... I thought was an appropriate title for this piece as we saw the launch this week of a new film version of Dad's Army in which no doubt the latest incarnation of Corporal Jones will utter his famous catch phrase. So what's that got to do with investing I can hear you thinking. Well the don't panic phrase is a good one to try and remember when we are experiencing volatile markets such as those seen this January and since equity markets, with the benefit of hindsight, topped out last spring / summer.
Now some readers may be younger than me and indeed you may have only got interested in the stock market in recent years when it seemed like it only ever went up. While some will be older than me and have seen it all before no doubt. But it is worth remembering that equity markets only go up about 60% of the time and in a bear market which is defined as a 20% drop from a top, they can and do go down by 30% to 50% or more as we saw as recently as 2008/9. In extreme cases when certain markets are unwinding from bubble conditions they can and do usually fall by around 80% or more from the peak - think .com stocks back in the early 2000's for a recent example of that.
Having said all that investing in equities for the long term (10 to 20 years) has in the past delivered decent real (after inflation) returns in the region of 5 to 6% per annum which is always worth remembering, but whether you achieve these returns is largely dictated by the price or rating you pay at the outset. Swings in ratings both up and down help to drive secular bull and bear periods in markets which seem to have lasted on average around 17 to 18 years. It seems to me that having had a 17 year or so re-rating which peaked out in 2000 with the .com bubble, we have remained since then in a secular bear market as the FTSE has failed to make a decisive break into new high ground. This has not however precluded big swings a profitable period within that along the way, which is also in common with history. Any way if you want to read more about the theory of these long cycles I would recommend a book Stock Cycles by By Michael J. Alexander - as featured in my Resources list of recommended books and other useful things. Included on there is a link to Crestmont Research - which is really useful resource for swatting up on market ratings history and secular bull and bear markets.
Aside from that I read a good piece on AAII.com recently which included some useful thoughts on a more rational approach to portfolio valuation. This basically talks about thinking like an owner as Warren Buffet talks about and having in mind a fair PE rating for the stocks you own. It suggests you then compare the rating that Mr Market is putting on your stocks and decide whether that is under or over valued and act accordingly rather than being influenced by noisy share price movements along the way. Seem quite sensible to me and well worth a read if you have been panicking about recent price moves on stocks in your portfolio.
Now for me the other longer term thing I focus on, as you know, is the income you can get from the dividends and compounding those. In a similar way to the article above, by focussing on these and what you think might be a fair or minimum yield you would expect on your stocks, you can also take a longer term perspective. Indeed it is also noticeable that in the past, although no guarantees for the future, that dividends have tended to hold up a lot better than prices during bear markets. This was evidence most recently in the 2008/9 bear market and subsequently when the UK stock market fell by around 50% but according to data from Capita (see page 6 of report) total dividend payments only fell by 14.3% between 2008 and 2010. They have since 2010 gone onto rise by 49% which represents an exceptional rate of growth of 8.3% per annum over the five years since then. I say exceptional as in the long run real dividends have tended to grow by more like 1 to 2% in real terms and indeed if you look at all the data in the Capita report on page 6 and include their forecast of a small fall in dividends for this year then the growth rate over the whole 9 years is likely to be closer to 3.5% per annum which in real terms will be closer to the long run average.
On the subject of dividends and their volatility versus the market prices there was an interesting look at the history of this in the US at A wealth of common sense - called The Incredible growing dividend. Now while this was US based data it did help to highlight why I like to focus on growing dividends and compounding them over time. Further to that there was an update last year to research from the value house Brandes Institute called: Income as the Source of Long Term Returns. This looked at the importance of dividends in the long term, the dividend yield gap versus bonds and also the stability of dividends in the longer term. Indeed they found that the volatility of the dividend streams themselves was a very small fraction (under one-twentieth) of the volatility of stock price movements.
From this report I particularly liked the lessons from the following extracts:
The message in Exhibit 7 is clear: higher dividend-paying stocks delivered higher total returns. While this was partly due to the dividend return, it is also notable that on a price-only basis, the top three quintiles of dividend-paying stocks had higher price and total returns than quintiles 4 and 5, as well as the non-dividend-paying stocks.
