How Not To Be Your Own Worst Enemy

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This story was first published two days ago in the form of an email sent to registered FNArena readers.

Today's story is for wealthy investors only. "Wealthy" is a relative term, but if you have enough capital to set out investments that can grow over time, without the pressure to increase your capital in the short to medium term, you are fit to be called "wealthy". All others will find this story amazingly frustrating, because it once again boils down to the fact that it is so much easier to make money when one has it. The alternative is, of course, to trade like a devil (make sure you check up on your luciferic credentials first).

By Rudi Filapek-Vandyck, Editor FNArena

I have been filmed throwing Zimbabwean dollar notes in the air during a live interview on television, and I did show up in alien costume during ASX Investor Hour a few months ago, but on Thursday last week I really did something crazy. I used my presentation at the annual AIA investor conference in Sydney to present investors with an alternative to the high volatile, high risk situation in the share market: to participate without paying attention to the share price.

Huh? Say that again? Yes, indeed, on Thursday last week I proposed: how about we start buying stocks in the Australian share market, and we forget all about what happens to the share price.

Sounds like I am on the road to ruin, doesn't it? Or the asylum, for that matter.

Yet, I think those investors who can circumvent their present misconceptions about investing in the share market, and who can see the true value and merits of my approach, will do so much better than those who cannot. There is one condition, however: you have to have enough money to play this game. To put it simply: I am going to teach you how to turn your current capital into a double digit cash generator over a five year period. The trouble with this is that if you only have $1000 to spend, this will still only translate into a $100 annual return.

Nobody ever said life -or investing- was fair.

Both you and I would be surprised if we found out how many investors out there have enough money to play this game. Yet, it is my long standing observation that most of these investors are confused, misguided and absolutely doing themselves little or no favours with the way they approach participating in the share market. Life is more about perseverance than it is about talent and luck, but this doesn't mean doing the same thing no matter what the circumstances. It is foolish to turn up in your swimming suit when the water is frozen, just like you wouldn't go looking for penguins on the North Pole.

So why are most of you still treating the share market as if this is still 2004-2007?

One major benefit from my approach is that it doesn't require investors sit behind their pc screens every day, all the time. In fact, the lesser human action is involved the better. It has long been established that when it comes to longer term investing, those strategies that rely on regular human intervention significantly underperform strategies that do not. It is one key observation that stands out in survey after survey, analysis after analysis: investors who manage their long term portfolios on a daily basis inevitably end up selling their shares too early while buying back into the market too late. This makes my approach close to perfect as it only requires human involvement once. At the beginning.

What I am suggesting is that we do our research, pick our entry and then stop being obsessed by the share price.

This is a good thing, because if we execute this strategy well, we don't want to sell our shares – ever. So why would we remain obsessed by what the price does?

Hohoho, I hear you object, am I not missing the point what investing in the share market is all about? It's all about buying low and selling higher.

Unfortunately, it's not. That's what it looks like in a bull market, and since everyone repeats the same mantra over and over again, it becomes "reality". It still doesn't mean that if you are in the game for the long haul you should be playing according to these rules. Think about how all good things in life require time. The whiskey that tastes like vitriol in the first months, becomes a joy to our senses if given enough time to mature. And so it is with a good wine, with personal skills and experiences, as it is with investing.

The difference between a bull market and a sideways market is that in the first case we think we can do better by ignoring these rules of nature, in the second scenario we are ultimately brutally robbed of our illusion.

Let there be no mistake: if you don't like the risk that is present in today's share market, then cash is your best friend. Full stop. However, if you do want to generate superior returns then equities are the better alternative, albeit with a higher risk profile.

The risk in today's market lies not so much with corporate earnings and balance sheets, but with central bank policies, government actions and sovereign debt. The irony is that most companies seem to be in good shape and many of them will grow their earnings in the years ahead. The unfortunate uncertainty for investors is that this does no longer automatically mean share prices will thus rise too.

The unfortunate reality is that with lower trend growth ahead in the two biggest economic zones and with sovereign debt risks continuing to linger, not to forget the fragile banking system in these countries, it is likely the future will see lower valuations in general being priced in for equities – this as a result of the global community pricing in a higher risk premium. Under such a scenario, higher profits can still translate into lower share prices.

As far as the sovereign risks go, anything is possible when it comes to political processes and budgets in both the US and in Europe, and in the absence of short term reckonings or solutions, this will remain the case for years to come.

Can stock markets crash to much lower levels from here? They sure indeed can, especially if we take guidance from the panic driven events in the first two weeks of August. But one would have to have a very dire view on the world in the years ahead to write off the possibility that troughs will still be followed by rallies, even if today we don't know when, why or how this might occur.

Which is why my analysis continues guiding me towards dividends. To put it bluntly: dividends are in today's market less at risk than earnings or share prices. This might seem odd as investors have always been told to carefully watch earnings as these are ultimately what generates the cash to pay for shareholder dividends. As said above, corporate balance sheets are, on average, in good health and many businesses are generating growth in profits. A broad-based change in the general climate can impact on this and earnings can turn out a lot less than what seems a conservative estimate today, but a whole lot more would have to happen before we will see a significant reduction in today's sustainable dividends.

