Wednesday, March 21, 2012
Tuesday, March 20, 2012
The Search for Yield - Dividends & Payout Ratios
In an era of historically low bond yields and zero percent benchmark interest rates,
the thirst for income has rarely been so hard to quench. Since 2009, the yield on 3-
month Treasury Bills has averaged 0.65% in Canada and 0.10% in the United
States. From 1954 to 2007, U.S. 3-month yields averaged 5.2%. Investors have
been fleeing pure equity investment vehicles for years and flocking to income
products/bond mutual funds in search of income and lower volatility. The latter is
likely to prove elusive in coming years as monetary policy normalizes higher. The
traditional high dividend paying sectors such as Utilities, Telecom, and REITs have
benefitted the most from income oriented flows in recent years, but other areas of
the market may now attract some attention. U.S. Banks that have cleared stresstests
will start raising dividends and Technology behemoth Apple announced
yesterday that it would re-introduce a dividend. The S&P 500 dividend currently
stands at US$27.53 and its dividend yield of 1.95% had until recently surpassed the
U.S. 10-Yr bond (2.38% yesterday, 1.88% last 3M average). In Canada, the TSX's
dividend yield (2.85%) still edges 10-Yr Canada bonds (2.29%). Both for the TSX
and S&P 500, a positive dividend yield-to-bond yield spread is a first since late
2008-early 2009. Dividend growth has lagged the profit recovery since 2009 and
the S&P 500's payout ratio of 28% is the lowest since 1871. Equity flows could see
a positive reversal if bond returns start to disappoint. Should this happen, we
believe companies offering high yields and the ability to raise dividends will benefit.
Non-traditional dividend areas are likely to join the dividend party as well. Our Chart
of the Day highlights the S&P 500 and TSX index/sector dividend yield and payout.
Thursday, February 16, 2012
Strategy Corner....Dividends and Share Buy Backs. (It's been a while)
Keeping in line with our strategy to look for new and innovative investment ideas, I bring you the following:
Dividends and Share Buybacks
Over the years, companies have created shareholder value through share repurchase programs and/or dividend increases. By share repurchase program we are referring to companies that buy back their stock in the open market. Both policies can create value for shareholders although there is an ongoing debate as to how much value is created, and which is the better use of free cash flow.
Certainly, the permanence of a dividend increase tends to be a better indicator of financial health and investors like to see dividends credited to their accounts. That said the return of cash to shareholders through share repurchase programs also benefits shareholders by reducing the number of shares outstanding, boosting earnings per share, and providing support for the share price. In this report, we have attempted to identify companies that have a history of consistently delivering on both shareholder friendly policies.
U.S. Corporations Flush with Cash
U.S corporations are sitting on record levels of cash with non-financial corporate businesses holding U$2.12 trillion in liquid assets at the end of the third quarter of 2011. High free cash flow yields combined with low returns generated on cash holdings should lead to increased dividend payments to shareholders and share buyback activity. In 2011, S&P 500 companies paid U$256 billion in dividends to shareholders, or about 29% of earnings. That’s well below the long-term average payout ratio of 47%. In 2011, U$530 billion worth of share buybacks were also authorized, up nearly 45% from 2010.
16 Companies with Investors’ Interests in Mind
We screened the S&P 100 Index of U.S. mega cap stocks, looking for companies that consistently repurchased shares and increased dividends over the past five years. To qualify, a company must have repurchased and reduced its common shares outstanding, and increased its dividend in each of the last five years without exception.
When creating our list, why did we not simply look for cash-rich companies with high free cash flow yields? Far too many management teams have destroyed shareholder value with poor investment decisions. Share buybacks and dividends put cash directly back into shareholders hands. However, these shareholder friendly policies should not come at the expense of strategic investments that could positively impact a company’s long-term growth and financial health.
There are 16 companies in the S&P 100 that met our selection criteria. Industrials, in particular defense companies, large retailers, and health care companies dominate the list. The stocks on the following page are ranked based on yield, decline in shares outstanding, and growth rate in dividends. On the basis of these three equally-weighted factors, Lockheed Martin (LMT) tops the list. On average, over the last five years, this defense company has reduced its shares outstanding by 5.3% per year while increasing its dividend annually by an impressive 21%. The shares currently yield 4.8%. Runner-up Texas Instruments (TXN) repurchased a similar amount of shares, but its Board was more aggressive in terms of annual dividend increases. However, the chipmaker’s shares yield only 2.1% at their recent quotation.
*Call or send me an email to discuss the companies that passed the test, and how this strategy may be a possible addition to your current investment policy.
