Wednesday, February 26, 2014

Investing and Mistake Avoidance

Excellent piece by Morgan Housel hits an important topic, investment success is more about avoiding the downside than striving for blinding insight:

"If it were up to me, I would replace every book called How to Invest Like Warren Buffett with a one called How to Not Invest Like Lehman Brothers, Long-Term Capital Management, and Jesse Livermore. There are so many lessons to learn from these failed investors about situations most of us will face, like how quickly debt can ruin you." 
At the risk of invoking a Buffettism to prove the above, when searching for dividend stocks I always keep in mind his saying that "more money has been lost reaching for yield than at the barrel of a gun." Investors in Boardwalk Partners recently learned this the hard way.

Up until about two weeks back, Boardwalk investors were cruising along with shares in the mid $20s range, collecting around an 8% dividend yield. Sure dividend growth was somewhere between tepid and non-existent; in 2011 Boardwalk paid $2.10/share by 2013 it was only raised to $2.13. But at 8% why concern yourself with growth?

However at the same time, Boardwalk's coverage could not keep up with maintaining much less growing its yield, payout ratio in 2013 was 190%, not exactly sustainable. The warning flags were there for all to see. The result was dividend got cut by around 80% and shares getting hammered down by around 40%. An investor depending on that beefy 8% yield, is staring at a yield on cost that is very likely under 2% on their cost, making it lower than the S&P. It gets even worse, because there's no good exit - the underlying economic engine (the shares) is repriced.

A related idea - the Loser's Game - comes from Howard Marks' "The Most Important Thing" and his reading an article by Charley Ellis:

Charley’s article described the perceptive analysis of tennis contained in “Extraordinary Tennis for the Ordinary Tennis Player” by Dr. Simon Ramo, the “R” in TRW. Ramo pointed out that professional tennis is a “winner’s game,” in which the match goes to the player who’s able to hit the most winners: fast-paced, well-placed shots that his opponent can’t return. But the tennis the rest of us play is a “loser’s game,” with the match going to the player who hits the fewest losers. The winner just keeps the ball in play until the loser hits it into the net or off the court. In other words, in amateur tennis, points aren’t won; they’re lost. I recognized in Ramo’s loss-avoidance strategy the version of tennis I try to play.

Charley took Ramo’s idea a step further, applying it to investments. His views on market efficiency and the high cost of trading led him to conclude that the pursuit of winners is unlikely to pay off. Instead, you should try to avoid hitting losers. I found this view of investing absolutely compelling. I can’t remember saying, “Eureka; that’s the approach for me,” but the developments over the last three decades certainly suggest his article was an important source of my inspiration.

 Bringing this all back to investing and dividends, investors in Boardwalk paid a very high price for that temporary extra point or two of yield versus looking at the coverage ratios (not just yield) and avoiding the downside and going with a company with a larger margin of safety around its income stream. Instead of reaching for yield, why not just win by not losing, say kick back and enjoy a refreshing Coke or a Pepsi instead?

Saturday, February 22, 2014

Coke versus Pepsi

The bull market continues to rage along, but while its certainly not leaving bargains lying around, there are some quality companies that have not fully participated in the upside. For different reasons, there could be something resembling a fair price for Coke (emerging markets plus slowdown in US) and Pepsi (market ignoring Frito-Lay).

But which is the better buy today?

Without further ado, let's try to answer one of life's most pressing questions "Coke or Pepsi?" by the numbers.

What price would you pay to own Coke or Pepsi?

Coca Cola Pepsi
P/E 19 18
P/CF 16 12

Advantage - Pepsi, cheaper both on earnings and cash flow basis. 

Of course, price matters but so does quality.


TTM Coca Cola Pepsi
Operating margins %  22 15
Net margins %  19 10
ROE % 27 29

Advantage - Coca Cola. A step behind on ROE, but margins much more impressive


Coca Cola Pepsi
Fwd Yield %  3.3 2.9
1 yr  Div growth %   8.5 5.3
5 yr Div growth %  8.5 6.3

Advantage goes to Coca Cola although its closer than it appears, because the Morningstar data that I am using does not have Pepsi's latest 15% dividend hike factored in.


