Thoughts from 2010:

Thoughts from 2010
DIVIDENDS MATTER: From December 1969 to December 2009, the compound total return with re-invested dividends for Canadian stocks was 5,285%. Not counting dividends, measuring stock-price gains alone, the gain over the same period was 1,481% (according to S&P in Barron's of March 22 2010). ♣ 5,285 vs 1,481 is right some significant? What's your conclusion? These numbers make me feel secure in my strategy: I buy good dividend paying stocks and do not trade very much? Dividends boost total returns. Do you own stocks which do not pay dividends? Why?

Low Interest Rates are dangerous because they lead people to do stupid things. People sacrifice quality to get a higher yield. In these dangerous times, you should focus on risk aversion rather than maximizing immediate return. Conserve your principal. You'll find out why in a year or so. The dung has not hit the fan yet. And if you still have a financial planner, he or she will be trying to sell you some type of guaranteed product. Say no. Stand up, turn the photograph of her or his family on the desk around to face them, not you, and leave. Don't say a word. If you don't, you will be enriching your advisor, not you. As Dan Richards says in a front page story in the March 26 2010 Investor's Digest, “the promise of high returns and safety of principal is an illusion”. You cannot have “a higher-than-market return without an equally high potential for risk. Sorry.”
Digest this fact from Barron's of February 11 2010: “roughly 45% of the S&P 500 total return from 1926 to 2009 came from dividends”. What's your conclusion? *
“focus on risk aversion rather than maximizing immediate return” Again.
“focus on risk aversion rather than maximizing immediate return” Or…
Do not sacrifice quality to chase yield.
Ramp down your expectations for growth: There is a new normal. Read “Stock market investors, it's time for a reality check” by John Heinzl in the Report on Business, April 7 2010. Double digit returns disappeared with the bull market (except for those of us who bought our dividend growing common stocks years ago and are now getting double digit yields from the dividends alone).
Think a range-bound market…at the best.
“focus on risk aversion rather than maximizing immediate returns” S. Klarman
The headline of my February 2010 issue was 'Seven Lean Years'
“equity bear markets have usually ended with the cyclically-adjusted p/e bottoming out in single figures” Buttonwood
“I still feel the bill for the crisis has not yet been paid.” Buttonwood
In the long term, Canadian equities have returned a real 5.8% per year. (real = after inflation)
“The final return of an equity investor is highly dependent on when he starts to put his money in.” Buttonwood, February 25 2010
A friend e-mailed yesterday to say he had just read my latest report on his Sony E-book at Tim's (on Feb 25 THI announced a dividend increase of 30%). How exciting is that? And the print edition of my Volume XXX No.1 was not even back from the printer yet. Technology! (By mentioning Tim's dividend increase, I am certainly not saying buy THI. THI's p/e is an expensive 21) THOUGHT: What a world we live in. Hundreds of folks slave away in places like Tim's serving coffee, and lots of 'stuff' we should not eat, for meagre wages. The capitalists who own the stock, on the other hand, get a 30 per cent raise in their income.
Eschew Synthetic Income: THOUGHT #2: If you hold a mutual fund which owns Tims, would your income be going up 30%. Does your fund even pay income? Probably not much. Why are you holding it? In my mind this is the biggest problem with mutual funds. As funds do not pay out much income, when you get to retirement, you are at the mercy of the market. If stock prices are up when you retire, you'll have a fine retirement. If not, sorry for your luck: ask for a job at Tim Hortons. Dividend growth investors, in contrast, set things up and buy common stocks that provide income while they are still working. When they retire, the income is already flowing, most likely at double digit rates. We do not depend on market prices to finance retirement. We do not have to create synthetic income out of capital, as mutual funds do. We enjoy actual income. And our income increases, as Tim's dividends do. When is the last time you received a 30% raise. In my last Connolly Report, I included four yield charts. One showed Enbridge's yield and dividends going back to 2000. ENB's dividend was .63½ cents a share then. Now it's $1.70. That's the kind of asset you want to own. Own assets that provide income. ENB's yield has been hovering around its average of 3.42% for the last decade. ENB's five year dividend growth rate is about 10%. Think this through. If the dividend is growing at 10% a year, and the yield is staying roughly at 3.5%, what's happening to Enbridge's price. Yep. That's right. It's going up at the same rate as the dividend. Dump your funds: switch to dividend growth!

