Dividends: More Is Less, Less Is More

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In this week's Weekly Insights:

– Dividends: More Is Less, Less Is More
– Australia Joining Global Low Inflation?
– All-Weather Price Tracker
– Industry Structures Revisited
– #NigelNoMates Not Enjoying A Holiday
– Catching Up On The Past
– Rudi On Tour
– Nothing Ever Changes, Or Does It?
– Rudi On TV

Dividends: More Is Less, Less Is More

By Rudi Filapek-Vandyck, Editor FNArena

"We are in a desperate period. Policymakers have taken it upon themselves to convince the world that they know better than the markets where interest rates should be, and are following a path that all but guarantees the very secular stagnation they are trying to avert – and that will lead eventually to a massive financial crisis."
[Charles Gave]

Over the past five years, the MSCI AC World index, representing equities for the global investor, has delivered a return of just 3.8% per annum, ex-dividends.

In Australia, share market returns over the past two years have been worse. Luckily, the Australian share market offers partial compensation by offering the world's highest yield from equities, on average.

No wonder investor attention is so much focused on dividends and on yield these days. It's what is required in order to achieve reasonable & acceptable returns, or so it appears.

Dividends: The Trend Has Been Your Friend

In the example of the MSCI AC World index, the average dividend yield over the past five years has been 2.9%, implying a direct contribution to total returns of more than 40% over the period. In Australia, the average dividend yield is usually around 4.5% but recent cuts, predominantly by resources companies, have lowered average yield for the ASX200 to circa 4%.

For superannuants in retirement phase trying to live off annual income from their investments, 4% probably is not enough, so they have gone searching for higher yielding alternatives. 6%. 7%. 8%. To those hunting for higher yield, it's all available in the Australian share market. Their key consideration is: can companies continue to pay at least the same dividends in years to come?

Despite high profile dividend cuts by the likes of BHP Billiton ((BHP)) and Woodside Petroleum ((WPL)) earlier this year, the answer in the overwhelming number of cases has been: yes, the company can.

Thus far, dividend-oriented investors have had the trend on their side. Faced with tougher growth and lower returns, companies have increasingly succumbed to satisfying growing investor demand for income/yield by jumping on the bandwagon themselves and sticking to the script at all costs.

Australia has a long tradition in this field, but consider, for example, in 1998 only 35% of companies in ASEAN countries paid out dividends to shareholders. Today the percentage is a whopping 95%. The average payout ratio throughout the region has steadily lifted over the period to 50% today.

But this is not an opportune moment to become complacent. There's a fair argument to be made the first cracks in the global dividend theme have now started to appear. With growth tepid and payout ratios often at elevated level, investor attention should now more than ever be focused on "sustainability" and on "growth".

While the absence of the latter might seem less important to income-only seeking investors, absence of growth can translate into capital losses in the short to medium term, and impact on sustainability in the longer term.

Why Less Is (Often) More

Share markets are not always efficient, they are not even always right, but they do have a sixth sense for separating the strong from the weak, in particular when it comes to dividend paying companies. Remember when BHP Billiton was supposedly offering double digit yield? Well, a few months later, and now the board has succumbed to the inevitable, BHP shares are trading on (forward looking) a yield of circa 3% (ex-franking).

In more subtle fashion, the share market provides investors with similar insights on a daily basis. Consider the graph below, taken from my eBook "Change. Investing in a Low Growth World", published in December last year.

The overview is based upon close monitoring of the yield trend that has dominated global equities over the five years past. It suggests that when it comes to deriving yield/income from the share market, "more" is seldom best while "less" might generate a lot more (in total return).

The practical application of this market observation is probably best illustrated through my list of personal yield favourites in the Australian share market: APA Group ((APA)), Goodman Group ((GMG)), Sydney Airport ((SYD)) and Transurban ((TCL)). All offer yields between 3.5%-4.5%. All remain in positive territory thus far in 2016, dividends not included, and all have generated positive returns in 2015 as well as in the years prior.

