You don't know who is drilling naked until the tide goes out

Given the grim near term outlook in energy, @PlanMaestro asked a prescient question a few weeks back:

This story has a personal angle for me, because some years ago I used to own Seadrill shares. I liked the overall business model which was the leader in off shore drill rigs. They were very shareholder friendly, paid a huge dividend around 7% at the time. It seemed the demand for oil rigs would go on and on. Problem is they borrowed from existing rigs future to fund the next rigs. Turtle stacking exercise that works until it doesn't.

The lesson to me is about process. I could not have predicted the level and pace of both increasing oil supply combined with the slackening of demand of this year. In fact, were I to bet a few years back,  I would have bet the other way on at least one of those. However, I avoid betting on future, macro events as much as possible. What I could do and luckily did, was just snap the chalkline against Seadrill's leverage and say - no matter how wonderful the dividend appears (remember not many 7% payers), no matter how much I think being a leading driller will matter, I just do not want to own a cyclical company with that much debt. Luckily I sold at a small profit. 

Today Seadrill suspended their dividend. That sent the shares down 17% for the day so far. The shares are down 50% for the year. Also the appeal was the dividend, and that is gone.

The big lesson here is quality matters - especially in dividend investing. You do not get the 10x kind of growth that growth investors may see in a Tesla.  If you are buying McCormick Spice and Unilever, its way more about mistake avoidance, grinding out great results over decades. 

Mistakes always hurt in investing, but for dividend investors they matter way more. For dividend investors it has to be don't lose first, because you do not have the 10 baggers to make up the difference for the flameouts. Growth investors can swing for the fences, whiff on 7 out of 10, and crush a couple out of the park and have a great overall result. Dividend investors have to look more like George Brett - hit .380, get on base, bang out some doubles. 

One thing I learned programming computers is that order of operations matters a lot. Its not just what you do, but in what order of execution. The motto of this blog is Safety, Dividends, Growth in that order. The dividend investing process has to set a bar that ensures the overall safety of the company before you consider the dividend and the growth, because otherwise its too easy to get swept away by an eye popping, yet illusory yield.

Fifth Pick in the WMD Portfolio - Tupperware

The more real they are, the more fun blogs are to follow. So in that spirit, rather than talking about ideas in the abstract I maintain a hypothetical portfolio to track ideas where I'll semi-regularly (and hypothetically) invest and track buying (and where required selling) shares.

For tracking purposes I will use $1,000 to keep it nice and simple. The overall goal is long run income and dividend growth. Portfolio page with goals and tracking is here.

I first came across Tupperware as an investment idea some years ago, through the work of one of the finest investors I know - Jeff Fischer who runs Motley Fool's Pro service.

Tupperware has a lot to recommend it on the business side. The most famous characteristic is the parties themselves and how they illustrate the Liking principle that Robert Cialdini describes - "People are easily persuaded by other people that they like. Cialdini cites the marketing of Tupperware in what might now be called viral marketing. People were more likely to buy if they liked the person selling it to them."

There is a lot to like in how Tupperware is able to engage with its target market, from Cialdini's book Influence - "It’s gotten to the point now where I hate to be invited to Tupperware parties. I’ve got all the containers I need; and if I wanted any more, I could buy another brand cheaper in the store. But when a friend calls up, I feel like I have to go. And when I get there, I feel like I have to buy something. What can I do? It’s for my friends.”

Its hard to find anything resembling a good price, so why is Tupperware in a zone of reasonableness? One guess as to why Tupperware shares are priced well compared to the market overall is that investors conflate them with Herbalife which is undergoing lots of scrutiny as to its business model. However, Tupperware gets its income from the consumers at the parties. 

Tupperware 10-Q: "The vast majority of the Company's products are, in turn, sold to end customers who are not members of its sales force."

Tupperware is a truly global business, its focused on the emerging market consumer. The U.S. is less than 10% of its business, and its sees India and Indonesia as its top markets going forward. Tupperware levels the playing field for women in emerging economies. The business model enables women all over the world to create profitable businesses.

The regional sales breakdown is as follows:

• AsiaPAC 32%
• Europe 28%
• North America 25%
• South America 15%

Tupperware sees itself as an AND company as in Developed Markets AND Emerging Markets. Still the latter plays the biggest role going forward - Argentina, China, Indonesia, Brazil, and Turkey grew over 20% last twelve months.