Best Regards and Safe Investing!
E
Dividends and Share Buybacks
Over the years, companies have created shareholder value through share repurchase programs and/or dividend increases. By share repurchase program we are referring to companies that buy back their stock in the open market. Both policies can create value for shareholders although there is an ongoing debate as to how much value is created, and which is the better use of free cash flow.
Certainly, the permanence of a dividend increase tends to be a better indicator of financial health and investors like to see dividends credited to their accounts. That said the return of cash to shareholders through share repurchase programs also benefits shareholders by reducing the number of shares outstanding, boosting earnings per share, and providing support for the share price. In this report, we have attempted to identify companies that have a history of consistently delivering on both shareholder friendly policies.
U.S. Corporations Flush with Cash
U.S corporations are sitting on record levels of cash with non-financial corporate businesses holding U$2.12 trillion in liquid assets at the end of the third quarter of 2011. High free cash flow yields combined with low returns generated on cash holdings should lead to increased dividend payments to shareholders and share buyback activity. In 2011, S&P 500 companies paid U$256 billion in dividends to shareholders, or about 29% of earnings. That’s well below the long-term average payout ratio of 47%. In 2011, U$530 billion worth of share buybacks were also authorized, up nearly 45% from 2010.
16 Companies with Investors’ Interests in Mind
We screened the S&P 100 Index of U.S. mega cap stocks, looking for companies that consistently repurchased shares and increased dividends over the past five years. To qualify, a company must have repurchased and reduced its common shares outstanding, and increased its dividend in each of the last five years without exception.
When creating our list, why did we not simply look for cash-rich companies with high free cash flow yields? Far too many management teams have destroyed shareholder value with poor investment decisions. Share buybacks and dividends put cash directly back into shareholders hands. However, these shareholder friendly policies should not come at the expense of strategic investments that could positively impact a company’s long-term growth and financial health.
There are 16 companies in the S&P 100 that met our selection criteria. Industrials, in particular defense companies, large retailers, and health care companies dominate the list. The stocks on the following page are ranked based on yield, decline in shares outstanding, and growth rate in dividends. On the basis of these three equally-weighted factors, Lockheed Martin (LMT) tops the list. On average, over the last five years, this defense company has reduced its shares outstanding by 5.3% per year while increasing its dividend annually by an impressive 21%. The shares currently yield 4.8%. Runner-up Texas Instruments (TXN) repurchased a similar amount of shares, but its Board was more aggressive in terms of annual dividend increases. However, the chipmaker’s shares yield only 2.1% at their recent quotation.
*Call or send me an email to discuss the companies that passed the test, and how this strategy may be a possible addition to your current investment policy.
Best Regards and Safe Investing!
E
Thursday, December 15, 2011
Upcoming Seminars:
WHY?Reduce your financial burden.
Maintain your independence.
Access cutting-edge medical services.
Assist in your recovery any way you choose.
Wednesday, November 23, 2011
Strategy Time... (a revisit to high yield corp bonds)
High yield bonds offer investors attractive income in the current environment, with an average yield of more than 600 basis points greater than the yield on government bonds.So, why is it important for investors to include an allocation to high yield bonds in their portfolio?
1. Enhanced Diversification - High yield bonds are often considered a distinct asset class, as they involve different return characteristics and have a lower correlation to traditional asset classes such as Government bonds and equity. For this reason, adding high yield bonds can increase portfolio diversification, and potentially reduce risk and enhance returns.
2. Attractive Income Potential - With interest rates at low levels, most investors cannot generate the income they require by investing in government bonds alone. Generally speaking, high yield bonds pay higher interest rates than investment-grade and government bonds to help compensate investors for the additional risks of investing in lower quality bonds. Over the life of a bond, those higher coupons provide a higher rate of return than higher quality (investment grade) bonds.
High yield bonds offer investors attractive income in the current environment, with an average yield of more than 600 basis points greater than the yield on government bonds.
3. Capital Growth Potential - In a recovering economy, companies who issue high yield bonds can see their debt rating upgraded due to improved cash flow, offering investors the potential for capital appreciation from the associated increase in the bond’s price. Historically, high yield bonds have tended to provide equity-like returns, but with much lower volatility – a characteristic that many investors are currently looking for.
4. Less Sensitivity to Interest Rates - High yield bonds tend to be less sensitive to interest rate fluctuations than most fixed income securities, primarily because they carry a higher coupon and have terms of 10 years or less. In addition, high yield bond prices react more to credit spreads and changes in credit quality than interest rates.
