Monday, October 26, 2020

Eleven Companies Rewarding Shareholders With Regular Dividend Increases

As part of my monitoring process, I review the list of dividend increases every week. This exercise helps me monitor the progress of existing holdings. It also helps me identify companies for further research. I use this process in conjunction with my screening process.

As part of this process, I look at the companies that raised dividends over the past week. I narrow my focus on companies with an established track record of annual dividend increases. I look for companies that have managed to increase for at least a decade.

I then review the company’s most recent dividend increase, and compare it to the ten year average for perspective.

I also look at the growth in earnings, along with estimated earnings for this year. It is helpful to gain an understanding if the company has been able to grow dividends due to growth in the business. If growth is achieved through expanding the payout ratio, I am generally not interested in such a company.

Last but not least, I review valuation. This includes P/E ratios, dividend yields, but also compare that with historical dividend growth and trends in earnings per share. As you can see, I have come to the conclusion that valuation is more art than science.

During the past week, there were several companeis that raised dividends. Each company has at least a ten year track record of annual dividend increases: The companies include:

Home Bancshares, Inc. (HOMB) operates as the bank holding company for Centennial Bank that provides commercial and retail banking, and related financial services to businesses, real estate developers and investors, individuals, and municipalities. 

The company increased its quarterly dividend by 7.70% to 14 cents/share. This marked the tenth consecutive annual dividend increase for this newly minted dividend achiever. During the past decade, it has managed to grow distributions at an annualized rate of 25%.

The company raised earnings from $/share in 2009 to $/share in 2019. Home Bancshares is expected to earn $1.18/share in 2020.

The company sells for 15 times forward earnings and yields 3.16%.

Middlesex Water Company (MSEX) owns and operates regulated water utility and wastewater systems. It operates in two segments, Regulated and Non-Regulated.

The company increased its quarterly dividend by 6.30% to 27.30 cents/share. This marked the 47th consecutive annual dividend increase for this dividend champion. Over the past decade, the company has managed to grow distributions at an annualized rate of 3.20%.

Between 2009 and 2019, the company was able to grow earnings from 72 cents/share to $2.01/share.Middlesex Water is expected to earn $2.12/share in 2020.

The company sells for 32.90 times forward earnings and yieods 1.56%.

Standex International Corporation (SXI), together with subsidiaries, manufactures and sells various products and services for commercial and industrial markets in the United States and internationally. The company operates through five segments: Electronics, Engraving, Scientific, Engineering Technologies, and Specialty Solutions. The company hiked its quarterly dividend by 9.10% to 24 cents/share, marking its tenth consecutive annual dividend increase. During the past decade, it has managed to grow distributions at an annualized rate of 8.60%.

Standex is expected to earn $3.65/share in 2020.

The company sells for 17.80 times forward earnings and yields 1.50%

American Electric Power Company, Inc. (AEP) is an electric public utility holding company that engages in the generation, transmission, and distribution of electricity for sale to retail and wholesale customers in the United States. It operates through Vertically Integrated Utilities, Transmission and Distribution Utilities, AEP Transmission Holdco, and Generation & Marketing segments.

American Electric Power raised its quarterly dividend by 5.70% to 74 cents/share. This marked the 11th consecutive annual dividend increase for this dividend achiever. During the past decade, the company has managed to grow its dividends at  an annualized rate of 5.15%.

Between 2009 to 2019, the company’s earnings went from $2.96/share to $3.88/share.

American Electric Power is expected to earn $4.32/share in 2020.

The company sells for 21.30 times forward earnings and yields 3.20%

Hubbell Incorporated (HUBB) designs, manufactures, and sells electrical and electronic products in the United States and internationally. The company operates through two segments, Electrical and Power.

The company increased its quarterly dividend by 7.70% to 98 cents/share. This marked the 13th consecutive annual dividend icnrease for this dividend achiever. Over the past decade Hubbell has managed to grow dividends at an annualized rate of 9.40%/year.

Between 2009 and 2019 the company managed to grow earnings from $3.15/share to $7.31/share. Hubbell is expected to earn $7.22/share in 2020.

The company sells for 21.25 times forward earnings and yields 2.56%

The Gorman-Rupp Company (GRC) designs, manufactures, and sells pumps and pump systems worldwide. 

The company increased its quarterly dividend by 10.70% to 15.50 cents/share. This marked the 48th consecutive annual dividend icnrease for this dividend champion. Over the past decade Gorman-Rupp has managed to grow dividends at an annualized rate of 7.80%/year.

The company grew earnings from 70 cents/share in 2009 to $1.37/share in 2019. Gorman-Rupp is expected to earn $1.10/share in 2020.

The company sells for 31 times forward earnings and yields 1.80%

Avery Dennison Corporation (AVY) produces and sells pressure-sensitive materials worldwide. The company raised its quarterly dividend by 6.90% to 62 cents/share. This marked the 10th consecutive annual dividend increase for this dividend achiever. Over the past decade, the company has been able to raise dividends by 6.35%/year.

In 2008, the company earned $2.70/share. It managed to grow earnings to $3.57/share by 2019. Avery Dennison is expected to earn $6.06/share in 2020.

The company sells for 23.40 times forward earnings and yields 1.75%

Stepan Company (SCL) produces and sells specialty and intermediate chemicals to other manufacturers for use in various end products in North America, Europe, Latin America, and Asia. The company operates through three segments: Surfactants, Polymers, and Specialty Products. 

Stepan raised its quarterly dividend by 10.90% to 30.50 cents/share. This marked the 53rd consecutive year of annual dividend increases for this dividend king. During the past decade, the company has managed to boost dividends at an annualized dividend growth of 8.60%.

Between 2009 and 2019, Stepan managed to grow earnings from $2.92/share to $4.42/share. Stepan is expected to earn $5.21/share in 2020.

The company sells for 22.70 times forward earnings and yields 1.03%

Lincoln Electric Holdings, Inc. (LECO), designs, develops, manufactures, and sells welding, cutting, and brazing products worldwide. It operates through three segments: Americas Welding, International Welding, and The Harris Products Group.

The company increased its quarterly dividend by 4.10% to 51 cents/share. This marked the 26th consecutive annual dividend icnrease for this dividend champion. Over the past decade Lincoln Electric has managed to grow dividends at an annualized rate of 13.30%/year.

The company earned $2.46/share in 2008, right before the Global Financial Crisis. While it has had some dips in earnings per share in 2009 and in 2014 – 2016, its earnings per share grew to $4.68/share in 2019. Lincoln Electric is expected to earn $3.58/share in 2020.

The company sells for 29.50 times forward earnings and yields 1.93%

Whirlpool Corporation (WHR) manufactures and markets home appliances and related products. It operates through four segments: North America; Europe, Middle East and Africa; Latin America; and Asia.

The company raised its quarterly dividend by 4.20% to  $1.25/share. This marked the 10th consecutive annual dividend increase for this newly minted dividend achiever. Over the past decade, the company has been able to raise dividends by 10.70%/year.