Here's one example to illustrate my point: even if the global economy goes into temporary meltdown tomorrow, will the world all of a sudden stop using PET bottles, tin cans and cardboard packaging? If the answer is negative then Amcor's ((AMC)) dividends for the years ahead look fairly secure. Similarly, what kind of apocalypse are we talking about that stops consumers in Australia from shopping at Woolies supermarkets, Dan Murphy's liquor stores and Big W stores?

In my presentation on Thursday I asked the question: did you know there are companies in the Australian share market that have never since listing lowered their dividends? As in: never, not even in the immediate aftermath of the Lehman Bros collapse? Others might have cut once (cut, which is not the same as scrapped) but they started adding again the following year. Others might have had a hiccup many moons ago, but they have kept growing their dividends throughout the past decade.

Companies that fit in with this profile include Fleetwood ((FWD)), Campbell Brothers ((CPB)), Monadelphous ((MND)), Woolworths ((WOW)) and Amcor, as well as all the major banks.

Which is why, on Thursday, I showed the following print from Stock Analysis (on FNArena website):

Taking guidance from these (fairly secure) projections, Fleetwood shares bought today are likely to yield 9% in fully franked dividends in five years time. This also happens to be the "new" long term average return for the Australian share market as recently calculated by AMP. 9% fully franked is superior to 9% in total returns and it certainly beats 6.25% in cash deposits which won't grow and are fully taxable.

Replace Fleetwood with Amcor and we are probably talking 8.5% in five years time. Replace Amcor with Wesfarmers ((WES)) and a similar picture emerges.

Add a few years and you should be talking double digits. This is why I believe investors who should be thinking long term are too often confused and misguided and they thus miss out on the true value on offer in the share market: cheaply priced generators of growing, sustainable dividends. Want to know what a few years of bull market conditions can do this approach? Take a look at the following picture:

Admittedly, I don't think it is feasible to expect similar returns in the years ahead when growth will be lower and harder to achieve, but double digits are still possible, in my view, if only we allow for enough time. And let's be honest, are you really going to sell your shares if they pay out double digits, while growing every year? Which is why I asked on Thursday: why are you so obsessed with what the share price is going to do tomorrow?

Think about it. This may well turn out the most important realisation you make for the rest of your life.

Meanwhile, the financial industry itself is gradually turning its focus to sustainable dividends. On Monday, Gamma Wealth which manages one fund dedicated to income and yield, reported: "Currently the Gamma Wealth Management investment team views a number of opportunities with many companies’ balance sheets being quite strong post GFC and producing high sustainable dividend yields. A number of companies in focus as potential entrants for this portfolio include Fleetwood, Cabcharge  ((CAB)), Adelaide Brighton ((ADB)), Cardno ((CDN)), United Group ((UGL)) and Metcash ((MTS)).  These companies have been priced for no earnings growth, yet have strong balance sheets and unique characteristics to their business which has made some of them market leaders in their industry."

Market strategists at Goldman Sachs equally lined up their favourite stocks expected to yield at least 7.5% (grossed up) and believed to be secure and sustainable: Myer ((MYR)), Bank of Queensland ((BOQ)), Tabcorp ((TAH)), National Australia Bank ((NAB)), Westpac (WBC)), ANZ Bank ((ANZ)), Metcash, Commbank ((CBA)), Bendigo and Adelaide Bank ((BEN)), QBE Insurance ((QBE)), Suncorp ((SUN)), United Group, Caltex ((CTX)), JB Hi-Fi ((JBH)), Leighton Holdings ((LEI)), AMP ((AMP)) and Toll Holdings ((TOL)).

Amongst smaller caps, Goldman Sachs selected: Hills Holdings ((HIL)), Prime Television ((PRT)), Cabcharge, WHK Group ((WHG)), Ten Network ((TEN)), BT Investment ((BTT)), Adelaide Brighton, OrotonGroup ((ORL)), iiNet ((IIN)), Charter Hall ((CHC)), Bradken ((BKN)), DuluxGroup ((DLX)), Breville Group ((BRG)), Flexigroup ((FXL)), TPG Telecom ((TPM)) and Australian Infra Fund ((AIX)).

While the question most on investors' mind is when is the next rally, so that shares in small cap miners as well as in BHP Billiton ((BHP)), Rio Tinto ((RIO)) and energy stocks instantly turn into "must owns", I remain convinced the true value in today's share market lies with industrial stocks that pay growing, sustainable dividends. For all of the above reasons, plus many more (such as Perfect Timing is the brother of Harry Hindsight).

Which is why Ardent Leisure ((AAD) remains one of my favourite stocks in the share market. Eight years ago, the shares were trading around $1, which is where they are today. In two years' time these shares will yield 12%, if not more. All I have to do is simply own them.

Do I care about the share price?.. Should you?

P.S. After my presentation at the AIA Conference on Thursday, an older investors approached and told me: "Your presentation made me realise I have been doing the right thing all these years, without actually realising it."

(This story was originally written on Monday, 05 September, 2011. It was published on that day in the form of an email to paying subscribers).

Events that changed the world

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– 2011 AD – September 1; in Sydney at the AIA Conference FNArena editor Rudi Filapek-Vandyck presents "equity investing sans share price"

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