With so much to like about the business model, what about the goals of the Wide Moat Dividend portfolio - Safety, Dividends, and Growth?

The first red flag is the Debt/Equity level which sits at 2.4, that normally would be enough to stop the analysis. However, looking to Todd Wenning's single most important metric Free Cash Flow cover shows that Tupperware's Free Cash Flow provides ample coverage.

Tupperware has the Free Cash Flow to pay its dividend, and with an Interest Coverage ratio of 7.5 it also has the ability to handle its debt load.

Tupperware's current yield is 4.0%. It has a five year annualized dividend growth rate of 23%. Tupperware buys back its shares, and has reduced its overall share outstanding from 64m in 2010 to 51m outstanding today.

Tupperware puts up very strong ROE and ROIC metrics year after year.

The overall combined effect shows a good opportunity for quality income. Tupperware's 4% yield is substantially better than average and above even what many Utilities pay today. But Utilities have pretty limited growth, whereas Tupperware more than doubled its revenue in the last decade.

Tupperware's current valuation also looks relatively attractive. Its P/E is 15.4 versus a five year average of 16.6. Its Price/Cash Flow is 12 versus five year average 13.4. Add it all up you get quality, income, and a fair price for an excellent business.

Last year, Tupperware "logged 24 million Tupperware parties worldwide in 2013, up incrementally from 22 million in 2012, 21 million in 2011, and 18 million in 2010." The company has a motivated, global sales force, treats its shareholders well, and room to grow.I plan to buy the shares, and keep them sealed up for a long time.

High Yield Reads - 10/5/14

Summary of recent stories of interest, sometimes enduring, to investors.

• Morgan Housel's "Not Your Father's Dividend Stocks" talks about the churn in dividend stocks that's left unexpected stocks like tech stocks among the most interesting dividend payers. Of course, that is no surprise to the users of Todd Wenning's Dividend Compass. The article cites analysis from Patrick O'Shaughnessy on Bell Canada, Telstra, and Total as good foreign candidates for dividend payers. I think these three are all interesting, but the article does not mention the tax implications of Canadian, Aussie and French dividends. All else equal its worth considering foreign payers from countries where there is not an additional dividend tax. Vodafone, BP, and Royal Dutch Shell (B class) are good examples of companies in the same industries in countries which do not have an additional withholding for US investors. Here I should note that I am not a tax professional, so do consult yours. More information courtesy Josh Peters, Morningstar here. What matters in the end isn't headline yield or even value, what matters is total return after taxes and fees to the investor.

• A Wealth of Common Sense "Fat Tails and Hyperinflationary Fears" - hedging sounds good in theory, but too much cancels out benefits. "You have to take some risk to make money in markets."

• Base Hit Investor "Importance of ROIC Part 4: The Math of Compounding" - great example of the quality of a top notch business being able to overcome even pretty rich valuations. Also liked that he gives dividends their due in Example B where a company generates 20% ROIC but can only invest about half of it whereas the rest of its paid in dividends. I think for many businesses this is the case, and that as a practical matter, having to pay the dividend forces management to be choosy about any cash they reinvest.

• Shale revolution - Five years ago Nigeria was the fifth largest oil exporter to the US, today they export no oil to the US. 

• Tim McAleenan tries to figure out what stock Buffett is buying and lands on Exxon Mobil. "Buffett thought it made sense to purchase long-term shares of ExxonMobil last year at a price of $90.85...Right now, after this most recent slide oil stocks especially, Exxon has come down to the $92, $93, $94 range. Even rounding up, comparing $90.85 to $94 is only a 3.46% increase. Heck, Exxon’s repurchased that much stock alone in the past year, leading me to believe that Buffett sees an intrinsic value increase for the year of at least 3.46%, and is using this opportunity to add some more stock."

• Speaking of Berkshire, I originally thought the deal for Van Tuyl automotive as a nice little add on purchase, generate a few billion here and there.  But then in thinking more about it, it looks pretty strategic, because it helps address one of Berkshire's unique "problems" - too much cash. When you generate as much cash as Berkshire does its hard to find places to put it to work at scale, this explains BNSF and utilities. In the case of Van Tuyl there are at least two ways to put the zero cost float to work. 1) Consumer credit for auto loans and 2) rolling up fragmented auto dealers under the Berkshire automotive brand. 

