Some notable quotes from Charlie Munger at the recent Daily Journal Annual Meeting:
AnrepViz.com is doing great work turning essential company information into simple-to-use visualizations. His visualizations include data such as Revenues, Book Value, Return on Equity, Price to Earnings Ratio, Dividend Growth, Payout Ratio and more. I like it.
Their latest effort includes data for 11 Canadian insurance companies, such as Manulife, Sunlife, Intact, Great West Life, IA, Power Corp and more.
I’ve shared the visualizations below. (Note: I didn’t create these so I can’t vouch for the accuracy.)
I recently had someone unsubscribe from this blog. That person was kind enough to let me know why – it was because I often endorse dividend growth investing.
This former-reader pointed to a behavioural bias called ‘mental accounting’ to demonstrate what they believe to be the flaw in dividend growth investing. Instead of separating returns into two forms – dividends + capital growth – this person argued that investors should focus on total returns. Moreover, by focusing on companies that pay growing dividends I am ignoring a large part of the market (e.g. the Teslas, Snowflakes of the world).
The funny thing is I actually agree with this person.
However, unlike the reader I believe that this behavioural ‘flaw’ is what helps dividend investors become BETTER long run investors.
The first thing people need to understand is investing is about what you take home at the end of the day. It’s about your personal returns on your account, relative to the risk you’re willing to take.
Most people start out believing they are ‘growth’ investors. That is, until they run into a bear market. Suddenly, they become ‘conservative’. People are allowed to change their minds. The problem is that these shifts create destructive financial behaviours.
In theory, the simplest, most efficient portfolio strategy might be to buy and hold a low-cost S&P 500 ETF. The problem is reality is messy.
In reality, the average investor dramatically underperforms the buy-and-hold S&P 500 portfolio over the long run. Why? Because they trade too frequently. They get excited after stock prices have run up (and buy) and then get scared after stocks have fallen (and sell). And then they sit in cash as the market rises again. Most investors buy HIGH and sell LOW.
I believe that dividend investing helps mitigate emotional trading. It is precisely because dividend investors separate their total returns into dividends + capital gains that keeps them from buying and selling on emotion.
Whether the markets are up or down, dividends still get paid. It is much easier to hang on to an investment if the positive reinforcement of dividends rewards you for doing so. Some refer to this phenomenon as ‘getting paid to wait’. In contrast, investors holding non-dividend paying stocks don’t receive that positive reinforcement.
The bottom line is that two similar investments might have the same expected total returns, but the characteristics of those returns have a significant impact on investor behaviour. The ability to capture returns on a consistent, frequent basis helps many investors stay the course over the long run.
Of course, this doesn’t apply to 100% of investors. Some investors will have better control over their emotions and have the intestinal fortitude to ride the big waves. It is entirely possible these investors beat the market over the long run. However, the empirical evidence suggests most investors are not in this category and require behaviour management.
Dividend Policy is Irrelevant? Yes and No.
Does this mean all companies should pay dividends? Definitely not. Dividend and stock buyback policy depends on the opportunities faced by the company.
Some argue that dividend policy is irrelevant to investors (because they can create ‘home made’ dividends by selling shares) and to the valuation of a firm (because they can raise capital if needed). This is technically true…in theory.
However, like all academic theories it comes with a lot of assumptions. A big one is that corporations have a better use for cash than their shareholders, and by paying dividends the company would be forced to raise debt or equity capital. This is why a company like Tesla doesn’t pay a dividend. The company believes it can earn a better return on invested capital than its shareholders. Clearly, this alone doesn’t make Tesla a good or bad investment.
Now, if Tesla couldn’t earn a high return on capital and still chose not to return cash to shareholders, you would have to question its motives. Many corporations hoard cash to build empires for their executives. A bigger empire = more executive pay. But it doesn’t necessarily mean greater shareholder returns.
Well managed mature companies return excess cash to shareholders. Well managed growth companies do not.
Over the long run every company eventually matures and must return cash to shareholders. For this reason, one might say that over the long run dividends are the ONLY thing that matter.
I highly recommend watching this video in which Scott Galloway breaks down the basics for building wealth. I couldn’t have said it better myself. So I won’t even try.
According to Galloway, there are four factors to the algebra of wealth: focus, stoicism, time, and diversification.
Please note that I am not commenting on the merits of bitcoin as an investment. To be honest, I’m on the fence. There are very smart people on either side of the argument. Bitcoin is a highly speculative and risky investment that comes with lots of volatility and a real risk of losing some or all of your investment.
