Dividend Oriented Portfolio Poised to Outperform?

I've recently written about the relatively high dividend yields available from some of the major S&P 500 companies in comparison to the terrible yields in things like US government bonds (10 years at 2.5%) and municipal bonds.

In my opinion, the bull market in bonds is due to come sliding - possibly crashing - down, just as other inflated investments have in the recent past, eg NASDAQ, peak years 2000-2001, US housing market years 2006-2007. Tears are inevitable.

On the other hand, with the idea in mind that you can construct a reasonably safe dividend-oriented, relatively diversified stock portfolio going forward, which provides a yield well above that, AND with decent potential for dividend growth, I screened the S&P 500 for stocks yielding above 3%, in market-leading names I recognize, and with decent (more than 10%) returns on invested capital (ROIC).

Here's the list I came up with, that I think will outperform the S&P500 significantly in total return over the next two years:

The only name that doesn't strictly meet that criteria is General Electric, which has a relatively low return on invested capital, given the capital intensive nature of its business and its past actions as, effectively, a bank.

The dividends all appear reasonably safe with these companies, as they have either relatively moderate payout ratios, or have recently lifted their dividend payments.

The last thing to consider is the potential impact of climate change on these companies over the short to medium term. In my view, none of them have the potential for short-to-medium term implosion, like I detailed for Compass Minerals.

However, some have a bit of climate-change short-to-medium-term risk as I see it, as discussed below:

Altria is a cigarette manufacturer/retailer. It is possible that climate change could affect their business in two ways:

Firstly, smokers tend to be in the lower economic strata; these are the folks who will be most effected  by potential food inflation. If they are spending more for food, then less is available for things like cigarettes which, despite their addictive qualities, are still a discretionary purchase. Some smokers may choose to quit if their budgets become more squeezed, accelerating the already evident trend of sales degradation, or they may trade down to lower margin brands.

Secondly, its possible that there could be some tobacco crop failures going forward (drought or too much precipitation/at wrong time), resulting in higher input costs. This would put Altria in the unenviable position of a margin squeeze, or having to hike prices (resulting in sales loss), or consumers trading down to cheaper brands.

On balance, I would rate their short-to-medium-term climate risk issues as moderate.

Heinz is a food manufacturer who could also be affected moderately over the short-term in a manner fairly similar to Altria. While consumers are unlikely to quit Heinz's type of product (they still need to eat), they may well trade down to cheaper brands with lower margins. Secondly, crop failures could also have a similar impact as described to Altria, above.

Sysco has moderate short-term climate risk, since they are a food distributor who supplies many restaurants. If food inflation picks up, then the general consumer will spend less on restaurant meals, meaning that many of Sysco clients could reduce volumes/orders (lowered revenue for Sysco) and suffer some financial distress (meaning Sysco's accounts receivables could also balloon).

Procter and Gamble is the final one which I believe also has some short-to-medium term climate risk. If food inflation occurs, and leaves fewer dollars on the table of their customers, then their customers may very well trade down from the PG family of premium products, to more economically priced ones.

On balance, I would say that this portfolio probably has average climate-change risk on a go-forward basis.

Disclosure: No positions.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

End of the Equity Cult? Maybe - but don't buy bonds!

Citigroup says that it's the end of the equity cult ...

It has taken 10 years, and two 50% bear markets, to reverse this cult. European and Japanese equities are already trading on dividend yields above government bond yields. US equities are almost there as well. An immediate reincarnation of the equity cult seems unlikely. Global corporates, especially the mega-caps, rushed to exploit cheap financing as the equity cult inflated. They have been slow to redeem equity now that the cult has deflated. Equity oversupply remains a drag on share prices."

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The investing buying public is now pouring into bonds, with tragically low yields, at a fraction of the purchase volumes for equities, a ratio signalling a top for bond prices, unless long-term deflation really is coming.

My question is ... how can deflation truly be on the long-term horizon, in the face of obvious and growing disparities between food production, and consumption? Food inflation, always and inevitably, leads to all other kinds of inflation. Long term deflation like Japan - not a chance! (Post-script addition: this food inflation will be caused by, mainly, climate change as the primary driver).

So what piling into bonds will get you, over the medium to longer term (5-10 years), is a yield unlikely to keep pace with inflation, or a price which virtually ensures that you suffer a capital loss if you sell early.

Instead, you can take a dividend yield for a great many S&P 500 stocks which are well above the 10 year US government bond rate, something that hasn't happened for a very long time.

Bonds or stocks? Well, at the yields offered, bonds are now very risky.

On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

A cautionary tale for bubblicious portfolios

What chart is this?