Between 2009 and 2019, the company managed to increase earnings from $4.34/share to $18.45/share.

Whirlpool is expected to earn $13.02/share in 2020. The company sells for 15.20 times forward earnings and yields 2.50%

Tompkins Financial Corporation (TMP), a community-based financial services company, provides commercial and consumer banking, leasing, trust and investment management, financial planning and wealth management, and insurance services. The company operates in three segments: Banking, Insurance, and Wealth Management.

The company increased its quarterly dividend by 3.85% to 54 cents/share. This marked the 34th consecutive annual dividend icnrease for this dividend champion. Over the past decade Tompkins Financial has managed to grow dividends at an annualized rate of 5%/year.

Between 2009 and 2019, Tompkins Financial grew earnings from $2.96/share to $5.37/share. Tompkins Financial is expected to earn $4.49/share in 2020.

The company sells for 13 times forward earnings and yields 3.70%

Relevant Articles:

How to value dividend stocks

Four Dividend Increases From Last Week

Price, Value and Sources of Returns

Dividend Growth Investing Principles

Friday, October 23, 2020

Price, Value and Sources of Returns

 As an investor, I follow a very simple model.

I look for companies that have a track record of annual dividend increases, supported by earnings growth. I try to buy enough of these companies in order to build a diversified portfolio.

Naturally, everyone discusses the fact that they do not want to overpay for companies. Obviously you want to buy at a discount.

The problem with this statement is that it assumes a static environment. 

We live in a dynamic environment. 

If I see a company that sells at a P/E of 20, it may look optically more expensive than a company that sells at a P/E of 10.

However, we cannot just look at P/E in isolation. Not all P/E ratios are created equal.

We need to look at the stability of the earnings and cash flows for each company. A cyclical company should in general have a lower P/E ratio, because its earnings streams are not defensible and they follow the rise and fall in the economy. A more defensive company such as a tobacco or spirits manufacturer whose earnings are more immune to the short-term ups and downs of the economic cycle would be more resiliant, and therefore pricier. The market participants are willing to pay a premium (usually) for things that are easier to forecast due to the repetitive nature and stability and intanglibles such as brands. 

We also need to look into the growth prospects for the company. A company with a P/E of 10, that doesn’t grow earnings is more expensive for a long-term investor than a company with a P/E of 25 that manages to double earnings every decade.

To paraphrase Warren Buffett: Price is what you pay, value is what you get

I also follow a simple model for when it comes to estimating future returns.

Future returns are a function of:

1) Initial dividend yield

2) Growth in earnings per share

3) Dividend Reinvestment

4) Changes in valuation

The first three items are part of the fundamentals return. The fundamental return – earnings, dividends, reinvested earnings and dividends, basically remind me that by buying a stock I am not just buying a lottery ticket, but a piece of an actual business.

That business sells products and services to customers, and hopefully it grows. Management hopefully works carefully at capital allocation too, in order to benefit shareholders. As I discussed earlier, management should invest earnings back into the business, but only if they expect those to generate a certain return on investment. If they cannot put that money back into the business and generate a high rate of return on it, they need to send it back to shareholders in the form of dividends. There is a natural limit to how much money a business can reinvest at a high rate of return and how quickly it can deploy that money as well in an intelligent manner. Just stocking up the balance sheet with cash may not be the most optimal decision. Excess cash can goad chief executives into making impulsive acquisitions at high prices, splurging on palatial headquarters or overfunding underwhelming projects. In fact, academic research shows that companies with the highest levels of cash go on to become less profitable in the long term; one recent study found that high-cash firms earn future profit margins 1.5 percentage points lower than those that carry the least cash. Source

Charlie Munger has stated that “Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return even if you originally buy it at a huge discount.  Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result.”

Terry Smith from Fundsmith states that Munger’s idea is a mathematical certainty. 

It is difficult to forecast returns or management ability to reinvest capital at high rates of return. Hence, it is important to look at predictable businesses that can deploy earnings back at a high rate of return. Not every company can do that, as there are limits to everything due to competition, nature of the industry, time etc. 

But perhaps this is what Buffett was refering to with this quote “ It's far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.’ 

It is good to buy a company that can grow earnings over time, since that grows dividends and intrinsic value. This is a good type of company to be in if you are a long-term investor. Otherwise, you would be stuck buying cheap stocks at a low P/E, that you have to sell when they get to a fair price. Only to repeat this process again and again.

Sadly, in this day and age, a lot of investors tend to view shares in terms of speculative returns.  

Let’s illustrate everything with an example. I will use the company Church & Dwight (CHD)

Back in 2009, the company sold at $15.11/share. It earned 85 cents/share, and had a forward annual dividend of 14 cents/share. Church & Dwight yielded 0.93% and sold for a P/E of 17.78.

Fast forward a decade, and the stock sold at $70.35/share, and earned $2.44/share. The annualized dividend rose to $0.91/share, and the dividend yield was 1.29%. The P/E ratio had expanded to 28.83.

If you had bought 1 share of Church & Dwight at the end of 2009, you would have paid $15.11 for it. If you had reinvested those dividends along the way, you ended up with 1.165038 shares by the end of 2019. At a share price of $70.35/share, the total investment value went to $81.96. Not a bad return for a decade.

You can see the breakdown of sourced of return.

Intrinsic value resulted in a $28.26 increase in value, while changes in valuation resulted in a $26.98 increase in value. The rest is attributed to dividend reinvestment. I believe that changes in valuation are part of the speculative return, so I would not expect that to be a key source of investor returns going forward. As an investor I would focus more on the fundamental returns, mostly growth in earnings per share and dividends. Over time, I would expect that valuations revert to the mean.

Between 2010 and 2019, the company earned $17.04/share in earnings in total. It distributed $6.03/share in dividends. This means that the company retained $11.01/share to reinvest in the business.

According to Morningstar, the company has been able to achieve a return on invested capital of roughly 13% - 14%, which is pretty impressive. I do not want to venture any further into calculating more numbers however. At first look, it may seem that retaining $11.01/share resulted in increase in earnings from 85 cents to $2.44 and intrinsic value by $28.26. However, it may be hard to break down what percentage of growth was derived from past capital investments versus the investments from 2009 - 2019. Some long-term investments may not bear fruit for many years; others may have been misallocated.

Right now, Church & Dwight is expected to earn $2.82/share in 2020. The stock sells at $90.99/share for a forward P/E of 32.21. At the annual dividend rate of 96 cents/share, the dividend yield is at 1.05%. If earnings and dividends grow by 7%/year over the next decade, then they will double by 2030. The basic return would be at least 8%/year ( 1% from dividend yields and 7% from earnings and dividend growth). There are various scenarios going on of course, one where P/E ratios remain elevated and another where they shrink. The speculative return is hard to estimate, which is why I doubt it matters too much, unless you plan to invest for less than 5 years. If Church & Dwight doubles earnings in a decade, but the P/E ratio shrinks, the share price may not deliver much in terms of returns. This has happened before and won't surprise me from happening again in the future. 