February 18th and 19th. Mark those days in your diary, because that’s when the world’s first bitcoin ETFs were launched.
This has been years in the making, as regulatory hurdles seemed insurmountable. Yet, Purpose Investments and Evolve ETFs (both Canadian firms, by the way) are listing bitcoin ETFs one day apart on the Toronto Stock Exchange (TSX).
Until now, investors could only buy bitcoin through a bitcoin exchange, which is cumbersome, or via a closed end fund. While the buy process is simplified using a closed end fund (because it is listed on a stock exchange), the product structure allows the fund’s share price to drift significantly from the value of its underlying assets – in this case, bitcoin.
The ETF structure should address these issues and the performance of the ETFs should more closely track the performance of the underlying asset.
According to an article on Bloomberg:
“There’s sizable untapped interest for a Bitcoin investment that has the benefits of an ETF,” said Todd Rosenbluth, CFRA Research’s director of ETF research. “Unlike pre-existing products, an ETF is unlikely to trade a significant premium- to-net-asset-value. While most ETFs come to market globally with an educational hurdle to overcome, many investors are familiar with what is inside BTCC.”
The U.S. currently has several active filings for Bitcoin ETFs including ones from VanEck Associates Corp. and Bitwise Asset Management, but the price swings notorious in cryptocurrencies and allegations of industry manipulation remain hurdles to regulator approval.Source: Bloomberg
The Purpose Investments ETF, which listed on the TSX February 18th, gained immediate attention from investors. Basic product details are as follows:
Som Seif, CEO of Purpose Investments discusses his company’s new ETF in the following interview with NASDAQ.
The Evolve ETFs bitcoin fund will be listed on the TSX on February 19th:
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Over the years, I have used high yield bonds as a hybrid asset class between stocks and higher grade bonds (like investment grade corporate bonds and US Treasuries).
Like stocks, high yield bonds benefit from improving business conditions, yet they rank higher on the capital structure because they are bonds. High yield bonds are issued by ‘below investment grade’ companies, and therefore pay higher coupons than investment grade corporate bonds because these companies come with a higher default risk. However, because of the higher coupons (and higher yield), high yield bonds have a lower duration (and are less interest rate sensitive) than lower-yielding bonds with a similar maturity.
Payments to bondholders typically take priority over stockholders – as a result, corporate bonds tend to be a less risky than the equity of the same company.
Believe it or not, high yield bonds have outperformed stocks from 1980-2019 with an average calendar year return of 15.10% vs 12.49%. Moreover, the worst calendar year performance (2008 for both) outperformed stocks by over 10 percentage points.
|Average Calendar Year Return||15.10%||7.81%||12.49%|
|Worst Calendar Year Return||-26.17%||-2.92%||-37.00%|
Overall, the risk-return profile for high yield bonds has historically been quite favourable. After all, interest rates (as shown by the 10yr US Treasury yield in the chart below) have been in a bull market since around 1980. With this sort of tailwind, anything with a fixed coupon experienced long-term upward price pressure. This has been great for high yield bondholders.
Looking at the chart below, one naturally has to wonder though if rates have bottomed for good. As I write this, the 10yr just moved above 1.3% for the first time since the pandemic began. With the firehose of fiscal and monetary stimulus expected to continue for the foreseeable future, it is likely yields continue to rise. I believe the Federal Reserve will allow the economy to run hot for a while before applying the brakes, so it is quite possible that both rates and inflation continue to creep higher.
While high yield bonds generally have a lower duration and benefit from an improving business environment, rising yields could put a damper on future returns expectations. At a minimum, I think it’s reasonable to argue that the capital gains are behind us, leaving only coupon clipping.
So why have I abandoned high yield bonds?
High yield bond yields have been pushed down to around 4%. As you can see in the chart below, this figure is historically low.
The following chart also shows yields on high yield bonds, but for a shorter time frame.
If high yield bonds are yielding a historically low 4% and rising interest rates act as a cap, at this point 4% is the best I can reasonably expect is for forward total returns on high yield bonds. I could be wrong, but given the information I have today I believe there are better alternatives.
You know what else yields about 4%? Royal Bank, Manulife Financial, TD Bank, Verizon and many other stocks out there. The kicker is that these companies will probably grow earnings and raise dividends over the years, flowing through a decent total return to shareholders. So at today’s cost, that 4% dividend yield could grow to a forward 5%, 7%, 10% yield on cost over several years. And as dividends grow, prices tend to follow. Try getting that kind of income stream and total returns profile from a bond.