In contrast, ANZ Bank ((ANZ)), whose implied forward looking yield has now risen above 7% (franking not included), has not managed to add any capital gains on top of the annual payout in dividends both in 2014 and 2015. With the share price down significantly already since January, 2016 might well become the third year in succession that total shareholder return will be less than the yield on offer.

The principle also applies among the banks with both CommBank ((CBA)) and Westpac ((WBC)) offering lower yield but significantly outperforming their higher yielding peers ANZ Bank and National Australia Bank ((NAB)).

Of course, the share market does not always get it right, but as a standard guide I think the samples above speak for themselves.

A Smorgasbord Of Possibilities

Investing in yield stocks is not a static concept. Changes in the economic cycle lead to shifts in investor preferences, impacting on share price momentum and, ultimately, on total investment return.

Often market commentators and investors take guidance from overseas leads but, beyond the day-to-day volatility, regional differences command differences in yield preferences and thus tailored investment strategies.

First, let's take a brief look at the various options of yield stocks & strategies investors can choose from:

– Bond proxies; defensive stocks with plenty of cash flows (hence the potential to offer yield) but oft with low to no growth. Think REITs and infrastructure owners & operators.

– Growth at a Reasonable Yield, also known as GARY; reasonable yield, backed by growth which is not yet priced at too high a Price-Earnings (PE) multiple. GARY often leads investors to industrial companies trading on mid-to low teens PEs while offering 4-5% yield. In today's context this could include the likes of Pact Group ((PGH)), Lend Lease ((LLC)) and Smartgroup ((SIQ)).

– Dividend Champions; companies who have a long history of not cutting dividends. In Australia Telstra ((TLS)) would be such an example and arguably the major banks. The obvious warning here is the legacy from the past doesn't count for much when things turn really dire. In years past companies including BHP Billiton, Metcash ((MTS)), Fleetwood ((FWD)), GUD Holdings ((GUD)), et cetera that used to have an enviable track record, have been forced to reduce or to scrap dividends.

– Cash proxies; companies swimming in cash but with low "beta". Genworth Mortgage Insurance Australia ((GMA)) just announced a special distribution of 34c per share plus consolidation of its outstanding capital.

– Yield at Low Risk; see my graph above and my favourite yield stocks.

– High Dividend Yield; Nine Entertainment ((NEC)) currently offers 8.6% (no franking), Monadelphous ((MND)) is not far behind and DUET group ((DUE)) is offering 8.14%. Investors should be aware at all times share markets do not offer free lunches, but sometimes all that matters is the potential yield on offer.

– Low Yield with Strong Growth; Investors who bought Blackmores ((BKL)) shares three years ago are this year enjoying a forward yield of 6.74% on their original purchase, plus franking.

Dividends: Cycle & Regional Differences

Analysts at CLSA recently issued a stern warning: average free cash flow (FCF) cover among US listed companies has in the past three years sunk to below 1. One possible explanation is that companies have been using low-cost borrowing to fund payouts. As financial conditions tighten amid slower growth, CLSA believes payouts will become unsustainable, with buybacks likely to take the biggest hit, but dividends should come under extra scrutiny too.

But the biggest risks to dividends are among companies in Emerging Markets, with Latin-America and Asia topping the list of CLSA's global concerns.

In Australia, the analysts anticipate a continuation of the low growth environment and thus their preference is for GARY and Dividend Champions when it comes to yield-oriented strategies. In terms of the Australian banks, CLSA is of the view banks should be put in the basket of "bond proxies", which provides an insight into their preferred stock inclusions.

For Developed Markets in general (see chart below) CLSA advises GARY and Yield at Low Risk are likely to generate the best results. This aligns with my own view and analysis for Australia too.

Australia Joining Global Low Inflation?

Traditionally, Australia's consumer price inflation has always been markedly higher than in the larger, developed economies.