Under this scenario, the stock would still sell around $90/share, but would be earning $5.60/share and have a P/E of 16. The stock would be paying a dividend of $1.92/share and yield 2.10%. If you hold for several decades, and the business is durable enough to continue compounding wealth and income, that valuation shrinkage won't matter. This is why Buffett states that you want to invest in quality businesses, and let the power of compounding do the heavy lifting for you.

I do want to emphasize focus on quality companies that have a strong brand, strong moat, repetitive purchases, strong competitive positions, which can also grow profits over time. We want a durable and predictable business model, with a slower pace of industry change.

Today, we learned a few important lessons.

We learned that when valuing companies, we need not look at P/E ratio in isolation. We need to take into consideration growth and stability of the earnings

We learned the factors that drive future investment returns, notably initial dividend yield, earnings growth and changes in valuations. We need to focus on fundamental return, because the speculative return based on changes in valuations cannot be relied upon, as it reverts to the mean.

If management is able to reinvest earnings at a high rate of return in the business, they should do so. But for excess cashflows, they should distribute it to shareholders. For most of the dividend growth stocks we have covered extensively over the past decade and a half, managements have managed to balance the long-term needs of the business and its earnings growth with the ability to distribute a growing stream of dividends. But those rising earnings and rising dividends, reinvested over time, really turbocharge returns for investors.

The really important lesson is to focus on quality, even if it looks optically more expensive. If you are a long-term investor, a quality company is more likely to deliver solid returns over time than a statistically cheap, but poor one.

Relevant Articles:

What drives future investment returns?

Not all P/E ratios are created equal

Evaluating Dividend Growth Stocks – The Missing Ingredient

Monday, October 19, 2020

Four Dividend Increases From Last Week

I review the list of dividend increases as part of my monitoring process. I find it helpful to observe the companies I own execute on their business plans, and watch them allocate money, and gauge their business sentiment through watching their dividend actions. 

The mental model I focus on looks for established companies that grow earnings, and generate more cashflows than they know what to do with. While some companies in the initial growth phases need all capital to grow the business, for most corporations in the US, there is excess cashflow left at the end of the year. There is also a limit as to how long you can profitably reinvest all cashflows too.

As a general rule, I prefer excess cashflows to be distributed to shareholders, in order to reduce the amount of wasteful acquisitions, spending on projects with low returns on investment, or just stocking up cash for no reason, which executives could waste on new headquarters, corporate jets etc.

I look for companies that grow earnings over time, which also manage to grow that excess cashflows and thus manage grow dividends for a certain number of years. Growing earnings, growing dividends and growing intrinsic values over time go hand in hand.

During the past week, there were four companies that raised dividends to shareholders. Every single one of those companies have managed to increase dividends for at least ten consecutive years. The companies include:

V.F. Corporation (VFC) engages in the design, production, procurement, marketing, and distribution of branded lifestyle apparel, footwear, and related products for men, women, and children in the Americas, Europe, and the Asia-Pacific. It operates through four segments: Outdoor, Active, and Work.

The company raised its quarterly dividend by 2.10% to 49 cents/share. This marked the 48th consecutive year of dividend increases for this dividend aristocrat.  V.F. Corp has managed to grow distributions at an annualized rate of 13% over the past decade.

Earnings per share went from $1.29/share in 2010 to $1.70/share in 2019. This is down from 2018’s earnings per share of $3.15.

The company is expected to generate $1.12/share in 2021 and $2.58/share in 2022.

Due to weakness in earnings this year, the company is selling at 67.70 times forward earnings. Even if earnigns were to normalize in 2022 however, V.F. Corp still seems expensive at close to 30 times forward earnings. The stock yields 2.60%, which does not seem well covered this year. It is a little better covered based on FY 2022 earnings. At this time I view the stock as a hold, but I would not be interested to add more.

Cummins Inc. (CMI) designs, manufactures, distributes, and services diesel and natural gas engines, products worldwide. It operates through five segments: Engine, Distribution, Components, Power Systems, and New Power.

The company raised its quarterly dividend by 3% to $1.35/share. This marked the 15th consecutive annual dividend increase for this dividend achiever. Over the past decade, it has managed to grow distributions at an annualized rate of 21.50%.

Earnings per share increased from $5.28/share in 2010 to $14.48/share in 2019.

The company is expected to earn $9.72/share in 2020 and $11.99/share in 2021.

The stock is selling at 22.90 times forward earnings and yields 2.40%. I think it is a little pricey, and believe it may be a better value on dips.

A. O. Smith Corporation (AOS) manufactures and markets residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products in North America, China, Europe, and India. It operates through two segments, North America and Rest of World.

The company raised its quarterly dividend by 8.30% to 26 cents/share.

This is the 27th consecutive annual dividend increase for this dividend aristocrat. During the past decade, A.O. Smith has managed to grow distributions at an annualized rate of 21.50%/year.

Earnings per share increased from 60 cents/share in 2010 to $2.22/share in 2019.

The company is expected to generate $1.87/share in 2020 and $2.29/share in 2021.

A.O. Smith is a little pricey at 29.60 times forward earnings. The stock yields 1.90%. It may be a better value on dips, provided that its short-term issues are finally resolved. The company is unlikely to exceed 2018’s earnings per share of $2.58 soon. That may be an opportunity if it does return to the path of profitable growth. It may be too expensive if earnings per share flatline.

Williams-Sonoma, Inc. (WSM) operates as an omni-channel specialty retailer of various products for home.

The company raised its quarterly dividend by 10.40% to 53 cents/share. This marked the 15th year of consecutive annual dividend increases for this dividend achiever. During the past decade, this company has managed to grow distributions at an annualized rate of 14.60%.

Earnings per share increased from $1.83/share in 2011 to $4.49/share in 2020.

The company is expected to generate $6.25/share in 2021 and  $6.04/share in 2022.

Williams-Sonoma is priced fairly at 16.80 times forward earnings and yields 2%.

Relevant Articles:

Dividend Growth Investing Principles

What is Dividend Growth Investing?

Rising Earnings – The Source of Future Dividend Growth

Friday, October 16, 2020

Cboe (CBOE) Dividend Stock Analysis

Cboe Global Markets, Inc. (CBOE) operates as an options exchange in the United States. It operates in five segments: Options, U.S. Equities, Futures, European Equities, and Global FX.

The company has managed to increase dividends for ten years in a row, which makes it a newly minted dividend contender.

The last dividend increase was in August 2020, when it hiked the quarterly dividend by 16.70% to 42 cents/share.

“This year marked the 10th anniversary of our IPO and each year since, we’ve raised our dividend, demonstrating Cboe Global Markets’ ongoing commitment to returning capital to our shareholders,” said Ed Tilly, Chairman, President and Chief Executive Officer, Cboe Global Markets. “The increase in our dividend reflects Cboe’s financial strength and cash flow generating capabilities, while we execute on our growth initiatives and deliver sustainable returns to our shareholders.”