I am sure that a lot of you are thinking that it must be some internet stock.

Well, it could be: the chart resembles many which peaked in the 1999-2001 period. I recently looked at the stock prices for Microsoft (MSFT) - it peaked around $59 back then, and is currently in the $25-$30 range - about half its peak value. Intel (INTC) peaked in the $75 range, and is now in the $25-$30 range. Cisco (CSCO)? $77 then and $21-$28 recently.

But no, this is not from the tech sector. This is a cautionary tale of how inflated prices can get in one, or many, sectors during a bubble.

No, this is the behemoth drug maker Merck & Co (MRK). which peaked around the same era at $94 and is now in the $35-$40 range. You can pull up the charts for the other pharmaceutical giants, then and now, like Pfizer (PFE), Abbott Labs (ABT), Novatis (NVS), etc. and find the same cratering effect: most of these still haven't reached the halfway point of their bubble prices.

Have some things changed for both sectors? Sure - but not nearly to the extent implied by both a lost decade of price appreciation and, worse, price declines that could have eviscerated some over weighted portfolios.

One thing remains constant - investors, whether buying single companies or weighing into sectors via ETF's etc., have to be very cautious on the flavour of the year. Avoiding the most popular sectors, especially after several years of popularity, can be one of the best things you can do for your portfolio's health - and can help you get a good night's sleep too.

Disclosure: No positions.
On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Investment Earworm Contest Winner - Rick

A fairly recent posting of mine challenged readers to identify the speaker of the following comment, together with the asset class he was speaking of.

The comment is, essentially, this:

Commodities wins both the optimistic and the pessimistic scenario."



Rick has correctly identified the speaker and the asset class as being Jim Rogers (the commodity guru) and speaking of the commodity asset class.

What Rogers is saying here, is that if the emerging economies continue their assent - and with it demand for commodities - then commodities prices will continue rising, even if inflation is benign. This is the optimistic scenario.

On the other hand, if inflation starts to run away, due to the extremely high levels of monetary and fiscal stimulus with continuing budgetary deficits (the pessimistic scenario), then the only thing that'll hold their value, are "real" assets, namely commodities and possibly real estate.

Congratulations Rick. You will receive your book choice, The Ultimate Dividend Playbook, shortly.


On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Compass Minerals International Inc (CMP) likely a future victim in climate change?

As this blog begins to grow its focus on climate change investment strategy, I thought I'd highlight a company that was mentioned in the fine Josh Peters book, The Ultimate Dividend Investor Playbook, which I recently reviewed.  In the book, Mr. Peters, of Morningstar, mentions Compass Minerals International Inc. (CMP) as then (sometime in 2006 or 2007) perhaps being a candidate worthy of consideration for addition to a dividend stock portfolio.

Compass' main business then, as now, "is highway deicing salt, so its profitability is determined by cold, snowy, or icy winter weather." So says Morningstar. 

Morningstar currently provides a three star (average) rating to Compass, meaning they perceive its total stock return outlook to be approximately comparable to the universe of stocks they cover. Owing to a wide economic moat (in this case, a low cost to bring the salt to market), balanced against other factors, is what produces the overall three star average rating.

Me - I think that Compass is an implosion waiting to happen, whether it's this coming winter season, the next year, or in three of the next six years. This is not owing to any prescient thoughts on my part about debt, customer loss, or competitors acting irrationally by pricing below the cost of production. No, I worry about the climate. Notwithstanding occasional contrary hickups, winters are growing shorter and less severe. The scientists say so, and it matches the global warming theory (first postulated by Nobel Prize winner Svante Arrhenius, in 1896).

Trying to continue to maintain salt volumes in the face of this reality, is the investment equivalent of expecting buggy whip makers to continuing to pump out similar volumes, something Morningstar apparently expects, as their quote in their outlook on growth states ...

Growth: We expect long-run demand growth for Compass' salt to be quite minimal. Earnings growth will depend on increasing sales prices and cost efficiencies. (emphasis not in original)


Note that they do NOT say they expect growth for salt to actually decline for Compass, something that can realistically be expected, unless competitors throw in the towel, and they gain a larger share of a shrinking pie. Even if that were to occur, most investors recognize the futility of fighting a secular "headwind". No pun intended.

Climate change investment strategy, as I will begin to explore over the coming while, involves a very few great opportunities, some good opportunities, and a whole lot of businesses to stay away from, unless you have the stomach for shorting stocks.

Compass is one example of a stock I'd be extremely cautious of getting involved with, especially since it is priced at roughly the same PE ratio as the S&P500.

No, if I were you, and thinking of holding Compass for a year or more, I would take Morningstar's rating, in this case, "with a grain of salt".