Being smaller and mainly surrounded by water is but part of the explanation. Having plenty of industries run by cosy oligopolies has certainly played a key part in this story too.

Now that technology is breaking down barriers and distance, and international competitors and new market entrants are changing the Australian economic landscape, should we expect a transformation in the local inflation outlook too?

Economists at UBS certainly are engaging the idea and they released a rather bold research report into this matter on Monday, predicting Australia might be joining the global low inflation movement from here onwards. This prediction is going to attract widespread attention without doubt. If not domestic media, then certainly the economist community will direct their attention to the deciphering of Australia's CPI dynamics by Scott Haslem and his team.

Bottom line: if inflation is now structurally heading towards lower levels, as arguably has already happened in the USA, Europe, et cetera, then this will have ramifications for RBA policies and the so-called Neutral cash rate, which should shift lower too, all else being equal.

Reports UBS: "Recent quarters have delivered the lowest core inflation prints (on average) in 18 years".

And to really bring home the point: "We see an 80% probability that inflation will print below the RBA's end-2016 2½% y/y forecast mid-point". Let the national inflation debate begin!

Given the heavy yield weighting in the Australian share market, the current trend in underlying inflation should thus be supportive for equities in general, point out UBS economists. Exporters will benefit from a weaker Aussie dollar.

As per always, there will be losers too: "lower inflation would bring negative profit implications in some sectors, such as consumer staples, general insurers, domestic health care and telcos".

All-Weather Price Tracker

Every quality newsletter deserves a subscriber such as James B. Having followed my analysis into changing market dynamics and All-Weather Performers from the sidelines for a while, James finally bit the bullet earlier this year and decided to join FNArena as a paying subscriber.

Since then he has written a number of emails, including directed at Nigel NoMates, said Hello when meeting me in Manly, and spent a few weekends and afternoons on calculating and re-calculating the numbers available on All-Weather Performers. His end conclusion: there is a whole lot to say in favour of these All-Weather Performers. Their performance in years past has been much better than the broader market, no matter how we slice and dice the numbers.

Thanks James. Good to see that my own research/analysis/calculations withstood the extra scrutiny of a motivated investor as yourself who really wanted to get to the bottom of this. Needless to say, James B has now been converted to the theme.

James's last email (thus far) reached us over the Easter weekend. Whether all stocks mentioned in the monthly price tracker (in excel – for paying subs only) should still be regarded All-Weather Performers looking forward, or was there some legacy from the past as well?

Timely question. I had already concluded our monthly update needed a general revamp, including for the structural growth sectors I had identified in last year's eBook "Change. Investing in a Low Growth World". From this month onwards there should be no more such questions, from James or from anyone else, as we have conducted a general review and restructured the price tracker.

Paying subscribers can send a request to info@fnarena.com

Industry Structures Revisited

My previous Weekly Insights, Bear Market Diaries – Episode 6 (March 21, see below), mentioned research by Credit Suisse into industry structures and how they impacted on sustainable, lasting shareholder wealth creation by companies operating under such supportive dynamics. No guessing as to why I suggested investors should include such research when conducting their own.

Alas, Credit Suisse has since been forced into releasing a correction on the research. Someone had used one of the tables with calculations upside down. We're all human, of course, but there's very few worst alternatives to having published a major piece of research and then having to release a correction which substantially changes the framework. I feel sorry for the lads at Credit Suisse.

Turns out, investing in companies with very bad industry dynamics over time generates similar results as investing in supportive industries. The ones missing out, if we rely on this angle only, are companies operating under rather neutral sector dynamics.

That's the statistical end conclusion. Credit Suisse points out while this might be true, the approach to investing in the two opposites would certainly have to be different. When it comes to weak industry structures, the search should probably focus on beaten down stocks who either attract the attention from a corporate suitor or whose fortune is about to turn for the better.