Since initiating a quarterly dividend in 2010 at 10 cents/share, the company has managed to quadruple its quarterly distribution to 42 cents/share.

Between 2010 and 2019, CBOE grew earnings from $1.03/share to $3.34/share. The company is expected to generate $5.16/share in 2020.

CBOEs key growth initiatives are the following:
- Expand product lines across asset classes
- Broaden geographic reach
- Diversify business mix with non transactional revenues
- Leverage leading proprietary trading technology
- Build upon core proprietary products

The company operates the largest options exchange in the US, where we have equity and index options being traded. A large portion of revenues is derived by trading fees. With the proliferation of online trading, exchanges such as CBOE should benefit form all this speculation. The company has a dominant position in options. It is the second largest exchange for equities trading in the US after Nasdaq, but ahead of NYSE.

Some popular products include its options products on S&P 500 options, which are under license from S&P until 2030. Other products include VIX options and VIX Futures, which are widely followed as well. The implosion of several VIX funds in early 2018 was a negative for CBOE however. Both S&P 500 options and VIX futures can be a positive for CBOE when there is increased market volatility and when investors want to hedge their market exposure.

Focusing on costs, and driving efficiencies across its business can results in higher profits over time and a better customer experience.  Investing in the trading platforms through technological advances will definitely be a plus.

New products and bolt on acquisitions can further be accretive to its offerings to clients, and further strengthen the moat. Acquisitions could be accretive due to synergies realized. CBOE realized synergies from its acquisition of BATS from a couple of years ago for example, which boosted revenues and increased profits.

The acquisition of BATS also diversified the revenue mix from 81%/19% in options/futures to options (51%), futures (11%), US Equities (27%), European Equities (7%) and Global FX ( 5%). This merger also reduced the transactional fees as a percentage of revenues from 68% to 57%.

The dividend payout ratio increased from 19% in 2010 to 40% in 2019. A large part of the increase in the payout ratio was the initiation of the dividend later in the year in 2010. 

It is possible for this phenomenon to continue in the 2020s as well, but sooner or later dividend growth and earnings growth would converge. If management takes the payout ratio too far, it is very likely that the next step would be dividend growth going slower than earnings. But I am getting ahead of myself here.

The number of shares outstanding have increased over the past decade. Between 2010 and 2016, the number of shares went down from 96 million to 81 million. After the acquisition of BATS however, the number of shares outstanding increased to 111 – 112 million.

Currently, the stock is attractively valued at 16.30 times forward earnings. It offers a dividend yield of 2%.

Relevant Articles:

Thursday, October 15, 2020

Peter Lynch Portfolio Holdings at the Fidelity Magellan Fund

Peter Lynch is a super-investor, who managed to compound money at 29.30% at Fidelity Magellan Fund between 1977 and 1990. He is a very smart investor, who has managed to mentor other fund managers at Fidelity. He has mentored a generation of investors through his books. I have learned a ton from his books "One Up on Wall Street" and "Beating the Street".

Peter Lynch seemed to have a fascination with the list of Dividend Achievers, which I discussed previously.

I have studied Peter Lynch, and tried to find out as much as possible about his investing style, in order to improve my own investing. In the process, I was able to uncover his long-lost articles from Worth magazine in the 1990s.

I have tried looking for historical reports from the Fidelity Magellan Fund, which would include his current commentary. 

I have been unsuccessful in this endeavor. However, I did uncover a list of his stock portfolio at Fidelity Magellan between 1984 and 1989 by going through my Mergen's Database ( it was Moody's at the time).

You can see the portfolio holdings for Fidelity Magellan Fund by clicking on each year. The quality of the copy is not very good in the early years, but it is still legible. 

Clicking on each resource opens a PDF. You may have to adjust and zoom to the maximum settings in order to view.

Fidelity Magellan Fund Portfolio Holdings for 1989

Fidelity Magellan Fund Portfolio Holdings for 1988

Fidelity Magellan Fund Portfolio Holdings for 1987

Fidelity Magellan Fund Portfolio Holdings for 1986

Fidelity Magellan Fund Portfolio Holdings for 1985

Fidelity Magellan Fund Portfolio Holdings for 1984

Thank you for reading!

Relevant Articles:

- Peter Lynch on Dividend Growth Investing
Peter Lynch Articles For Worth Magazine
Buffett Partnership Letters
These Books Shaped My Investing Strategy
Dividend Achievers Offer Income Growth and Capital Appreciation

Tuesday, October 13, 2020

Time in the market beats timing the market

"The idea that a bell rings to signal when investors should get into or out of the market is simply not credible. After nearly 50 years in this business, I do not know of anybody who has done it successfully and consistently."  Jack Bogle

We all know that timing the market is so difficult to make it worthwhile, that it is essentially not worth doing. A lot of brainpower goes into market timing, but it always comes back with worse results over a long period of time.

I wanted to illustrate the futility of timing the markets by a simple calculation I made.

I assumed that there were three separate investors, each of them starting in January 1980. Every investor has $100 to invest every month. They keep investing $100 per month from January 1980 to September 2020.

The first investor is great at timing, and always buys at the bottom of the month. This means that this investor is able to correctly predict the lows for the month for 40 years.

The second investor is unlucky at timing, and always ends up buying at the highest price for the month. This investor is so unlucky, that he always buys at the worst time of the month.

The third investor simply puts $100 to work at the end of each month, like clockwork.

So how do they do in the end?

The first investor ends up with 648,103.85

The unlucky investor ends up with 611,372.16

The investor who just buys regularly every month, ends up with 628,047.32. I think that this is the most realistic scenario.

The chart below shows no visible difference between the three investors.

I have crunched the numbers before for Johnson & Johnson, and I have come up with a similar conclusion. While you may be able to get an edge in a perfect situation, it is not large enough to warrant trying to time the markets, especially given the high failure rates. Therefore, it is best to identify a process, and stick to it on a repeatable basis. If you manage to buy regularly, on a predictable schedule, you will do better than most investors due to discipline and good behavior.

Monday, October 12, 2020

Three Dividend Growth Stocks In the News

I review the list of dividend increases as part of my monitoring process. This helps me review the story behind companies I already own. It also helps me review companies for potential inclusion into my watchlist.

A long track record of annual dividend increases is an indication of a quality company with a strong business model. Its strength could be due to a favorable environment, competitive position, unique product, patent or trademark, a strong brand, a loyal group of customers or a combination of the above. 

I find it helpful to identify these businesses and place them on my list for further research.

During the past week, there were three companies with long histories of annual dividend increases, which also hiked distributions to shareholders.

The companies include:

Northwest Natural Holding Company (NWN) provides regulated natural gas distribution services to residential, commercial, industrial, and transportation customers in Oregon and Southwest Washington.