Cocktail napkin math on 5 plus 5 dividend yield and growth

One of the main metrics I use is the simple 5+5 rule that I first came across in Daniel Peris' excellent book Strategic Dividend Investor. The 5 + 5 rule looks for a combination of dividend yield and dividend growth. So the total should equal 10 percentage points, for example 5 percentage points of current dividend yield plus 5 percentage points of annual dividend growth.

Putting this into practice is about a rough separation for high yield and low dividend growth versus lower yielders with high dividend growth. . A company with a 3% dividend yield would need at least 7% dividend growth to clear the bar. Likewise a high yielding company with say 6% would only need a tepid 4% growth to get over the 5+5 hurdle.

GlaxoSmithKline's 5.6% current yield combined with a 6.6% 5 year annualized dividend growth clears the 5+5 hurdle with a total of 12.2. By the same token, IBM clears the hurdle even though it has a much lower yield of 2.3%, IBM sports a 5 year dividend growth rate of 14.3% for a combined 16.6 percentage points.

Before any mathematicians jab a pencil into their eye, the 5 + 5 rule is not about mathematical precision. Its much more about orienting your frame of reference for investment selection and ongoing portfolio management - what am i looking for with this investment? What does "good enough" look like? What are the minimum expected growth rates that are acceptable given the current yield? Is a low yielder with decent growth as good an investments as a high yielder?

I did some cocktail napkin math with four scenarios

• 2% current yield with 8% growth
• 3% current yield with 7% growth
• 4% current yield with 6% growth
• 5% current yield with 5% growth

First cut is income only and 5% current yield wins here, more than double the income at the end of the decade (though not double on cost)

Yield Plus Growth	2+8	3+7	4+6	5+5
Income - Year 1	2	3	4	5
Year 2	2.16	3.21	4.24	5.25
Year 3	2.33	3.43	4.49	5.51
Year 4	2.52	3.68	4.76	5.79
Year 5	2.72	3.93	5.05	6.08
Year 6	2.94	4.21	5.35	6.38
Year 7	3.17	4.50	5.67	6.70
Year 8	3.43	4.82	6.01	7.04
Year 9	3.70	5.15	6.38	7.39
Year 10	4.00	5.52	6.76	7.76
Total	28.97	41.45	52.72	62.89

For Capital appreciation I tracked the growth of $100 and assumed that the shares roughly track the dividend growth and so the 2% yield wins here

	2+8	3+7	4+6	5+5
Capital - Year 1	100	100	100	100
Year 2	108.00	107.00	106.00	105.00
Year 3	116.64	114.49	112.36	110.25
Year 4	125.97	122.50	119.10	115.76
Year 5	136.05	131.08	126.25	121.55
Year 6	146.93	140.26	133.82	127.63
Year 7	158.69	150.07	141.85	134.01
Year 8	171.38	160.58	150.36	140.71
Year 9	185.09	171.82	159.38	147.75
Year 10	199.90	183.85	168.95	155.13
Total	1,448.66	1,381.64	1,318.08	1,257.79

Then in the last scenario I combine the income plus capital plus reinvest the dividends each year.

	2+8	3+7	4+6	5+5
Total W Div Reinvested	100	100	100	100
Year 2	110.16	110.21	110.24	110.25
Year 3	121.31	121.36	121.35	121.28
Year 4	133.53	133.53	133.39	133.13
Year 5	146.93	146.81	146.45	145.86
Year 6	161.63	161.29	160.59	159.54
Year 7	177.73	177.09	175.90	174.21
Year 8	195.38	194.30	192.46	189.96
Year 9	214.71	213.06	210.39	206.84
Year 10	235.88	233.48	229.77	224.94
Total	1,597.25	1,591.13	1,580.54	1,566.01

The ten year total returns are for all intents and purposes identical. I think this shows the value of 5 + 5 as a conceptual model. Of course, its a model not reality, but despite it breaking any number mathematical rules it holds up well as a rough guide.