So if the only remaining reason to hold onto high yield bonds is to collect the 4% yield, I’d rather move my money to dividend growth stocks. Consequently, I have sold all my high yield bond holdings and am redeploying into dividend growth stocks.
I understand the lure. It’s the weekend or you’re on holiday and your work phone pings. Or perhaps you walk by it on a desk and get the urge to ‘catch up’.
We’ve all been classically conditioned to check our phones.
So you sneak away for 2 minutes to check in to see if there’s anything urgent. Next thing you know you’re elbows deep in work emails, you’re mind is in corporate mode and your stress levels are rising.
Today in Canada is ‘Family Day’. Presidents Day in the US. Yet, just 10 minutes ago I felt the pull to check my work phone.
In a flash, I saw dozens of unread messages. Suddenly the final moments of my long weekend turned from relaxing until the sun rises to dreaded anticipation for the shit-storm about to hit in the morning. Nothing out of the ordinary. Just the ordinary, regular, daily shit-storm that we call work.
Repulsed at what I had just done, I quickly put the phone back down and walked back to my family and comfort of my living room. I’ll deal with it all tomorrow. Of course, I now must pay the price for my curiosity with a cortisol spike pushing through my bloodstream.
I spent no more than 30 seconds looking at my phone, but it was enough to see I received a dozen emails over the past 3 days – Saturday, Sunday and a holiday Monday.
Who the fuck is sending me emails when they should be spending time with their families or on leisure pursuits? I understand the drive to get ahead, but if productivity is really the siren’s call then why not learn a skill or read a book? Why attempt to ruin your colleagues’ Sunday with the Monday-to-Friday chaos?
Are these people bored? Do they have no interests outside of work? Or are they trying to cultivate the 24/7 workaholic image, which is celebrated in North American culture?
Worse, do they feel pressured by their peers to check their emails? After all, there’s nothing worse than being 2 days behind on a crisis.
Regardless of the reason, it’s unhealthy.
We already devote 5 out of 7 days to work, and much of the remaining two days is spent preparing for Monday. There’s already no such thing as a work-life balance. We don’t need to make it worse by answering emails on a Sunday.
- Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.
- The propensity to gamble is increased by a large prize versus a small entry fee, no matter how poor the true odds may be.
- Derivatives are like sex. It’s not who we’re sleeping with, it’s who they’re sleeping with that’s the problem.
- Wall Street makes its money on activity. You make your money on inactivity.
- I will tell you the secret to getting rich on Wall Street. You try to be greedy when others are fearful. And you try to be fearful when others are greedy.
- The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.
- We know that the less prudence with which others conduct their affairs, the greater the prudence with which we should conduct our own affairs.
- For some reason, people take their cues from price action rather than from values. What doesn’t work is when you start doing things that you don’t understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it’s going up.
- The stock market is a device for transferring money from the impatient to the patient.
- Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future.
- Buy a stock the way you would buy a house. Understand and like it such that you’d be content to own it in the absence of any market.
- The market is there only as a reference point to see if anybody is offering to do anything foolish. When we invest in stocks, we invest in businesses.
John Hussman of Hussman Funds is pretty bearish. Others are bullish. But I think it’s investing best practice to listen to both the optimists and pessimists. Only then can you approach the markets with a balanced perspective.
In his most recent market commentary, Hussman makes several points that shouldn’t be ignored. His most recent commentary is quite long, so I’ve provided a visual summary of his key points and charts below:
Valuations are at record highs for all stocks (not just an especially expensive segment of the market). The chart below shows price-to-revenues broken down by decile. Across the entire range of valuations, all segments are at record price-to-revenue ratios.
The same is true when breaking down the market by market capitalization. Small, medium and large cap stocks are all trading at record valuations.
Companies with negative earnings in particular have skyrocketed in valuation. This speaks to investor focus on the future. Unfortunately, expectations – like during the Internet bubble – often go unrealized, and lofty valuations eventually fall back to Earth.
As an investment strategy, hope is prevalent in the IPO market too. New issues – such as the recent Bumble IPO, which jumped 64% on the day of listing – shoot to the moon. Yet, many of these companies barely have any earnings (or even revenues in many cases) to speak of. Again, investors are flocking to IPOs in the hope of profiting off massive future potential.