The utility raised its quarterly dividend by 0.50% to 48 cents/share. This marked the 65th consecutive annual dividend increase for this dividend king. Over the past decade, it has managed to increase the dividend at an annualized rate of 1.75%. 

Earnings peaked at $2.83/share in 2009, and gradually declined to $2.07/share in 2019. The company is expected to generate $2.27/share in 2020. 

Currently, the stock is fairly valued at 20.70 times forward earnings and yields 4.10%. Given the lack of earnings growth, and the high payout ratio, 

RPM International Inc. (RPM) manufactures and sells specialty chemicals for the industrial, specialty, and consumer markets worldwide. 

The company raised its quarterly dividend by 5.60% to 38 cents/share. This marked the 47th consecutive annual dividend increase for this dividend aristocrat

“One of the primary ways we continuously reward our shareholders is by annually increasing our cash dividend,” stated Frank C. Sullivan, RPM chairman and CEO. “Increasing the dividend, combined with an appreciating stock price, is key to our ability to consistently deliver long-term value and outperform the cumulative total return of the broader market.”

Over the past decade, RPM International has managed to grow dividends at an annualized rate of 5.80%. 

Between 2009 and 2019, RPM International grew earnings from $1.39/share to $2.34/share.

RPM International is expected to generate $3.93/share.

Currently, the stock is selling for 22.20 times forward earnings and yields 1.75%. RPM International is close to being fairly valued today.

McDonald's Corporation (MCD) operates and franchises McDonald's restaurants in the United States and internationally.

The company increased its quarterly dividend by 3.20% to $1.29/share. This marked the 44th year of consecutive annual dividend increases for this dividend aristocrat.

"Today's dividend increase reflects our strong financial position and represents continued confidence in our ability to drive profitable growth and long-term shareholder value while still investing in our people and the business."

During the past decade, McDonald's has managed to increase dividends at an annualized rate of 8.70%. 

Between 2009 and 2019, McDonald’s was able to grow earnings from $4.11/share to $7.88/share,

McDonald’s is expected to generate $5.88/share in 2020.

Right now the stock is selling for 38.24 times forward earnings and yields 2.30%. I find the stock to be pricey at the moment. I would love to be able to buy McDonald's at a lower price from here.

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Friday, October 9, 2020

Morgan Stanley (MS) to acquire Eaton Vance (EV)

Morgan Stanley (MS) announced that they are planning to acquire Eaton Vance (EV) at a premium to the closing price on Wednesday. Eaton Vance shares went up over 48% on Thursday. I am pretty sure this is close to the all-time-highs for Eaton Vance that were reached in early 2018.

Shareholders of Eaton Vance will receive $28.25/share in cash and 0.5833 shares of Morgan Stanely for every share of Eaton Vance that they own. The deal is expected to close by the second quarter of 2021. Before the deal closes, Eaton Vance shareholders are expected to receive a one-time special dividend payment in the amount of $4.25/share. 

Eaton Vance closed at $60.65/share. Morgan Stanley closed at $49/share. This means that at current prices, Eaton Vance shareholders will receive a special dividend of $4.25/share, cash in the amount of $28.25/share and 0.5833 shares of Morgan Stanley worth $/28.58/share. This comes out to a total of $61.08/share. There may be a few regular dividends in between today and the closing of the deal. At the current rate of 37.50 cents/share, that could be 75 cents if you get two payments.

I have a position in Eaton Vance, both for my personal account and for the premium newsletter I write.

While many folks focus on dividend cuts as risks, acquisitions are another risk to be aware of in a long-term portfolio. They may be as likely as cuts over the long term for a diversified portfolio consisting of quality companies. The risk with acquisitions is that while you get a big premium to get the shares taken from you, you may also be robbed of any future potential that the business would have generated on its own. 

Each Eaton Vance share generates $1.50 in annual dividends. Eaton Vance is a dividend champion with a 39 year history of annual dividend increases. Check my last analysis of Eaton Vance (EV) for more information about the company.

As part of my approach, I have learned to be as passive as possible when it comes to investments. This means that when I buy a stock, I will hold it for as long as the dividend is at least maintained. I sell after a dividend cut or suspension. If a stock is acquired for cash, I have to sell. 

In the case of Eaton Vance, I will not make any elections of whether I want stock or cash, I will go with the default election. 

Let's walk through a situation where I do nothing.

This means that I would likely shares of Morgan Stanley (MS) and some caash when the acquisition closes around the end of first half of 2021. I am not sure if I would receive fractional shares in Morgan Stanley as a result of the acquisition - It is possible that they would be paid in cash instead.  I am going to wait and see if Eaton Vance continues paying the regular dividends until the deal closes.

I would continue reinvesting Eaton Vance dividends received in the meantime however. This includes the regular dividend and the special dividend. Many brokers would not reinvest the cash amount received, so that would likely be invested in the best investments in 2021. Let's hope we are all well, and able to participate. It is also likely that at that time, my broker TD Ameritrade may have migrated my brokerage account to Schwab.

Morgan Stanley (MS) is a financial holding company which provides various financial products and services to corporations, governments, financial institutions, and individuals in the Americas, Europe, the Middle East, Africa, and Asia. It has been on an acquisition spree recently, acquiring ETrade, and now wanting to acquire Eaton Vance. Morgan Stanley is trying to get into more fee based assets, in order to better compete in todays financial markets. It pays an annual dividend of $1.40/share. It has increased dividends for 7 years in a row - it cut dividends in 2009 during the Global Financial Crisis.

Morgan Stanley yields 2.85%, while Eaton Vance yields 2.50%. This deal may actually increase the dividend income from the remaining shares of Eaton Vance. 

The problem with doing nothing however is that this action would increase my fees, when the deal closes some time in 2021. That's because TD Ameritrade has a $38 reorganization fee. Other brokers like Etrade have the same fee, while others like Sogotrade may have a $50 fee. I am pretty confident that this fee would be charged when the deal is completed, and the shares of Eaton Vance are cancelled, and replaced with cash and shares of Morgan Stanley in my account. That's a pretty steep fee for a position. If I was using another broker that didn't charge this fee, I would have likely done nothing. Hence, it is good to check for any hideen fees from your brokerage house. I have been charged this fee by Etrade, when Shire was acquired by Takeda a few years ago. Since commissions are zero today, the best course of action would be to sell. When you keep investment costs low, this leaves more money working for you as an investor.

I just have to decide how I am going to replace the dollars/shares of Eaton Vance. I do have over half an year to decide of course. In the meantime, it is possible that a bidding war could emerge for Eaton Vance, which may increase the price even higher. It is also possible that we get increased volatility in the stock market, and Morgan Stanely is unable to complete this acquisition for one reason or another. If I sell today, I would have a long-term capital gain.

This is perhaps why it is best to invest through a retirement account such as a Roth IRA account for example, in order to minimize the tax drag on dividends and capital gains. Since I may not be eligible to contribute in a Roth IRA every single year until I reach this portfolio objectives, I am using a tax account. If I keep my personal income low through legal means, I may not have to pay taxes on the proceeds and dividends however. Personal tax situations are personal, hence I seldom discuss them here.