What’s the outlook for high yield bonds?
We believe conditions remain extremely favorable for high yield bonds. Weak demand, particularly from consumers is providing an environment of slow but positive economic growth, low interest rates and low inflation. Corporations, having cut costs and delevered balance sheets during the credit crisis, are showing strong profit growth but only marginal revenue growth. As a result, leverage across the corporate sector remains low, and cash has been building to record levels. Credit quality, as measured by balance sheet strength is at record levels and corporate default rates are headed towards new lows.
With yields on traditional income producing investments at record lows, investors are increasingly looking to high yield bonds to provide steady, sustainable cash flows. In addition, many investors have been unnerved by the extreme volatility of equities in recent years, with high yield bonds offering an attractive, less volatile alternative. As a result, flows into the sector from both institutional and retail investors continue to grow, putting downward pressure on spreads.
How are we incorporating them in our client’s portfolios? (A study)
All portfolios reflect the clients individual risk tolerances, goals and requirements, so we sit with each and build out a strategy on a case-by-case basis. However, from a macro view, parts of client’s portfolios that are focused around a 100% equity mandate have benefitted greatly from scaling back (say 25%) and reallocating to High Yield.
The chart below shows the 15 year return of the S&P 500 along with the 15 year return on the US High Yield Index. Interestingly, High Yield outperformed by over 8%, but with substantially less volatility during that period.
We believe conditions remain extremely favorable for high yield bonds. Weak demand, particularly from consumers is providing an environment of slow but positive economic growth, low interest rates and low inflation. Corporations, having cut costs and delevered balance sheets during the credit crisis, are showing strong profit growth but only marginal revenue growth. As a result, leverage across the corporate sector remains low, and cash has been building to record levels. Credit quality, as measured by balance sheet strength is at record levels and corporate default rates are headed towards new lows.
With yields on traditional income producing investments at record lows, investors are increasingly looking to high yield bonds to provide steady, sustainable cash flows. In addition, many investors have been unnerved by the extreme volatility of equities in recent years, with high yield bonds offering an attractive, less volatile alternative. As a result, flows into the sector from both institutional and retail investors continue to grow, putting downward pressure on spreads.
How are we incorporating them in our client’s portfolios? (A study)
All portfolios reflect the clients individual risk tolerances, goals and requirements, so we sit with each and build out a strategy on a case-by-case basis. However, from a macro view, parts of client’s portfolios that are focused around a 100% equity mandate have benefitted greatly from scaling back (say 25%) and reallocating to High Yield.
The chart below shows the 15 year return of the S&P 500 along with the 15 year return on the US High Yield Index. Interestingly, High Yield outperformed by over 8%, but with substantially less volatility during that period.
For clients scaling back to a 25% High Yield / 75% Equity portfolio - the average annual return bettered the 100% Equity portfolio by around 2.2%. ***And it did so at 25% less volatility.
How does one best invest in this asset class?
It is important to view High Yield Corporate Bonds in a similar risk category as equities. (I commonly refer to them as a “stock in bonds clothing”.) So, I do not look to include them in the Fixed Income portion of client’s portfolio profiles, but rather towards the overall equity portion.
There are a number of ways to participate in High Yield: directly buying the bonds from the issuer, buying the index through various ETFs, or buying units of a High Yield fund. All 3 are great ways, but are unique and dependant on the requirements of the client. **Questions such as Cost, Liquidity, Diversity (market and sector), and Manager Risk are all part of the decision process.
Here are some examples:
iShares IBOXX Hi Yield Index ETF (HYG)
Costs 0.5% MER
The 3 year return 9.36%
The 3 year index return was 10.41%
Small tracking error for this ETF
Current Yield: 8.17%
Marret High Yield Fund (MHY.UN)
Barry Allen – Fund Manager
Costs 1% MER
Average duration – 3 yrs.
Since inception (June 2009) return 10.51%
Current Yield: 7.34%
The High Yield market in Canada is quite small, with most new issue allocations going towards the institutional investor, so looking towards a managed or indexing approach would provide access to much broader markets for the individual investor.
As always, contact your investment advisor to see if this asset class is an appropriate fit in your current portfolio.
Best Regards and Safe Investing.
Eric.
How does one best invest in this asset class?
It is important to view High Yield Corporate Bonds in a similar risk category as equities. (I commonly refer to them as a “stock in bonds clothing”.) So, I do not look to include them in the Fixed Income portion of client’s portfolio profiles, but rather towards the overall equity portion.
