against 2014 Predictions with Silver Medals

Its prediction season! What will the market do? What will happen in economics? In the world? No one really knows but there sure are lots of people ready, willing, and able to give authoritative sounding predictions on what will happen in 2014.

I follow a simple rule of thumb - I do not read anyone's predictions unless first they also give a full accounting of how their previous year predictions panned out (usually poorly). This eliminates 90+% prediction reading.

Jason Zweig goes one further:

"The consensus already emerging on Wall Street is that U.S. stocks will have a decent year in 2014, perhaps returning 8% or 10%. That sounds plausible; since 1926, when modern data on the U.S. stock market began, stocks have averaged a gain of 10.1% annually. But in how many of those years did stocks return between 8% and 10%? In 88 years, it has never happened once. Stocks almost always perform either much better, or much worse, than investors expect them to. That's why relying on the comfort of a consensus forecast is so dangerous. As G.K. Chesterton wrote, "Wisdom should reckon on the unforeseen." So should investors."

The point here is to not get hung up on yours or anyone's ability to predict the future, this week, this month, this year. Instead position to deal with a range of possible events.

A good example of this is from Markel CIO Tom Gayner. Gayner once referred to his holding dividend paying stocks in this environment as his Silver Medal strategy. If there are two possible near term outcomes in the current situation - Inflation or Deflation.

In an Inflation scenario the likely best place to be is commodities which rise with prices, the second best is dividend stocks in companies which can raise their prices and the third (worst) is bonds which cannot keep up. Bond investors get killed in an inflationary scenario.

In a Deflation scenario the best place is bonds, the second best is dividend paying stocks and the worst is commodities.

So we do not know for sure if we get inflation like the 70s or we get deflation like Japan, in Gayner's view, the Silver Medal, second place in either case is the place to be.

So rather than predicting and handicapping a specific outcome, find steady Eddy, dividend payers that do well enough over multiple scenarios.