So today, I am not going to do anything. I would have personally done nothing, until the deal closes. 

Sadly, my broker would charge me $38 when the deal closes, which is too much in my opinion. If this position was in the hundreds or thousands of shares, it would have made sense. If there was no reorganization fee, I would have not done anything. As it is not, I would very likely sell the stock at some point between tomorrow and June 2021. I would keep reinvesting Eaton Vance dividends however in the meantime. If they stop paying the regular dividend, I would sell the stock pretty much right away. 

Historically, Eaton Vance raises dividends every October, so I was expecting an action by early next week. Let's sit back and see what happens.

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Thursday, October 8, 2020

Dividend Growth Investing Principles

We have had some new readers join the Dividend Growth Investor website. As a result, I wanted to discuss briefly what Dividend Growth Investing is all about.

The basic premise of dividend growth investing is that companies that grow earnings can grow dividends over time, and can see increases in intrinsic values over time. Add in the power of reinvested dividends, and you have a decent picture of what to expect.

When you are paid a rising dividend to hold onto a stock, you can afford to be patient. You can sit out any temporary weakness, or situations where the valuation is stretched out for a while. 

This is quite obvious when you review long-term charts of dividend kings such as Johnson & Johnson (JNJ) and Procter & Gamble (PG).

You can see that in the case of Procter & Gamble, the company has generally managed to grow earnings per share for decades, since 1970.

Procter & Gamble has been able to grow its dividend for 64 years in a row. The last 50 of those years are visible in the chart above. That dividend growth was possible only because the company has a solid line-up from products, which face demand that is somewhat immune from recessions. In addition, the company has a durable moat, stable cash flows and had a lot of factors going for it. It had a long runway ahead of it, and a line-up of products that were not going to be made obsolete by technology. They were going to be aided by technology.

You can see however, that there were times when the share price went nowhere for extended periods of time. That was despite the fact that earnings per share and dividends per share grew during those times.  A few notable examples to focus on include 1972 - 1985 and 2000 - 2012. The reason for these periods is that the share price got ahead of itself for a while, so it took a few years to correct the imbalance. Share prices oscilate above and below intrinsic value. By the time of maximum pessimism, the pendulum swings to undervalued. At the time of maximum optimism, the pendulum swings to overvalued. Some great investors like Warren Buffett may be able to sell above intrinsic value and buy below intrinsic value. For the mere mortals like you and me, the best course of action is to buy and hold, and sit patiently, while collecting a rising stream of dividend payments. This is your fair share of the company earnings. This is your incentive to hold on to your shares as a long-term shareholder. Trading in and out of a stock is usually going to cost you, lead to frustrations, and lead you worse off than simply doing nothing.

While the intrinsic value of the business grew steadily, the share price did not grow steadily in lockstep each year. This is where new investors need to learn that equities do not just generate 10%/year every single year. There may be long periods of time with no or low returns, which test everyone's patience. During these periods of time, everyone starts questioning if buy and hold investing even works

By the time the weakest hands have sold, because they became discouraged from hearing bad news about the company they owned, the price starts reverting back to intrinsic value, turbocharging returns for the patient shareholders. This reminder should help you avoid the temptation to sell, because the amount and timing of capital gains is very uncertain and sporadic. As you can see from the chart above however, dividend income is more stable and dependable than share prices. 

In general, a Dividend Growth Stock is a company that has managed to grow dividends for a certain number of consecutive years. I look for ten consecutive years of annual dividend increases , but sometimes I look for 25 years, while other times I can live with a 5 year streak of annual dividend increases. It depends on the company.

The basic model is that a company can afford to grow dividends because it generates more free cash flows that it knows what to do with. Such a company usually has a strong business model, a moat or is riding some long-term trend. Either way, that streak of consecutive annual dividend increases is an indication of a quality business with growing earnings, which should be researched further.

I view dividends as a signal from management, which shows me their confidence in the near term and long-term prospects of the business. A company that can afford to grow dividends, shows me confidence in the near term business prospects. This is valuable information that things are going according to plan, particularly for a company with a long track record of annual dividend increases. 

However, if management is just growing dividends, while earnings are flat or not rising, this is a warning sign. That’s because without earnings growth, future dividends have a natural limit. Ultimately, flat earnings and rising payout ratios increase the risk of a dividend cut.

A company that cannot grow dividends usually serves as a warning sign that not everything is going according to plan. A lot of companies go through changes in the business model, economic environment or competition, which is why a dividend freeze is something that can be expected at some point. If this comes from a company with a long history of annual dividend increases, this shows that something is not working as expected. As an investor, I want the company that delivers rising earnings, rising dividends and rising intrinsic value over time. If I do not see that any more, I would likely keep the investment for the time being, but allocate new money and dividends elsewhere.

A company that ends up cutting or eliminating its dividend shows me that things have changed for the worse, and that it cannot afford a dividend any more. Usually this happens when the business is at risk, and it needs all financial resources available for survival. While the odds of reinstating the dividend and the business going under are perhaps equal, I see this as a change in fundamentals. I invest to see one outcome, following my thesis that things go up gradually over time. If they do not, and I am proven wrong, this shows me that my thesis was incorrect. If my thesis no longer holds, I sell a stock. Usually, I sell after a dividend cut or suspension. Most other reasons to sell have been a mistake. When things change and I receive information about this material change, I change my mind. Selling after a dividend cut is helpful, because quite often investors may fall in love with a stock, and fail to see objectively that the company is no longer the cash flow generating machine it once was. A dividend cut is a wake up call that the thesis has changed, so a course revision may be necessary.

When discussing dividends, investors often tend to view them either as great or terrible. In reality, things are much more nuanced.

There are two or three major types of companies. The first type includes companies that can reinvest all of their earnings at a high rate of return in the business, which can translate into high earnings growth over time. A lot of these companies do not pay dividends, because they reinvest everything back into the business. The problem with this approach is that a lot of these companies may hit a ceiling point, at which it would be difficult to find projects to reinvest all earnings at a high rate of return. As a result, once the company hits that ceiling, they start distributing dividends. No company in the history of the world has ever been able to reinvest all earnings back into the business at a high rate of return for extended periods of time. The ones that may have done it, have been more of an outlier than a trend.

The second type includes companies that generate a lot of excess cash flows, and they may not need all of that money to be reinvested into the business, in order for it to grow. Usually, these are companies in mature, slow growth industries. They can grow slowly over time, but only need a small fraction of earnings to reinvest back into the business. There is a natural limit to how much more capital can be productive put back into the business at a high rate of return. You may recall Warren Buffett’s discussion of his investment in See’s Candies, which generated over $2 billion in profits between 1972 and 2007, and needed an increase in working capital from $8 to $40 million during the same time period. They managed to grow slowly over time by raising prices, increasing productivity, eliminating waste from the system. While growth was slow, the company still managed to generate a lot of income over time.