Investors are so confident in the future they are willing to borrow to place their bets. Accordingly, margin debt as a proportion of GDP is at record levels! Borrowing to invest is a risky strategy. While one can profit handsomely investing other people’s money during a bull market, once asset prices turn it can lead to poverty. Moreover, the collective level of margin debt tends to exacerbate market declines as investors clamor to liquidate at the same time.
The US stock market capitalization is at record highs relative to US GDP. The value of companies relative to the value of what they produce has risen immensely.
Perhaps these charts don’t concern you because you’re a ‘long-term’ investor. Well, they should.
Valuations tend to be a pretty good predictor of future returns. The chart below maps Hussman’s estimated 12yr forward returns against actual forward 12yr returns – you can see the fairly tight relationship. Currently, Hussman’s model is forecasting a forward annualized 12yr return of -2.15%. Yes, negative. And yes, it is possible that long-term returns are negative because it has happened before. Moreover, historical periods of negative long-term returns tend not to be graceful and orderly. Rather markets violently oscillate between upward momentum and downward spirals.
Is Hussman right this time? I don’t know. Nobody can predict the future. And the future doesn’t have to look like the past. So who’s to say that valuations don’t stretch even further? Or that revenues and earnings climb rapidly to close the valuation gap?
I don’t know. You don’t know.
But what I do know is that history shows the risks are real. Hussman is observing rhe signposts.
I’m not arguing there will be a crash tomorrow. Yet, the probability of one grows as valuations are stretched and investors gain confidence.
My suggestion to all investors is to keep your confidence in check. If you start to feel highly confident in your investing prowess you may be taking on too much risk. Great declines are often preceded by great hubris. Be aware of your own behavioural biases and remind yourself that investing in stocks could mean losing 50% of your money at any point in time. And no, you’re not good enough to get out at the right time.
If Hussman’s market return projections are right, individual investors will perform far worse. Most investors tend to plough more money into investments near market peaks and withdraw money near market bottoms, experiencing all the downside and missing out on upside.
Consequently, most investors could have real world experiences far worse than -2.15% annualized over the next dozen years.
When people begin their journey into dividend investing, they frequently mistakenly focus on what they can earn today.
For example, a $100,000 portfolio invested in a diversified portfolio of dividend stocks with a yield of 3% will earn $3,000 per year. Dividend investors see this immediate income as the goal, and often stretch to find higher yielding stocks to boost their current income. What they fail to understand is their long term income goals are often at odds of their current income needs.
Remember: the dividend that is paid today will grow over time.
The S&P 500 dividend has grown on average 6.01% per year since 1989. If you exclude 2009 – a once in a lifetime financial crisis – during which the dividend on the S&P 500 fell by over 21%, the average annual growth rate is 6.89%.
The long term growth of dividends is the key consideration for dividend growth investors. If your time horizon to retirement is 20 years, you’re investing today for the dividend you expect to receive then. Because higher dividend yields often come with lower growth rates, it can be counterproductive to your future income to focus on generating income today.
Below I provide 3 hypothetical examples of portfolios generating 2%, 3% and 4% current dividend yield growing at 10%, 7% and 4% respectively. The growth rates differ because companies that pay out less in dividends generally can use capital for better purposes (i.e. growth). (Of course, this relationship is better represented by the dividend payout ratio, but for argument’s sake most companies with lower dividend yields tend to have lower dividend payout ratios.) The faster the company grows, the faster it is able to grow dividends. I then carry these assumptions forward over 20 years to see what income is generated at retirement.
As you can see, the lower current dividend/higher growth rate combo wins over the alternatives. In 20 years, this portfolio (assuming no additional investments) would earn $12,232. That’s 12.23% yield on original cost of $100,000. In reality, most people would be re-investing dividends along the way, growing the capital base on which more dividends are earned. But I’ll stick to a super-simple example.
The 3% portfolio ended up earning $10,850 per year in 20 years and the 4% portfolio $8,427. The 2% portfolio provides 30% greater income in 20 years! Why? Because it came with higher growth rates.
While today it might feel like a 2% yield is pointless for a dividend growth investor, over the long run that portfolio could potentially generate much greater annual income.
I look at dividend investing like I’m paying for something I will get in the future. When you invest for dividends, you’re really gaining a lower-cost entry point for the dividend that you expect to receive some time in the future. The longer your time horizon, the greater that dividend will be.
The thing is, to generate tomorrow’s income you need to invest today. Because the price for that income rises all the time. If the portfolio yield remains a constant 2%, the portfolio generating $12,232 in 20 years will then cost over $1.1 million.