Saturday, April 18, 2015

The Surprising Link Between Jeff Bezos and Neil Woodford and What It Means to Dividend Investors

On the surface it appears that Amazon and Jeff Bezos are worlds away from anything a dividend investor would care about. After all, Amazon struggles to even show earnings, much less pay a dividend. But remember the first rule of investing, you are buying a part of a business, and Bezos has built a formidable business.

Here's the killer business insight from Bezos that should be a hallmark for long term and dividend investors (emphasis added):

"I very frequently get the question: 'What's going to change in the next 10 years?' And that is a very interesting question; it's a very common one. I almost never get the question: 'What's not going to change in the next 10 years?' And I submit to you that that second question is actually the more important of the two -- because you can build a business strategy around the things that are stable in time. ... [I]n our retail business, we know that customers want low prices, and I know that's going to be true 10 years from now. They want fast delivery; they want vast selection. It's impossible to imagine a future 10 years from now where a customer comes up and says, 'Jeff I love Amazon; I just wish the prices were a little higher,' [or] 'I love Amazon; I just wish you'd deliver a little more slowly.' Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it."

So here we have from the most unlikely source, a true blue, original dotcom, that even today struggles to show earnings, worlds apart from the staid world of dividend investing, yet Jeff Bezos has nailed one of the single most important things to dividend investors - staying power.

After all, the stock market prizes current yield, and it is hard to get excited about current yield at 2.5-3% range for blue chips like Clorox, Coke or Pepsi. But at the same time, the stock market misprices long run dividend growth and its easy to get excited to invest in a business that can compound and quadruple their dividends a decade out. 

For that to happen, then the operative question becomes Bezos' - what will not change ten years out? Will consumers still want beverages, candy, and salty snacks? Will they prize convenience (delivered by global supply chains)? Will there be more stuff to clean? Will they respond to ads?

These kind of questions should factor into any style of investing, but I would suggest that they are more relevant for a dividend investor than any other type. Long term focus is a hallmark of successful value and growth investing, but they can do quite well by defining long term as 3-5 years, meanwhile dividend investors see the best payoffs then plus years out.  A five year dividend investment could look something like this - 3% starting yield with low double digit growth rate (good luck finding one of these today, this is just for illustration purposes). So at five years your 3% may be yielding 6% on cost. Not bad, but its much more interesting to see where it can go next, and can you get it into a double digit yield on cost territory? 

Someone like Mohnish Pabrai can find great value investments that have a good shot at doubling inside of five years. Dividend investors can likely approximate that if we simply look at yield. However since the starting yield is so low, the yield must double twice say 2.5% x 4 before things get interesting. But once they do get there, a 10% yield on cost in a business that with a wide moat is a snowball rolling down hill. That's about as good as it gets for a dividend investor. 

The key ingredient in that is not yield or even dividend growth rate, its finding what won't change. Morningstar's Heather Brilliant says it well - ""The persistence of excess returns is much, much more important than the magnitude of excess returns"

Utilities, long the core engine in dividend investors portfolios are perhaps the ultimate example here - hard to be more basic and essential than electricity and heat. Looking at one of the all time great dividend investors portfolio, Neil Woodford, what do we see? We can learn from what he does and what he doesn't.

Woodford famously avoids banks (perhaps what he sees is that what wont change is bankers' ability to blow up at least once a decade?). The main sectors in Woodford's portfolio all have one thing in common - sustainable, long run demand - Pharma, Consumer defensive, Utilities, and Defense/Industrials. These all lack glamour, but have clear long run demographics and reasons to think that the healthcare, electricity, and defense will be as relevant a decade on as they are now.

Judging by the amount of ADD in the world, smartphoness Tweets et al, I'd say long term orientation, itself, is likely to be as rare ten years from now as it is today. So to sum up, think like Jeff Bezos, invest like Neil Woodford.