We have stressed the long-term nature of this research. However, many investors still have concerns over short-term price volatility. Did a focus on higher yielding stocks cause exposure to extreme stock price fluctuations? Again, the answer from our research is “No.” In Exhibit 8, we look at volatility of both stock prices and dividends within the quintile universe. Volatility of stock price returns was lowest for the highest dividend yield stocks, and increased steadily as dividend yields declined. So investors in the top quintiles received both higher returns (Exhibit 7) and lower volatility (Exhibit 8). My emphasis on the last bit there as that is as close to investing Nirvana as you can get I would say. I would also highlight that they also observed:
We have long held that paying excessive attention to short-term price movements is a behavioural error that can lead investors to make bad investment decisions. The data in this research suggests that investors might do much better to focus on their portfolio’s income stream as it develops over time. Exhibit 8 shows that the volatility of that dividend income stream was a very small fraction (under one-twentieth) of the volatility of stock price movements. To the extent that volatility causes investors to worry, switching attention from price volatility to dividend volatility might ease that worry substantially.
Summary & Conclusion
So definitely worth focussing on the income and thinking long term to avoid worrying about short term market volatility and making behavioural errors as a result I would say. Having said that though in the short term it is worth bearing in mind the Capita forecasts and the suggestions of others that dividends are more vulnerable now as levels of cover in the UK have been run down to low levels, so I suspect the outlook for dividend growth from the market overall may not be as good going forward in the short term, but do try and think long term and don't panic.
This is especially obvious in the UK given the concentration in income from the top 5 stocks which represent 33% of the income while the top 15 represent over 50%. As the top 5 all have question marks over the sustainability of their dividends, this is worth bearing in mind if you are investing in tracker funds.
That's why I prefer to invest and seek out companies able to grow their dividends in a diversified fashion so my income is not dependant to a large extent on a handful of companies and should therefore give me a growing income stream to live off of and compound over the long term as hopefully I might have another 20 to 30 years on this planet if I'm lucky. Or as the Brandes Institute put it:
We believe this research illustrates that the industry acceptance of five years as a long-term investment horizon underestimates the potential of reinvesting and compounding income. By reinvesting the income contribution of investment returns, investors can leverage the power of compound interest. Investors should not let recent market experience distort their perspective, and particularly should avoid preconceptions that income is less important than capital gains in its contribution to total equity returns. Income has served as a significant component of returns, and the combination of reinvested income and capital appreciation historically has presented the best option for long-term investors to realize optimal returns.
Cheers have a great weekend, whatever you are up to. Finally to bring the post to a close and to bring it back full circle to the title - as it is the weekend and it has been a while since I inflicted any music on you - here's a song from a new band The Brothers Osbourne called - Stay a little longer which seems appropriate in the context of this post.
...according to the latest Capita Asset Services Quarterly Dividend monitor in which they are forecasting a modest fall in underlying dividends of 1.3% for 2016 after 6.8% growth in 2015. This is predicted on the back of major dividend cuts and takeovers already announced with the mining and oil sectors also making a major contribution to this, although they note the oil majors have held their dividends for now. If they join in then I suspect the fall at the headline level could be even larger given that RD Shell and BP are the Number 1 and 3 in the list of largest payers.
Other interesting snippets are that the strength of the US$ v £ helped to boost dividends by £2.5bn or nearly 3% as around 40% of dividends in the UK market are declared in US$'s.
While more than 50% of the yield comes from the top 15 companies further illustrating the concentration risk in the UK index, while Mid Caps saw much stronger growth in dividends.
Despite this expected fall they point out that Equities still offer the highest yield of all asset classes, although clearly this may reflect the capital risks and the distorted rates on cash and bonds. There is also a useful table on page 11 breaking the index into cyclical and defensive sectors which might be worth noting going forward if we are going into a more difficult phase in the market.
We had the second budget of the year this week was much heralded as the first fully Tory budget for around 20 years. However it was quite strange and looked more like a budget from a coalition with Labour to me as he seemed to raid some of the tax changes Red Ed had proposed before the election. Then as George became Red George he even decided to intervene in the markets by forcing employers to pay what he called the living wage - I reckon Maggie Thatcher will be spinning in her grave!
The other surprising thing from a Tory chancellor and the one significant thing for income investors in the Budget was the change to the taxation of dividends. He scrapped the dividend tax credit from April next year and introduced from the same date a new £5,000 tax free allowance fro dividend income. This is supposed to encourage people to invest, but will mean a tax hike for more wealthy investors who have portfolios that earn more than £5,000 per annum in dividend income.
I shared this article on Twitter recently and it generated quite a bit of discussion. So just in case you're not on Twitter I thought I'd add it here. It gives a good explanation of the effects of the changes and discusses the best ways to use the various allowances that are available. Obviously makes sense to use your ISA allowance as a result of this if you can afford to and them at least beyond that your first £5,000 of income will be tax free.