When looking for strong, supportive industry dynamics, investors can take note of the fact this has been one of key factors in support of my own research into All-Weather Performers. These stocks trade on market-premium valuations, and for good reasons too. I sincerely hope all readers of my weekly updates have a good portion of those in their long term investment portfolios.

Regardless, the revised outcome of Credit Suisse's research is intriguing, to say the least, and once again shows there is no such thing as one strategy or one approach that fits all circumstances and suits all kinds of investors.

#NigelNoMates Not Enjoying A Holiday

Nigel remains sceptical whether central bank actions in March have now fundamentally re-shaped the outlook for the global economy and for financial assets.

Catching Up On The Past

In case you missed some of the preceding stories, here's your chance to catch up (in reverse order):

– Rudi's View: 2016 is The Year Of Conviction

– Rudi's View: Who's Afraid Of The Big Bad Bear?

– The Bear Market Diaries – Episode 1

– The Bear Market Diaries – Episode 2

– The Bear Market Diaries – Episode 3

– The Bear Market Diaries – Episode 4

– The Bear Market Diaries – Episode 5

– The Bear Market Diaries – Episode 6

Rudi On Tour – Who's Afraid Of The Big Bad Bear?

They seem to come along every eight years or so, the dreadful bear market so many investors detest, causing risk appetite to evaporate and share prices to reset at lower levels. Every time the cause and follow-through are different. So what lies at its origin this time and what's going to be the likely outcome? As a self-nominated bear market expert, I will be sharing causes, explanations, insights and strategies for investors who want more than keeping their fingers crossed while hoping for the best.

I will be presenting:

– To Perth chapters of both Australian Shareholders' Association (ASA) and Australian Investors' Association (AIA) for presentations on Monday 9th May, both afternoon and in the evening.

– To Melbourne chapter of the Australian Shareholders' Association (ASA) in early July

– At the Australian Investors' Association's (AIA) National Conference in August on Queensland's Gold Coast.

– To Chatswood chapter of Australian Investors' Association (AIA) on September 7, 7pm, Chatswood RSL

Nothing Ever Changes, Or Does It?

Yes, of course, investing in the share market is never really different and best working strategies today are the same that worked pre-GFC. Seriously. I tell you, seriously.

Now that we had a good laugh about it, let's get straight to business. This is a low growth environment. Has been since 2010 (it was masked at the time because of the V-shaped recovery from the global recession) and it is not likely to change fundamentally in the near term. I wrote a book about this (see below). This means investment strategies must adapt. You'll be turning your portfolio into a wish list for dinosaurs otherwise (and your returns will be a reflection of it).

Those not afraid to contemplate "this time is different" can subscribe to FNArena and read all about it in our bonus eBooklets 'Make Risk Your Friend' (free with a paid 6 or 12 months subscription) plus the freshly published eBook 'Change. Investing in a low growth world' (equally free with subscription, or available through Amazon and other online distributors).

Here's the link to Amazon: http://www.amazon.com/Change-Investing-Low-Growth-World-ebook/dp/B0196NL3KW/ref=sr_1_1?s=digital-text&ie=UTF8&qid=1454908593&sr=1-1&keywords=change.investing+in+a+low+growth+world

See also further below.

Rudi On TV

– On Tuesday, around 11.15am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes
– I will be appearing as guest on Sky Business's Trading Day, 12.30-2.30pm on Thursday
– Still on Thursday, I shall appear on Switzer TV, between 7-8pm
– On Friday, around 11.05am, on Sky Business, I shall make a brief appearance through Skype-link to discuss broker ratings for less than ten minutes

(This story was written on Monday 4 April 2016. It was published on the day in the form of an email to paying subscribers at FNArena).

(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.

In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: info@fnarena.com or via Editor Direct on the website).

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BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS

Paid subscribers to FNArena receive several bonus publications, at no extra cost, including:

– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow. This book should transform your views and your investment strategies. Can you afford not to read it?

Subscriptions cost $380 for twelve months or $210 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup 

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