Disclosure: CMP - no investment position.


On a blog aggregator? Go here, The Confused Capitalist, for additional content and our growing focus on climate change investment strategy.

Book Review - The Ultimate Dividend Playbook

Any investor worth his or her salt, who doesn't want to rely on the vagaries of capital appreciation to grow their net worth, and who would readily lean on the best shortcut in the world to wealth creation, dividends, simply must seek to understand them. Numerous studies have shown that dividend paying stocks outperform all other stock classes, and usually by a wide margin of 2% or more annually.

This book, by Josh Peters of Morningstar, helps the investor understand the case for dividends, and how to select individual stocks for a modestly diversified portfolio. While many investors may think dividends are suitable for income investors only, the fact is that dividend paying stocks should be a or the major stock holding style in most investors' portfolios.

Why? Well, as Josh points out, it's very simply because they outperform most other stocks, and generally with reduced volatility. So, it's a more stable, higher-returning investment. What could be better than that?

As Josh points out, dividends are a sign of many things investors like to see:

• An alignment of managements and the investors interest (return of, and return on, cash);
• Corporate self-discipline (have to keep grinding out the cash to pay and grow the dividend);
• Financial strength;
• And a Valuation basis (dividends can show when a stock is overpriced, and underpriced).

Josh covers economic moats, which he likes all his dividend-paying stocks to have, as well as return on equity (see his book, or mine, on why this is important). He suggests looking at the trend of the dividend (the trend is your friend, in terms of projecting the future), so see how the dividend might grow into the future.

He covers handy items like payout ratios, high yielding stocks (generally, be careful) and high payout ratios (look out if ratio has been continuing to rise).

In the book, Josh covers especially two items that make the book an entirely worthwhile addition to any investors bookshelf: the dividend drill, and the dividend drill return model.

The dividend drill focuses on three items;

1. Is the dividend safe;
2. Will the dividend grow;
3. What does the dividend stream tell me the stock is likely to return to me as a shareholder?

Attempting to answer these questions will help you decide whether or not a prospective stock investment is one that you can or should add to your portfolio.

In relation to #3 above (the total return from the stock), he also introduces one very handy shortcut (and investing is full of them, from PE ratios, to inventory turns, to PEG ratios). Think about the potential of the total return of the stock as the sum of the actual dividend yield, plus the likely growth rate of dividend over the next while, say ten years.

A couple of simple examples showing how the total return might be different for two stocks, is that one might be yielding a 5% return, and has recently been increasing the dividend by about 4% annually. If you think that increase would continue over the next decade or so, then the likely total return on that stock would be about 9% annually (5%+4%). In the case of a stock which has a lower initial yield, but is increasing the dividend more rapidly, the projected return might look like this; a 3% dividend yield, plus expected future dividend increase at 8% annually, suggests an 11% (3%+8%) total return.  The book is full of handy advice like this, written in a straightforward and uncomplicated style.

The book also details the more complicated (but not complex) Dividend Drill Return Model, which encourages you to think more deeply about the company and its prospects. Yes, it's more work, but relies only on elementary/grammar school arithmetic, so it's within the reach of virtually any investor.

I highly recommend this book, and thank Josh Peters for writing it. The information is handy, practical, simple, and timeless.

The Confused Capitalist

Retail Investors Indicate Bonds are lousy deal right now ....

The retail investor has long been a contra-indicator of what's truly both a timely and good investment ...

Firstly, they often have trouble knowing the difference between a savings vehicle (holding time frame of under five years, generally; and very low expected return) and an investment vehicle (holding time frame of over five years; and relatively high expected return).

Add to that the mistiming of buying and the comedy of errors reaches Shakespearean proportions. 

Municipal bond mutual funds that report their figures weekly reported $953.9 million in new money from investors during the week ended Aug. 11, according to Lipper FMI. That was the biggest weekly inflow since March, and heavier than all but 33 inflows since Lipper started tracking the data in 1992 — 970 weeks ago.

AND

Solender said because expectations are that the Federal Reserve’s target for interest rates will remain near zero well into next year, people are growing increasingly comfortable with the yields offered on municipal bonds — even though they have never been lower. (highlighting not in original)

The yield on a 10-year triple-A rated municipal bond sank below 2.5% for the first time last week, according to Municipal Market Data.

Article here

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As opposed to that, IndexArb reports that the current average dividend yield of all the S&P500 dividend-paying stocks is 2.51% (with a reasonable expectation of future dividend growth), yet the retail investor saver piles into the bond market, potentially locked into a 2.5% yield for 10 years.

Yikes!

The Confused Capitalist