There are various stages for dividend growth companies. The companies that are in the initial phase of paying and growing a dividend may have a lower payout ratio, but manage to grow the distribution faster than earnings per share, up until they hit a certain target payout ratio. Other companies are in a more mature phase, hence their dividend growth and earnings growth are fairly similar. A third group is in the decline phase, and they have been unable to grow earnings, which means dividends are at risk. 

There are also various types of companies depending on their payout ratios and dividend growth trajectories. 

Some companies have high yields, pay a large portion of earnings, but grow distributions at a low rate. Some utilities, telecom companies, REITs and tobacco companies are in this group.

Other companies are in the sweet spot, with average yields and average dividend growth.  Companies like Johnson & Johnson, Procter & Gamble and PepsiCo fit this bill.

A third group of companies has a lower dividend payout ratio, but they have higher growth expectations. A few examples include Visa, United Technologies and Cintas.

There may be a third type of companies, which cannot afford to pay a dividend. That could be because they cannot earn a profit or they need to reinvest all profits to stay competitive, without a corresponding impact on their profitability and intrinsic value. 

Now that you have a general idea of dividend growth investing, I wanted to mention briefly that a long streak of dividend increases is usually an indication of a quality business with a business model that needs to be researched further by the enterprising dividend investor. 

This analysis should include a qualitative, and a quantitative evaluation of the business. A qualitative evaluation would look at brands, moats, the competitive environment and likelihood for future growth/strategy. A quantitative evaluation should look at trends in earnings, dividends, payout ratios, revenues, return on capital, and capital allocation. It is imperative that the investor understand the business. Otherwise, they would be unable to get the conviction to buy and to hold on to it if things get tough.

It is very important to acquire a quality business at a very good valuation. If you overpay for a business, you may end up sitting at an unrealized loss or a small gain for years, even if the business grows revenues, earnings and dividends. If you overpay for a business, your dividend income would be smaller than a situation where you buy that business at a more adequate valuation. As you saw in the chart above, overpaying for Procter & Gamble in 1972 led to seeing the capital value of your investment go down substantially, before recovering and breaking even by 1985. The only return you received was from dividends. I doubt that many investors would be willing to sit for 13 years with little to show for it. Only a patient investor would have enjoyed receiving more in dividends, despite gloom and doom. When you overpay for a stock, you should be willing to sit out any overvaluation and not earn returns for a few years, before breaking even. It may or may not be worth for you to overpay for future growth that could take up to a decade to resolve itself. If you are patient enough, and plan to hold for 40 years, it won't matter at the end. If you are impatient, and want instant gratification, you may end up selling low and destroying capital and future compounding potential.

Today we discussed a simple mental model called Dividend Growth Investing. With this strategy, you have a quality company that grows earnings, and raises dividends regularly for a long period of time. This growth in earnings and dividends typically leads to growth in intrinsic value. Reinvestment of dividends also increases net worth for the investor. This long streak of dividend increases is the quality factor that piques the interest of the enterprising investor, who places the company on their list for research, before deciding if the business, the fundamentals and the valuation are right for their portfolio. 

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Monday, October 5, 2020

Three Companies Raising Dividends to Shareholders

As part of my monitoring process, I follow the dividend increases for companies I own, and companies on my watchlist. This process can also put companies on my watchlist, if I see and exciting dividend growth story. 

I typically focus on the companies that have managed to increase distributions for at least a decade. There were three companies that fit those parameters last week. The companies include:

OGE Energy Corp. (OGE) operates as an energy and energy services provider that offers physical delivery and related services for electricity and natural gas primarily in the south-central United States. It operates in two segments, Electric Utility and Natural Gas Midstream Operations.

The company raised its quarterly dividend by 3.90% to 40.25 cents/share. 

"Strong operational execution at the utility has enabled us to increase our dividend for the 14th consecutive year," said Sean Trauschke, Chairman, President and CEO of OGE Energy. "We realize many of our shareholders count on our dividend for income, and I am grateful for the hard work and dedication of our members to provide value to our shareholders during these difficult times."

Over the past decade, OGE Energy has managed to grow dividends at an annualized rate of 7.60%. It is a dividend achiever with a 14-year track record of annual dividend increases.

OGE Energy grew earnings from $1.50/share in 2010 to $2.16/share in 2019.

The company is expected to earn $2.13/share in 2020 and $2.21/share in 2021.

The stock is fairly valued at 14.60 times forward earnings, yields 5.20% and has a payout ratio of 75.60%. I would expect dividend growth rates of around 3% over the next decade.

Starbucks Corporation (SBUX) operates as a roaster, marketer, and retailer of specialty coffee worldwide. The company operates in three segments: Americas; International; and Channel Development.

SBUX Starbucks increased its quarterly dividend by 9.80% to 45 cents/share.

“The Board’s decision to raise our quarterly dividend demonstrates confidence in the strength of our recovery and the robustness of our long-term growth model,” said Kevin Johnson, Starbucks president and CEO. “Our cash flow generation is strong, and we remain committed to reducing our financial leverage while continuing to invest for future growth,” concluded Johnson.

Starbucks initiated its dividend in 2010 and has increased it in each of the past 10 years. During the past five years, it has managed to grow dividends at an annualized rate of 22.10%.

Starbucks managed to grow earnings from 62 cents/share in 2010 to $2.92/share in 2019.

Starbucks is expected to earn 95 cents/share in 2020 and $2.70/share in 2021.

The stock is overvalued based on 2020 and 2021 times earnings estimates. The dividend is not covered out of 2020 earnings. The payout is high even based on 2021 earnings. It is quite possible that Starbucks will weather the Covid-19 storm stronger than before. Of course, if we get a second wave of lockdowns, it may be interesting to see if investors would reevaluate the business downward.

Bank OZK (OZK) provides various retail and commercial banking services.

Bank OZK increased its quarterly dividend by 0.90% to 27.50 cents/share. It has increased dividends for 24 years in a row. The current distribution is actually 10% higher than the distribution paid during the same time last year. The bank has managed to grow distributions at an annualized rate of 21.90% during the past decade.

The bank has managed to grow earnings from 67 cents/share in 2010 to $3.30/share in 2019.

The bank is expected to earn $1.67/share in 2020, and $2.53/share in 2021.

The forward payout is at 65.90%, but if earnings do rebound in 2021, the payout drops to 43.50%. I do not like drops in earnings per share. My model looks for growth in earnings, dividends and intrinsic value over time. Short-term weakness does happen, but it changes the dynamic.

If you believe any problems by Bank OZK are temporary, and not indicative of a permanent change for the worse, the stock is fairly valued at 13.20 times forward earnings and offers a dividend yield of 5.10%.

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Thursday, October 1, 2020

The Nifty Fifty: Valuing Growth Stocks

Back in the early 1970s, there was a group of companies which are referred to as “The Nifty Fifty” in the US. These were companies which were expected to grow earnings forever, by taking advantage of trends in demographics and the economy of the future decades. The stocks were often described as "one-decision", as they were viewed as extremely stable, even over long periods of time.