There are a number of ways to participate in High Yield: directly buying the bonds from the issuer, buying the index through various ETFs, or buying units of a High Yield fund. All 3 are great ways, but are unique and dependant on the requirements of the client. **Questions such as Cost, Liquidity, Diversity (market and sector), and Manager Risk are all part of the decision process.
Here are some examples:
iShares IBOXX Hi Yield Index ETF (HYG)
Costs 0.5% MER
The 3 year return 9.36%
The 3 year index return was 10.41%
Small tracking error for this ETF
Current Yield: 8.17%
Marret High Yield Fund (MHY.UN)
Barry Allen – Fund Manager
Costs 1% MER
Average duration – 3 yrs.
Since inception (June 2009) return 10.51%
Current Yield: 7.34%
The High Yield market in Canada is quite small, with most new issue allocations going towards the institutional investor, so looking towards a managed or indexing approach would provide access to much broader markets for the individual investor.
As always, contact your investment advisor to see if this asset class is an appropriate fit in your current portfolio.
Best Regards and Safe Investing.
Eric.
Monday, November 7, 2011
Market Update.... Emphasis on the Pro's not the Con's
So here we are...
It's been entirely too long to go without an entry to my blog. Albeit, my weekly Market Watch newsletter has refocused my attention, it is now time to place some very serious thoughts into perspective.
I've lost all craving for houmous, grape leaves and spanikopita. Probably for ever...
Here's a summary of the expected Euro plan for Greece:
1. Greek bondholders will “voluntarily” write down the value of Greek debt by 50% which will help reduce Greece’s debt load from 150% of GDP down to 120% by 2020.
2. The European Financial Stability Fund (EFSF) will be expanded to 1 trillion euros from the current 440 billion euros through a combination of additional funding from the IMF and possibly a capital injection by China and/or other nations.
3. European banks will be recapitalized to offset the impact of the haircut on Greek bonds.
As encouraging as this European agreement is in principle, it is clearly just the first step in a multi-step program to resolve the European debt crisis.
Despite the significant stock market rally, equities remain the favoured asset class versus bonds. That said, we expect equity market volatility to continue and recommend profit taking to lock in recent short term gains. For buyers building longer term portfolio positions, we expect the market will provide yet another lower entry point so there is no rush to buy at current levels.
One of a few exceptions would be gold which has pulled back almost US$200/oz. since the highs reached in August. Both gold bullion and gold equities should perform well in the current environment.
Commodity cyclicals and industrial stocks offer the most upside potential in the event equities rally again, but they also will likely continue to exhibit the greatest volatility.
Many high quality dividend paying stocks at current levels do not offer much capital appreciation potential but will provide investors with the most downside protection if the market retreats, and the steady dividend income generated remains an important component in portfolio total returns.
Given our outlook for an extended period of slow economic growth, whether falling into outright recession in North America or not, equities are expected to trade in a range for the next several years. We are inclined to trim some profits on holdings that have performed well. In turn, emphasizing the need to be more tactical in the current environment, this capital could be selectively rotated into stable names that are more reasonably valued.
We place particular emphasis on the word "selectively" given the fragile situation in Europe and we continue to encourage a focus on larger-cap companies with sound balance sheets.
Stick to your knitting....
There are indications of a Bullish time for equities ahead.... Why?
1. Systematic/mechanical devaluation of the US$
*Global Commodites/Resources priced in USD.
*Forecasting of some substantial falls in commodity prices over the next few years.
*Which will lower Inflation pressures in global Markets.
(I.e. A $10 fall in the price of a barrel of oil would transfer an amount of income equivalent to around 0.5% of world GDP from producers to consumers.)
*Eventually drive resurgence of demand.
*Good for Canadian resource heavy economy which some argue could overheat and (as we've seen in the past) fail to diversify.
2. The death of Defined Benefit Pension Plans.
*Larger institutional money must be reallocated away from risk-free assets towards stronger blue-chip portfolios.
*Equities will benefit from this "refocus" by pension plans and other large institutional players.
It's been entirely too long to go without an entry to my blog. Albeit, my weekly Market Watch newsletter has refocused my attention, it is now time to place some very serious thoughts into perspective.
I've lost all craving for houmous, grape leaves and spanikopita. Probably for ever...
Here's a summary of the expected Euro plan for Greece:
1. Greek bondholders will “voluntarily” write down the value of Greek debt by 50% which will help reduce Greece’s debt load from 150% of GDP down to 120% by 2020.
2. The European Financial Stability Fund (EFSF) will be expanded to 1 trillion euros from the current 440 billion euros through a combination of additional funding from the IMF and possibly a capital injection by China and/or other nations.