Coca Cola Pepsi
Debt/Equity  0.4 1.0
Payout ratio %  57 52
Cash flow coverage%  1.68 1.97

This is too close to call, Coca Cola wins on its Balance Sheet, but Pepsi is is ahead on coverage, and so you can see why Pepsi was able to raise their dividend in the double digits. Tie.

Neither is a screaming buy, but they are not wildly expensive either. Quality at a reasonable price. Pepsi looks cheaper and potentially better able to grow its dividend. On the other hand Coca Cola wins on overall quality. Investors in either should have a fair shot at doubling their money in the next 5-10 years but Coca Cola looks like the better buy.

Saturday, February 1, 2014

How do you solve a problem like Emerging?

That was fast - Emerging Markets went from everyone's darling to everyone's whipping boy. One of the main points of agreement for the last five years or so is that maybe the US would struggle, maybe Europe would struggle but Emerging Markets would be a good place to be. What happened?

I can sling some theories, but really I don't know. More to the point, it seems to me that the long term Emerging Market story, an emerging global middle class, is still in tact. Income investors will take dividend and growth from many places, and it makes sense to have diverse, global sources of income. Its surprisingly simple to construct a dividend portfolio where the sun never sets on your income stream.

All else equal, the preferred approach would be to simply screen for dividend payers in markets like China, India, Brazil, Turkey, Mexico and so on, and then try to find some steady Eddie's selling for bargain prices.

But all is not equal.

First off, the investor seeking global income will in most cases see their returns impeded by taxes. Deloitte has a handy reference on dividend taxation by country. According to Deloitte the tax rate imposed by country often means addtional tax burdens based on the country's policies, for example:

  • China 10%
  • Israel 20-25%
  • Turkey 15%

So this means if you are intrigued by, say Teva Pharmaceuticals, an Israeli company with global exposure. The Israeli government crimps your income from Teva's 2.5% forward yield. For most investors this takes a low but perhaps tolerable dividend to below market average. Over time those withholding rates will really take a toll. So why bother?

Some countries, particularly those where the British flag once flew, do not impose additional tax burdens. Companies domiciled in these areas offer a good opportunity at global income. China imposes a 10% tax burden on most dividends. However in Hong Kong there are listings of "Red Chip" companies with large operations in China, but listed in Hong Kong and the dividends should not be subject to foreign withholding. Red Chips include China Mobile, which has 767 million customers (not a typo) and a 4.2% dividend.

So when investing in other countries, its just as important to read up on tax and dividend withholding as it is to understand the business and its valuation. I will close out this section with a reminder that I am not a tax pro and you should always consult your tax pro to understand what any of these policies means to you.

Part of the basic idea of international investing is to choose stocks from a wider pool. What could be better than not limiting yourself to buying US stocks when the whole country only represents ~5% of the global population? Why not look to the whole world?

India's population is about 4 times the size of the US, around 1.2 Billion people, about 20% of the planet. Yet, there are only a small handful of Indian ADRs that trade on US markets.

Company Types
The emerging market story is tied to the burgeoning global middle class, but the reality is that consumer demand is pretty hard to access in many of these markets. Consider the Indian ADRs, you get access to companies like Wipro and Infosys which sell services to US/EU companies. You get access to mining companies. So while you are buying companies who are housed in emerging markets, their income is tied to the first world, sometimes quite directly.

You could punt and an ETF, but all of the above plays into your ETF selection as well. Many ETFs are sort of levered bets on first world economies. Targeting global income probably means looking for markets that do not impose additional dividend taxes and give access to companies that can weather storms rather than cyclical and levered commodity exposure.

Eliminating companies based on the above removes most companies from consideration. Where does all this lead then? Interestingly enough, right back to Lake Wobegon.

"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

The goals of an income investor seeking opportunities in Emerging Markets may in fact be best served by buying blue chips. To look at one examples here - Unilever(UL) gets 57% of its revenue in emerging markets and pays a 3.8% dividend. So in many cases its back to the blue chips for global exposure and an efficient total return.