First Quarter 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.

“Measly as these yields may be . . .