There are a  number of caveats here, first there is no guarantee that share price will track dividend growth, although it usually does over a long enough time scale.  One of my starting points is 5 years annualized dividend growth, but just because IBM and GSK have grown their dividends in line with the 5 + 5 rule for the last five years, the future can be different. Just ask Tesco or Boardwalk Pipeline shareholders.

I still find it interesting to see that in a total return view the 5+5 thinking works pretty well and it confirms to me that both low yielders like IBM and high yielders like GSK can be worthwhile long term holdings when dividends are reinvested.

Bill Gates, Dividend Investor

WSJ Story on Michael Larson who manages investments for Bill Gates mentions the variety of different assets in the portfolio. This includes real estate, hotels, and a lot of stocks, too.

The stock portfolio is interesting to study, as you might imagine its pretty defensive. Berkshire Hathaway is 46% of the portfolio. Clearly follows rule 1 - don't lose money.

There are a number of idiosyncratic ideas in the portfolio like Liberty Global, Grupo Televisa, and Crown Castle.  These things all sound interesting but overall majority of these kind of things just goes into the "too hard" pile for me.

Luckily though, a clear theme emerges in something I can get traction on - over a third of the stock portfolio is high quality dividend growth stocks.

Here is my calculation of dividend income from the top dividend payers in the portfolio.

	Shares	Div	Income	Yield
Coca Cola (KO)	34,002,000	1.22	41,482,440.00	3.10%
Caterpillar (CAT)	11,260,857	2.8	31,530,399.60	2.8
McDonald's (MCD)	10,872,500	3.24	35,226,900.00	3.4
Wal-Mart (WMT)	11,603,000	1.92	22,277,760.00	2.6
Waste Mgmt (WM)	18,633,672	1.5	27,950,508.00	3.4
Exxon Mobil (XOM)	8,143,858	2.76	22,477,048.08	2.8
Republic Services (RSG)	1,350,000	1.12	1,512,000.00	3
Arcos Dorados (ARCO)	3,060,500	0.24	734,520.00	3.8
Coca Cola FEMSA (KOF)	6,214,719	1.11	6,898,338.09	1.1
BP (BP)	7,315,267	2.34	17,117,724.78	4.7
			$207,207,638.55

The portfolio construction has a couple of patterns. There are blue chip stalwart, dividend champion types - Coca Cola, McDonald's, Wal-Mart, and Exxon Mobil.  The kind of stocks where you buy right and sit tight.

Then there is trash - Waste Management and Republic Services. I really appreciate the static nature of these businesses. Waste Management owns I believe around half the of the landfills in the US, so even if they lose a hauling contract their competition has to pay them to use the landfill. Though I like the model, I could not get the math to add up on the safety of their dividend to get comfortable with WM. Republic Services looked more interesting some years back but the price has really run up.

There is a minor theme in the portfolio - US brands in Latin America. Coca Cola FEMSA is the largest Coke bottler outside the US and distributes products across Mexico and most of Latin America. Arcos Dorados (currently at/near 52 multi year low with a single digit forward P/E and near 4% yield) is the McDonald's franchisee for all of Latin America with over 2,000 McDonald's in 20 countries. These two standout as separate from the blue chip dividend approach and offer a potentially viable way to invest and earn income in Latin America.

Like Charlie Munger says its often profitable to learn from great investors.  With a track record like Michael Larson's where "Mr. Gates's net worth has swelled to about $82 billion from $5 billion since he hired the former bond-fund manager and gave him autonomy to buy and sell investments as he sees fit." its for sure that 16x growth with low risk is worth learning from. My takeaways from the stock portion of the portfolio are - 

1) Play defense first - 45% in Berkshire Hathaway helps anyone sleep well at night.

2) Generate quality income - boring is beautiful, the dividend championesque list above comprises over 33% of the portfolio and continues to deliver dividend growth

3) Be opportunistic - investments like Canadian National Railway and Liberty Global have paid off big time with each up over 200% since purchase

Reverse engineering those rules sounds just like the philosophy here- Safety, Dividends, Growth - in that order.

High Yield Reads - 9/14/14

Summary of recent stories of interest, sometimes enduring, to investors.

• Jason Zweig - Fireside Chat with Charlie Munger.  "Knowing what you don’t know is more useful than being brilliant."