“Dividend yield telegraphs what a management team knows about its business and its prospects for growth as well as the state of its balance sheet and franchise.”
Don Killride, head of Vanguard's $2.8 billion Dividend Growth Fund from Barron's of February 8 2010. Over ten years, this dividend growth fund returned a…hold onto your hat now, 1.72% annually. Talk about a lost decade. It was not, however, a lost decade for Canadian dividend-growth investors. Here's but one example: Metro's dividend was .125 in 1999, now it's 68 cents. And MRU's yield fluctuated around its average yield for the decade of 1.43%, so it's price much have risen by about the same amount as the dividend…more than a triple.

If you are thinking of just buying a dividend mutual fund to execute the dividend growth strategy, think again. In the last five years, only one Canadian dividend fund beat the S&P/TSX total return. Only one! (Source: Report on Business March 6 2010, Shirley Won's table of 33 Canadian dividend funds in order of return over the last five years.) Ten of these Canadian mutual funds returned less than 2% a year. And 'they' say professional management is better. It's tosh! And many of the fund fees are in the 2% range. Are you still holding mutual funds? Why? Get out while the getting is good. Yes, I know there is an exit fee to get your own money back, but if you stay in for two more years, you'll pay fees which could equal the exit fee and than still have to pay the exit fee in two years. At the very least, stop the automatic deposits into the fund, while you consider it. Consider this too.
The last market peak was in 1999. If you think your fund will get back to that level soon, don't. Prices were irrationally high before the crash. The last peak before 1999 was in 1968. Our daughter was born in 1968. She's over 40. Can you wait that long? The peak before 1968 was in 1928. And before that, 1906. The waves are long. (Source: The Economist, Buttonwood: 'The very long view' February 25 2010.) “The patterns suggest that each generation discovers a passion for equity investment that is followed by disappointment.” We are in the disappointment period: it will be long. Google to find this column. Read it thrice. There's a link inside dividendgrowth.ca for subscribers. Here's another snippet: “Investors had made no capital gains in real terms over 40 years”. “Real” means adjusted for inflation. The only return was, in essence, dividends. Do your investment produce income? If not, rectify it. But do not fall for life insurance company plans: they promise a lot, but only guarantee your money back…not income. And do they use the word 'potential' a lot. Financial innovations can be highly dangerous. Many, certainly not all, Financial Planners/advisors tend to flog and forget. So much for the rant. With the nice weather, I'm off to the cottage to celebrate my 70th. After 30 years there, we are putting in running water. I'll miss the outhouse.