The most common characteristic by the constituents were solid earnings growth for which these stocks were assigned extraordinary high price–earnings ratios. 

A P/E of forty times earnings, far above the long-term market average, was common for these one-directional glamor stocks.

As a result, these companies were seen as one-directional bets which were good investment ideas at any price. The investment public was excited about these companies prospects, and wanted in at any price, without thinking about valuation.

Since buyers were willing to acquire these companies at any price, the prices moved higher. As prices moved higher, investors who bought without worrying about valuations felt vindicated and wanted to buy more without paying attention to valuation. Those who missed out wanted to buy in as well, which pushed prices even further up. By late 1972/early 1973, a lot of these Nifty Fifty companies were selling at insanely high valuations. That was because investors expected lots of future growth for these enterprises. The rest of companies in the US were more adequately valued, but were ignored by many investors, because they were not exciting enough.

By 1973 investors lost interest in the stock market, and by the bottom in 1974 lots of the Nifty-Fifty stocks were down by 70 – 80 – 90% from their highs just a couple of years earlier. Many of the companies did not deliver price increases for a while, with the majority of their returns coming from dividends in the first decade since the top. Some of these Nifty-Fifty companies ended up failing outright, while a few others ended up becoming successful beyond their original investors dreams.

In reality, an investor who bought a portfolio of these companies and held through thick and thin for the next 30 years did well in the end.  

While that doesn’t matter to me as much as it does to others, the portfolio of the original Nifty-Fifty companies did slightly better than the S&P 500. This is according to research from Jeremy Siegel, which you can read about here:

Valuing Growth Stocks: Revisiting the Nifty Fifty

The problem is that it took 30 years to get there. A lot of investors would have bailed out at the first sign of trouble. Even if you managed money and held these companies, your investors may have wanted out. So it is very likely that very few investors realized the excess returns.

You can view the performance of the Nifty-Fifty companies between 1970 and 1995: 

Source: New Low Observer

There are lots of lessons to be learned from the Nifty-Fifty companies of the 1970s. 

The first lesson is to be diversified. Nobody could have known in advance which of these companies would turn out to be rockstars in terms of performance, or which would turn to ashes. Therefore, it makes sense to spread your bets accordingly. Doing so on an equally weighted basis makes sense.

The second lesson is to hold through thick or thin. If you buy a portfolio of investments, put them away and just forget about them. If you are going to be disappointed, because a company did poorly over a certain short period of time, you will never have the tenacity to hold on to any portfolio you select. It is possible that any portfolio could disappoint over any short-term period of time of five to ten years. Of course, deciding whether your portfolio is truly bad or it simply has a temporary setback is more art than science. This is similar to the Coffee Can Portfolio approach.

The third lesson is that valuation matters. Buying these securities at lower valuations would have resulted in an amazing track record. Buying these securities without worrying about valuation would have generated a great return, but a lifetime to get there. If it appears that an investment is “not working”, many investors may be quick to abandon ship. Selling is usually a mistake.

However, I did some additional digging and learned that there never was an official Nifty Fifty list of securities. It is quite possible that the securities in Jeremy Siegel’s list were not the ones investors were buying in the 1970s. Therefore, their results would have been wildly different than what Jeremy Siegel suggests. His research makes me believe that it is fine overpaying for securities, because things worked out at the end. He even goes on to show that certain overvalued securities like Altria were not overvalued enough, since they generated amazing returns over time. 

The Nifty-Fifty Re-Revisited


I do not like where this is going, because I think that overpaying for securities teaches investors bad habits and can lead to buying companies without thinking about valuations or fundamentals. And most importantly, that can lead investors to ignoring any common sense and buying without having any margin of safety. Just because things worked out in the end, doesn’t mean that things couldn’t have gone the other way. 

Altria could have just as easily taken the path of John’s Manville and wiped out the common shareholders in the process due to lawsuits. I think that blindly buying securities is not a good habit in the first place. Therefore, I would caution against overpaying for securities, no matter how exciting their growth prospects may seem. That’s because the future can be uncertain, and things could change for one reason or another – competition, government regulation, changes in consumer tastes and preferences, technological disruptions etc. 

To reiterate the third, but most important lesson, you should not overpay for future growth. While a lot of the hot growth companies of any era are usually seen as high quality, they are frequently overvalued. However, buying an overvalued security exposes the investor to the risk of valuation shrinkage. This is where you buy a security at an inflated valuation of say 50 times earnings, and then your growth expectations materialize, but the business is now worth only 10 times earnings. After all, trees do not grow to the sky, and growth usually hits a plateau after a few years, due to competition, obsolescence and disruptions and regulations. If you buy for 50 times earnings, and earnings go up 8 times in 21 years, your stock would only go up by 60% in total.

When you overpay too much for a security, you are taking a big gamble, and you are probably speculating. No company is worth overpaying for.

I have seen this lesson everywhere I have looked. For example, Japanese stocks did very well in the 1980s, delivering double-digit mouthwatering returns. Japan was overvalued in 1980, but still delivered amazing returns to investors. When returns come easy, without looking, it would be easy to tell yourself that valuations do not matter.

Unfortunately, the stock market was selling at 100 times earnings by 1989 and a dividend yield below 0.50%. It has taken the stock market 30 years for it to sell for a more normal P/E of roughly 12 and a dividend yield of roughly 2% - 3%, while the stock market is down by 50% since then. This means that earnings per share and dividends per share have been rising gradually over the past 30 years. The reason why investors didn’t generate much in returns is due to the massive overvaluation of securities.  While ignoring valuations worked in the 1980s, the law of gravity caught up with investors by 1990, and they are still paying the price many decades later.

I saw this first hand in 1999 and 2000, when stock market investing became a national sport, and companies sold at high valuations. As a result, we had the lost decade in 2000 – 2009, where stock prices went nowhere, despite increases in earnings and dividends. It took a decade for fundamentals to catch up to share prices. Since share prices are driven by investor sentiment, we went from massive exuberance in 1999/2000 and overpaying for future earnings to a massive depression in outlook for stocks and unwillingness to pay for future earnings.

My analysis of the performance of the Nasdaq 100 companies from 2000 shows that it ultimately did work out for investors. However, we should also strive for margin of safety and some humility along the way. In general, while investing in Nifty-Fifty from 1972 ultimately worked out, I still think investors should be cognizant of these factors:

Investors should always be conscious of starting valuation when placing their bets. Starting valuation matters.

Ignoring entry valuation may work for a while and the ease of making money may trick you into believe that it doesn’t matter.

When stocks go nowhere or go down from your purchase price, you may have to wait for a long time, before even breaking even.

I wanted to include a few printouts from a 1980s Moody's Manual, which show the decrease in P/E ratios in the 1970s and the increase in dividend yields:



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