Apr 9, 2011
By James C. King
The global equity markets’ volatility experienced during this summer, while extensive, was driven more by emotions than fundamental investment principles. Our economy is still steadily growing. The recent earnings of most companies were very good if not robust. The valuations of many of the larger capitalized companies were in the lower quartile of their historic range. Additionally, for companies paying dividends, these dividend payouts were well covered by earnings and are at low payouts by historic standards. So, what is causing all of this extreme volatility?
Volume of shares traded on the NYSE rose precipitously in late July and August. Our research shows us that this is a result of ‘traders’ rather than ‘investors’. Since the 2008-09 equity market downturn, high frequency trading participants, that includes big banks and hedge funds, are causing higher volume and more volatility. The short term trading strategies employed at these firms provide no economic or investment benefit to the markets. We question why this type of trading is allowed. The regulators contend that this excessive trading adds liquidity to the markets, but we believe it continues due to the strong lobbying efforts by the participants motivated by the strong profitability this trading brings.
Another cause of the volatility is the expanding popularity of Exchange Traded Funds (ETFs); mutual funds that can be traded intraday. Today, ETFs account for 35% - 40% of the volume of the U.S. stock markets, compared to just 2% in 2000. Diversified ETF index funds can be easily invested long or sold short for hedge funds to quickly participate in upward or downward market momentum, and/or to moderate portfolio risk.
These concentrations of trading activity seem to be driven by emotionality rather than fundamental investment principles. As we shared with you last quarter, we believe the stock market by traditional standards is in the lower quintile of historical valuations. We continue to recommend owning high quality, large capitalized dividend paying companies for the long term and especially during this current period of instability.
By Paul J. Kronlokken, CAIA
It has always been our belief at Palisade that dividends are a highly important part of a stock’s investment return. There is a common mindset amongst many equity investors that dividend paying stocks ‘do not grow fast’, and are ‘boring’ or ‘unexciting’ to own. In the lower return environment that we have been experiencing, the power of dividends on a stock’s total return cannot be ignored.
There are plenty of stocks available that pay a solid dividend. Many of these stocks are household names, such as Procter and Gamble, Johnson & Johnson and Kellogg. In looking at the dividends of these larger capitalized U.S. stocks, our research shows that dividends have grown at a rate greater than three times the rate of inflation over the past five years. When you couple this growth with the modest capital appreciation that larger dividend stocks have returned, investors should be quite excited about their total return over this period.
It is important to note that we are not supporting all high dividend yielding stocks. We see the most important factor to be consistent dividend growth over time, not just high yield. When we then add the ‘high quality’ selection bias that we utilize at Palisade, we end up with stocks that have a much higher assurance of continuing to grow their dividends over time.
Of the current thirty stocks in Palisade’s High Quality Growth (HQG) Strategy that focuses on high quality dividend paying stocks, seventeen have been owned for the five year period of 12/31/05 to 12/31/10. Over this period, these seventeen stocks have grown their dividends at an average annual rate of 9.2%. In other words, the $1.00 annual dividend an investor received in 2005 would now be $1.55 annually. Unfortunately, we cannot say the same thing about the overall market as measured by the S&P 500, where dividend growth has been essentially flat (-0.1% annually) over this same five year period.
See Table 1 below for a comparison of the strength of the five year dividend growth of the HQG-17 stock portfolio and the current HQG-30 stock portfolio (looking back five years) vs. the S&P 500 index.
TABLE 1
Dividend growth stocks may not be the most exciting stocks to invest in, but over time using this strategy with these ‘unexciting’ stocks can achieve total returns that are anything but ‘boring’. See Tom Welch’s article on how this strategy can be even more valuable for trust beneficiaries looking for income growth.
By E. Thomas Welch, JD
As we have mentioned in past articles, Palisade has extensive experience with investing trust portfolios. In fact, we have a large number of accounts where individual or corporate trustees have selected us as the portfolio manager. Many of those trusts are what attorneys call “split interest” trusts, where the income from the trust is paid to one or more parties for their lifetime with the remainder going to a different party (remainder beneficiary(s)). With these split interest type trusts, the trustee and the investment manager have the challenge of producing a reasonable amount of income plus inflationary increases for the income beneficiary and at least retaining purchasing power for the remainder beneficiary.
With that challenge in mind, let’s review a hypothetical situation where the portfolio manager invested $1 million in thirty stocks at year end 2005 and held them for five years (see Table 2). In 2006, the income beneficiary would have received about $18,700 in dividends. In 2010, the beneficiary’s income would be about $33,100. This is a wonderful increase, about 76%; especially considering that inflation (CPI) was up around 11% during that same five year period. The income beneficiary will have nothing but hugs for the portfolio manager for increasing their income distribution by about $13,000 over inflation during that time period.
Many trustees have taken a simplistic investment approach and just buy the S&P 500 Index (through Index mutual funds or ETFs). As shown above, for the same 2006 to 2010 time period, when using the same hypothetical $1 million invested in the S&P 500 Index, the dividends paid stayed flat. Thus, the income beneficiary had no income growth and less purchasing power. Here, there would be no hugs for that trustee/portfolio manager.
Investing in high quality companies that hopefully grow their revenues and profits, maintain their strong balance sheets and grow their dividends, works well for the income beneficiary. In the thirty companies in Table 2 above, eighteen increased their dividends in each of the five years shown and twenty-four increased their dividends by 50% or more over the five year period.
The outcome of having a trust portfolio that consistently grows its dividend over time is a happy income beneficiary. But, what about the remainder beneficiary? Ah, that is an article for a future edition. Stay tuned!