Shares versus Funds: I was asked to do an interview for a column in Les Affaires, a Quebec-based business magazine, comparing owning shares directly versus holding funds. Here are the points I made.
There are three main problems with holding mutual funds or ETFs versus owning shares directly. 1. In retirement we need income. Mutual funds and ETFs are not noted for providing income. So, on retirement, income has to be created from funds by selling holdings. I call it synthetic income. If the market is down when you retire, or goes down during retirement, there is a big problem. You must sell when prices are low. In contrast, the income from dividend growth common stock can grow. You go into retirement with stocks that already provide income, often double digit yields. You do not have to sell to obtain income. I buy common stocks that pay dividends for the income, and I hold, as Warren Buffett does, forever. ♣ 2. With holding shares directly, there is no annual fee. Fees on mutual funds, in the long term, kill you. ETF fees are lower, but there still are fees. ♣ 3. Most professionals do not beat the market. Most dividend mutual funds do not beat the market. ETFs and mutual funds hold shares that do not pay dividends. That's not good. It is the income people need. I buy common shares for the income. I hold them for the income, as other people would hold a bond for the income. ♣ It's all about the income. Going forward from this point, for years, the market will not be providing much in the way of gains. The great bull market is over: we are in a secular bear market. Believe it! If your investments do not provide income, you will not have a comfortable retirement. If your investments do not provide actual (real) income, you might have to continue working. I feel sorry for the folks who hold the $585 billion in mutual funds. ♣ BENIGN NEGLECT: Regarding the possible return for the investor - Dividend growth investors keep track of income from their stocks, not so much the gain in price. The price does not really matter as we do not plan to sell. It's called benign neglect Here are some examples of the income provided by a few of the stocks I follow. Eventually, the gain in price will be about the same as the gain in the dividend. Yield on GWO bought in March 2009 at $14.20 is 8.7%; yield on BMO bought in 1987 at $6.90 is now 39%; Yield on Toromont bought in 1996 is now 16.3%; yield on TransCanada bought in March 2000 at $11.80, now 12.9%; Sun Life bought in March 2005, now 3.3%; Cdn Utilities in 1992 at $12.50, now yields 12.6%. Some of those purchase dates were years ago. See what I mean about patience! But it's worth the wait. Interest rates are very low currently. However, yields on our common stocks purchased years ago, are mostly double digit. Ask me if I care, or even know, what the current stock price is? ♣ Or alternatively, income can be measured this way (from Feb 2010 Connolly Report): GWO's dividend in 1992 was .06 cents per share, now the dividend is $1.23; Metro's dividend was .125 in 1999, now it is .68; Enbridge's dividend was .63 per share in 2000, now it is 1.70. It is the income produced by your investment that is important. Income you can spend during retirement.

* Dividends matter. If your shares do not pay dividends, are you losing about half your return? For the decade ending December 2008, 63% of the return from the stocks I follow was from dividends. The average compound growth rate of the common stocks I follow was 9% for that decade. (Connolly Report June 2009 p.675) If your stocks do not pay dividends, how do you make money in a dismal (read sidewards) market where their might not be any capital gains. Don't believe me? Do a ten year price chart for Walmart (WMT). WMT has been hovering a few dollars above or below $50 for over a decade. 


Second Quarter 2010

 “To not only learn but also effectively implement investment lessons requires a disciplined, often contrary, and long-term-oriented investment approach.	 It requires a resolute focus on risk aversion rather than maximizing immediate returns, as well as an understanding of history, a sense of financial market cycles,	and, at times, extraordinary patience.”	Seth Karlman

Yields on 1982 cost - I've written about holding common stocks for the growing income many times before. In the February 1993 Connolly Report, for instance, I had a table showing 1993 yields on stock bought ten years before in 1982. Those who were with me then are very wealthy now. Here are some examples: Quebec Tel bought in 1982, with dividend growth, yielded 17.2% by 1993, Maritime Electric 14.2%, MT&T 13.8%, BCE 13.7% Island Tel 13.7%, BC Gas 13.3%, Fortis 12.7% and Newtel 12.4% on the 1982 price. Most of those companies no longer exist (BC Gas was sold to Americans, Quebec Tel was bought by Telus, Maritime Electric in PEI was purchased by Fortis). The bank 'yields on cost' based on 1982 prices and 1993 dividends were just single digits. Banks mess things up every decade or so. BNS* was 8.9%, BMO 8.8%, CIBC 8.3% and Royal Bank was 8.2% on $14.12 price in 1982 and the 1993 dividend of $1.16. RY's dividend was up from $1.00 a decade before. RY's price was up from $14.12 to $25.37 over those ten years. The price gain is NOT included in the yield on cost. Return is composed of two elements: income and capital appreciation. Besides the growing income, dividend growth investors also get capital appreciation. We get both. That is why our wealth grows. This February 1993 Connolly Report also included this statement: “Income growth - increasing the amount of spendable dollars your portfolio earns each year -must be the most important goal of any investment plan.” Mal Berko (TD was not in my list then, nor was GWO or Power.) Unfortunately, Royal Trustco was. RYL was on top of the list, then in yield order, at 12.3%. Not good. Enbridge, then called Inter Provincial Pipeline, was second at 8.5% yield in 1993. Do not reach for yield. Royal Trustco was in trouble at that point and its stock soon became just about worthless. RYL was my worst mistake. Ship happens! Thankfully, it's rare with the good commons I follow.
* Had you purchased Bank of Nova Scotia in 1990 though, after it got into trouble yet again, at a price half way between BNS's high and low price in 1990, $3.64 a share, your yield, because the dividend grew from .25 a share to $1.96, by 2010 would be 53%. Twenty years is a long time, but a 53.6% yield means a comfortable retirement. And, here's the icing on the cake: your capital would have grown from a split-adjusted $364. for 100 shares, to $3,659 per 100 shares. Unbelievable, eh! Do the math to check. I do not expect BNS's dividend to rise this year (2010). Ask me if I care? We are getting 53% on our money. I expect BNS's price to fall in 2010. Ask be if I care? I don't! I'm not selling. Would you sell an investment that is paying you $196 every year and that you paid $364 for? I think not. So, if you are not going to sell, the price does not matter. What a strategy dividend growth is. Buy an hold good dividend-growing common stock (never preferred).