• A Wealth of Common Sense - "The Best and Worst Things About Investing in Emerging Markets", the growth is there for all to see, but when it comes to picking winners in stocks that is not so easily done "China had by far the highest economic growth rate but also had one of the worst performing stock markets. Mexico, Brazil and South Africa all showed excellent stock returns with only decent economic growth. Other counties, including Turkey and Taiwan, actually showed economic and market performance that were in line with one another

• Morgan Housel doubts there have been 48,000 "perfect storms" in the last month. Bernstein's shallow risk is an annoyance not deep risk.

• Microsoft buying Minecraft and Co. Count me as a believer. Continue to be impressed with Nadella. If you go way back to the 80s, Apple's strategy had at its core a focus on kids and school computing. What are smart, creative kids doing today? A lot are crafting. So in a week that saw Apple introduce a device with three shopworn features presented as innovation, Microsoft gains direct access to waves of the next generations to hit computing platforms for decades to come. 

• John Huber on how to be the best plumber in Bemidji. "The good news is that the stock market is filled with opportunities (10,000 opportunities in the US alone), and most people—if they have the will and the work ethic—can carve out an advantage in some small corner of the market not unlike the one that the best plumbing contractor in that small Minnesota town has." 

Book Review - Education of a Value Investor

We live in a categorized, check box kind of world, so Guy Spier's "Education of a Value Investor" is bound to be sitting on a shelf in the Business/Investment category at Barnes & Noble right next to the numerous How To investing guides. But this is not a How To book, its a personal journey of discovery and value investing as conducted by Buffett, Munger, and Pabrai is a North star on this journey.

I received the book today and read it in one go, I suspect others will have a similar experience; find a quiet place and a comfortable chair - Guy Spier's story, told warts and all, pulls you in. Its hard to imagine rooting for a  self admitted Gordon Gekko type, but when he eventually starts to get it and figure out the bigger picture, and helps the reader learn from his own travails its easy to get behind Guy Spier's journey.

The book plainly isn't about the mechanics of investing, there are lots of books that covers these. The main theme is much more fundamental - make sure you spend as much of your time as possible with high quality people. One of my mentors in my own career advised you should always take at least one job in your career simply because of the people you would work with at that company. Guy Spier has sort of adopted this and expanded so its not about one job but a core operating philosophy. He cites a numerous second and third order powerful obliquities that arose out of this mode of operating.

There is another unexpected theme along this journey - gratitude. One of the most compelling parts of the book to me is the description of Guy Spier's devotion to the small, thoughtful kindness of writing thank you notes. To many people. This has the effect of both touching other people and ensuring that you are accounting for what you have received. These are important lessons not to lose sight of in today's world.

Friendships, people, gratitude - there are large parts of the book that are more like a self improvement book, and Guy Spier points to Tony Robbins' and others influences. Lots of people have benefitted from their work to improve their own productivity, health and personally develop, but Guy Spier shows exactly how this plays out in financial markets and in investor psychology which is a unique contribution, especially due to his transparent writing. Its a brave effort to put his mistakes on display and to share the journey at this level.

Value investing is almost like its own character in the book, and in the beginning of his career, Spier is as far from that concept as you could be, but by the end he has fully embraced and internalized the concepts.

Practically speaking there are number of good lessons, too. Spier's discussion of moving his practice from New York to Zurich goes into some detail about his thought process on designing the new space. There is a hard separation between the computer, Bloomberg busy room and a quiet library for reading with no computers. It struck me that Kahneman might call them System 1 room and System 2 room.

Spier stresses the importance of checklists and shares the key insight that checklists are not to tell you what to do, checklists are critical as a mistake avoidance tool. He includes a helpful way to think about processing investment ideas - do your own research first and then read news and other things about companies. Don't be led in by news or analyst reports because your susceptible to seeing things through their lens.

The overall theme is personal growth and connecting on a deeper level with great people (living and dead(through books)) they will help you discover vital things you can't on your own. The personal theme is to be true to yourself, do your research first, or as I say - outsource execution if you want, but never outsource strategy. Guy Spier writes that the "path to true success is through authenticity"and on this measure the book is a Peter Lynch ten bagger.

The real gem is the insight that value investing principles can go well beyond making money in the stock market; Guy Spier shows how value investing principles can be applied to enrich your personal life.