...but a 12 year low against the US dollar, you might want to think about the currency exposure of stocks in your portfolio. Those that have large exposure to Europe will be likely to see translation related downgrades if this strength in Sterling lasts and conversely those with dollar earnings will see a benefit. Also simplistically if they are exporting to Europe or the US from the UK then they will be likely to either become more or less competitive and gain or lose business or perhaps suffer a margin squeeze as they may have to cut prices to stay competitive.
However having said that the market is quite good at anticipating and looking through these type of effects, especially as Companies are better these days at highlighting results in constant currencies and often use average rates and some undertake hedging too in any event, so worth bearing that in mind. It is also quite beneficial for the UK markets overall dividend growth as a number of large dividend stocks declare their dividend in US dollars.
So when looking at earnings revisions it is also important to discern those which are more driven by fundamental changes in the business rather than just driven by currency fluctuations, although clearly at the margin currency moves can affect the prospects of a business if they are exporting as mentioned above.
Any way other than that it is a pretty quiet news day but I see that Dart Group (DTG) a Leisure Airline, Package Holidays and Distribution and Logistics company has had a positive profits surprise this morning which may well have been helped by the € move which I highlighted recently as possibly helping Easyjet (EZJ). I guess there should also be a positive read through from this to TUI who also have merger benefits on top too.
Finally talking of travel and holidays with excellent timing I'm driving off to the airport soon to fly with Easyjet to enjoy a relaxing City break in Europe, so no posts next week. So I'll leave you with a couple of classic 70's tunes appropriate to this, au revoir.
We have had final results from the Lloyds of London Corporate capital vehicle Amlin (AML) today. This is a well managed group that says about itself that:
"The strength of our franchise, underwriting expertise and ability to adapt are powerful advantages as the market evolves. Amlin is well positioned to take advantage of the opportunities created by the pace of change in our markets, and has an excellent track record of cross-cycle underwriting discipline. We continue to believe that we can deliver attractive returns on equity."
Talking of ROE they delivered around 14% this year down from nearer 20% last year, reflecting the more competitive nature of the insurance market this year which they flag up in the statement. They expect this to continue in the year ahead and as a result they are cutting back in some areas where there is excess capital chasing premiums and reducing returns.
Consequently they have announced today a special dividend of 15 pence, as they do periodically in times like this, to keep their balance sheet efficient and to support their returns. This gives a yield of 2.9% based on the 513p share price this morning and is in addition to the full year dividend of 27p which was up by 3% for the year and which itself gives a yield of 5.3%.
Summary & Conclusion
They shares look fairly valued on around 1.6 to 1.7x tangible book value given their ROE and similar metrics that apply to Catlin (CGL) which is about to be taken over. The main attraction is the 5%+ yield from dividend which had grown by nearly 9% per annum over the last 5 years. However, this years dividend of 27p was some way short of the estimates that were in the market, although perhaps they included some expectation of a special? Taking this into account the compound growth rate over the last 6 years comes down to 8%, which is still quite good given the current yield. I guess given the outlook the rate may be a little slower in the current year but it should still be sufficient for the shares to offer a double digit potential return, which seems fair enough. So they would seem like a strong hold for income as part of a diversified income portfolio.
Meanwhile in brief GlaxoSmithKline (GSK) have confirmed that its three-part transaction with Novartis has completed today. As a result, following today's completion, GSK plans to use the transaction proceeds to fund the full amount of the previously announced capital return of £4 billion to shareholders. Subject to shareholder approval, the capital return is expected to be implemented through a B share scheme, which will provide capital treatment for all UK tax-resident shareholders. Further details on the capital return will be sent to shareholders in due course.
In light of the timing of closing the transaction, the Company intends to report its first quarter results for 2015 and hold an Investor Meeting on 6 May 2015, at which it will provide 2015 earnings guidance and profile the medium and long-term shape and opportunities for the enlarged Group.
So if you are a holder it will probably be worth putting that date in your diary. While the £4bn is around 5% of the market cap and could effectively double this years expected unchanged dividend from GSK it is just a return of capital so the value of your remaining holding will go down by the same amount.
Longer term readers will also know that I have concerns that this business restructuring and the New Chairman Sir Philip Hampton (who has been involved with dividend cuts and omissions throughout most of his career) increases the risk that GSK will use this as an opportunity to "re-base" the dividend (as nobody cuts these days) going forward after this year.