A Poor Financial Plan – One finds individual financial plans regularly in the press. While you can often garner a good idea or two from the columns, most plans, in my view, are next to useless because the financial planner is usually just toeing the industry line, hawking mutual funds and not thinking outside the box. In the Report on Business of May 8 2010, there was one with the headline “Time to shift away from risk”. The subject, an engineer, was age 57 and had lost her job. Among other things, her non-registered portfolio has $65,000 in dividend-paying mutual funds and $215,000 in dividend-paying stocks. Her locked-in retirement account of $230,000 has 60% stocks and 40% fixed income. Her house is free and clear, but she has an investment line of credit of $52,000. You can read what ‘the expert’ said, if you like.
http://www.globeadvisor.com/servlet/ArticleNews/story/gam/20100508/FACELIFT08ATL

I was interested in what this financial planner did not say. This planner, and most don’t, does not understand dividend investing. No mention was made of dividend income or dividend growth. All those dividend stocks she already owned, and there was no mention of the essence of dividend investing: her yields are probably very high already and her income will grow as retirement progresses. And, with all that dividend income, she will most likely not be paying any tax at all, even on her OAS and CPP. What an error. The headline was off-putting too. In the actual newspaper it was “Time to shift away from risk” On the web site it was “Time to shift some investment holdings. If early retirement is the goal, a move away from market volatility is key.” Volatility is not risk. Volatility only become risk is you have to sell. This person at age 57 does not need to sell. Dividend stocks provide income. Why would you sell assets that provide a growing income? Culling maybe, but wholesale selling, no way, even though the market is overvalued. It’s the income that counts: the price of the stocks is irrelevant as she should not sell. What's important is the sustainability of the dividend. Dividend eliminations are very rare. Folks need income in retirement: dividend-paying common stocks provide it. Forget about all that GIC income ladder bunk. In the long run, GICs are not really secure: they have lost value every year since 1932.

GUARANTEED PRODUCT* The headline over Fabrice Taylor's May 5th 2010 ROB column stated, “The guarantee is not worth the price”. You lose with guaranteed products: “Not principal, but opportunity. You should not buy them.” TC: That's quite clear, isn't it. I also advise staying away from financial planners who peddle these products. You'll get your money back, but that's usually about it. The income is not guaranteed. And, you do not even get the dividends from the package. People* who are sold principal protected notes only have the potential of price gains and there are clauses which restrict gains too. *I used the word 'People', not 'Investors', notice. Life is perilous: guarantees are expensive.
Here's something to think about. If your stock does not pay a dividend, you are left with only one way to realize a return: hope the price goes up and sell your shares to someone else. I well remember the 1970s. The market went sidewards for years. Colleagues who had been sold mutual funds in the late 1960s, were devastated (mutual funds are sold, not bought). I began the Connolly Report after that in 1981, looking for a better way. I found it. Now I do not focus on price: it's the income that counts, the dividends. With the sideward market that looms ahead, dividends will provide most of my return. Some sixty three per cent (62.8%) of the return from the stocks in my list for the period 1998 to 2008 came from dividends. (a stock by stock report on this is inside dividendgrowth.ca) The compound annual growth rate (CAGR) of the common stocks I follow (never preferreds…they are not) over this decade was 9% per year. Have you done this well? And prices were not high at the end of 2008 either: the data is not doctored. Nine percent a year beat the market too…by quite a lot. Investigate dividend growth investing. The last decade was not dismal for dividend growth investors. The Dow, at just over 10,000 as I key this in May 2010, however, is much the same as it was then, just over 10,000.