3. European banks will be recapitalized to offset the impact of the haircut on Greek bonds.
As encouraging as this European agreement is in principle, it is clearly just the first step in a multi-step program to resolve the European debt crisis.
Despite the significant stock market rally, equities remain the favoured asset class versus bonds. That said, we expect equity market volatility to continue and recommend profit taking to lock in recent short term gains. For buyers building longer term portfolio positions, we expect the market will provide yet another lower entry point so there is no rush to buy at current levels.
One of a few exceptions would be gold which has pulled back almost US$200/oz. since the highs reached in August. Both gold bullion and gold equities should perform well in the current environment.
Commodity cyclicals and industrial stocks offer the most upside potential in the event equities rally again, but they also will likely continue to exhibit the greatest volatility.
Many high quality dividend paying stocks at current levels do not offer much capital appreciation potential but will provide investors with the most downside protection if the market retreats, and the steady dividend income generated remains an important component in portfolio total returns.
Given our outlook for an extended period of slow economic growth, whether falling into outright recession in North America or not, equities are expected to trade in a range for the next several years. We are inclined to trim some profits on holdings that have performed well. In turn, emphasizing the need to be more tactical in the current environment, this capital could be selectively rotated into stable names that are more reasonably valued.
We place particular emphasis on the word "selectively" given the fragile situation in Europe and we continue to encourage a focus on larger-cap companies with sound balance sheets.
Stick to your knitting....
There are indications of a Bullish time for equities ahead.... Why?
1. Systematic/mechanical devaluation of the US$
*Global Commodites/Resources priced in USD.
*Forecasting of some substantial falls in commodity prices over the next few years.
*Which will lower Inflation pressures in global Markets.
(I.e. A $10 fall in the price of a barrel of oil would transfer an amount of income equivalent to around 0.5% of world GDP from producers to consumers.)
*Eventually drive resurgence of demand.
*Good for Canadian resource heavy economy which some argue could overheat and (as we've seen in the past) fail to diversify.
2. The death of Defined Benefit Pension Plans.
*Larger institutional money must be reallocated away from risk-free assets towards stronger blue-chip portfolios.
*Equities will benefit from this "refocus" by pension plans and other large institutional players.
3. 100 Years of Expansion and Consolidation Trends.
*As per the chart at the top of this entry, there are very interesting themes that have taken place throughout history of the stockmarkets (in this case, the Dow Jones Industrial Average).
*After expansionary periods in the markets (which last on average 20 years), there are contractions/consolidations that last around 15 years.
*Roughly putting the next 20 year "up" period at a start date of around 2015... (Almost there)
The key of course will be to find ways to continue to navigate the turbulent waters ahead. It is paramount that we tailor our investment policies to reduce volatility and ensure a certain margin of safety is built in, should the macro-economic environment take a turn for the worse.
Best Regards and Safe Investing.
Thursday, September 15, 2011
How interesting... All out sector correlation (again)
The S&P 500 sector correlation is at its highest level since '89.With Global macro-economic factors continuing to drive equity markets, generating alpha (I.e. beating the market) is getting much harder. With the intensification of the Euro debt crisis and the U.S. credit rating downgrade, the correlation amongst S&P 500 sectors has increased rapidly. With sectors (and stocks) moving in lock-step, the average correlation among S&P 500 sectors has exploded, giong from 68% in eraly June to 90% currently, the highest level since at least 1989.
In comparison, the 22-year average sector correlation stands at 57%. The current sector correlation is surpassing the levels hit last summer (87%) and during the 2008/2009 crisis (89%), as illustrated in the chart above.
From a contrarian perspective, however, the last two peaks in sector correlations provided good entry points in the equity market.
Could ETF's be adding to this all out "unification"?
ETFs account for more than 30% of volume in U.S. stock markets, compared with just 2% in 2000. It may be reasonable to expect ETF trading to drive correlation higher because many of the vehicles are tied to stock indexes.
For example, the 10 different industry sectors of the S&P 500 show well over a 95% correlation over the last month, and a low of 72% in February 2011. High yield bond prices are at a 93% correlation to stocks, which is another multiyear record.
This is unusual for U.S. equity markets, which have tended towards lower correlations in rising markets and clustered returns when things get ugly.
It may not mean that we are necessarily in for tougher markets from these points, but it does make the decision about asset allocation more important than sector or stock selection. (At least for the time being)
Best Regards and Safe Investing.
E
Subscribe to:
Posts (Atom)