Third Quarter 2010

”[T]he starting yield is very important to future returns. And it is currently low. (Buttonwood's blog, The Economist, September 13 2010) TC: This is the lesson of the day, week and month. What's he saying?
Long term “80 percent of your total return is generated by the price you pay for the investment plus growth in the underlying cash flow” James Montier p.155 The Little Book of Behavioural Investing

THE INERTIA BENCHMARK : Mutual funds do not, but should, compare their returns to the inertia benchmark: what performance would have been achieved if the portfolio manager had done nothing. In his gem of a book, James Montier has a chapter (thirteen) called 'The perils of ADHD Investing': attention deficit hyper-activity disorder. The average holding period on the NYSE is six months today. In the 1950s and 1960s it was seven or eight years. Montier puts it this way on page 155 of The Little Book of Behavioural Investing: “At a one-year time horizon, the vast majority of your total return comes from changes in valuation - which are effectively random fluctuations in price. However, at the five-year time horizon, 80 percent of your total return is generated by the price you pay for the investment plus growth in the underlying cash flow.” TC: You noticed the last few word, eh, “growth in the underlying cash flow”. That is why we do what we do. We hold dividend growing common stocks for their cash flow.
Foreign stocks - I've added a paragraph on global investing under Diversification on the Investment Topics page.
Beat the benchmark - Money managers are happy when they beat their benchmarks¹. Some even put a half-page ad in the Report on Business. Such was the case for Manulife Investments on July 7 2010. Their Global Opportunities Class fund substantially beat their benchmark¹, the MSCI World Index. They are proud. The headline in their advertisement said: “It will help take your portfolio to new heights”. Below the headline was the data. The three-year rate return for the Global Opportunities Class was negative. Actually, so was the two-year data. New heights? But they beat their benchmark¹. And this Global Opportunities fund received a Morning Star 5-star rating for being in the top 10% of funds in the category. I wonder if the people who were sold the fund are happy. The inception date of this fund was April 2007. Did these professional money managers not see the crisis coming? The Connolly Report headline in February 2007, just before this fund started, was: “Liquidity, Froth and Low Yield: Be Cautious. The market peaked, according to Value Line, in July 2007 with a yield of 1.6% and a p/e of 19.7 (the p/e was 10.3 in March 2009) ♣ The lesson: do not buy when stocks are expensive. If you do, future returns will be lower. Learn to control your behaviour *, to be patient. Do not hold professional money managers in high esteem either: most of them do not beat the market. These global numbers do not incline one to diversify internationally, either. Do they? I don't. One reason: Canadian dividend income is just about tax free, unless you are really wealthy.

* The Little Book of Behavioural Investing (2010) by James Montier is excellent¹. It will help you to control your behaviour and help you become a better investor. Chapter 5, 'The Folly of Forecasting, for example, outlines five ways you can invest without forecasting. I'll detail them in the August 2010 Connolly Report. ¹ Actually, James Montier's big book ( 706 pages) Behavioural Investing - A practitioner's guide to applying behavioural finance (Wiley, 2007) is great too, but it costs some $100 more.

In Chapter 11 of The Little book of Behavioural Investing, James Montier talks about professional money managers and why they “fear underperforming that index above all else (aka career risk)” Hence, the professionals cannot do the right thing. They must index. Absolute returns are not part of their equation. The returns of Manulife's mutual fund mentioned just above, speak to this. Professional money managers seem happy with negative returns. I'm not. I'm after income from my investments.
¹ In his July 10th 2010 Economist column, Buttonwood, taking about indices, put it this way: “Fund managers started to focus on 'tracking error' rather than buying the best stocks. The definition of risk changed from losing money to underperforming the benchmark.”