Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement. You can get a free copy here.
There’s nothing especially interesting about interest rates. You can lend the government of Canada money for 10 years and earn less than two cents on the dollar. It’s a pretty safe bet, but it’s not enough to live on unless you’ve got at least a few million to lend Ottawa, and who really wants to lend politicians money anyway.
The average yield on five- to 10-year government debt, in fact, is 1.56 per cent and falling. The true cost of living for most people is going up faster than that so you might as well spend your money instead of saving it.
Why are interest rates so low around the world? Because economies are sputtering and everyone’s in debt. Will that change in the short term? To answer just look at Europe. It’s been gorging on debt and drowning in profligacy since the end of the Second World War. Do you really think a quick rebound is in the cards?
The United States is in slightly better shape, but not much. BRIC countries? Well, you’re only as healthy as your customers in business, so no surprise they’re sputtering, too.
This may make you want to throw in the towel as an investor, but don’t. There are always opportunities. Today the opportunity lies in companies with the following characteristics: They are easy to understand, they produce lots of cash, they are stable, they have the opportunity to cut costs if revenues stagnate or fall, and they pay dividends and offer a generous yield.
A fine example is BCE. Ye Olde Telecom Shoppe has been around for about a century. The business has evolved from regulated supplier of landline services to a conglomerate of mobile, landline, media and satellite offerings, but it’s still pretty easy to figure out. The company has a market capitalization of $34-billion and cranks out cash for shareholders, most of which it pays in dividends, but it does retain some to make acquisitions and re-invest. Some of that investment is defensive – meaning it protects the business. Some of it is supposed to help the company increase its revenues – modestly of course. It’s hard to grow quickly in a mature industry.
Lots of analysts cover BCE and they are, by and large, lukewarm on the stock. But I think investors should be bullish and the argument is pretty simple (I own stock, incidentally).
BCE’s dividend yield is 5.1 per cent. Government bonds yield less than 2 per cent. Is that a realistic gap? Is BCE, an equity that can and has increased its dividend lately, really that much more risky than a government bond? BCE stock trades at 13.5 times earnings, a multiple that I’ll grant you might seem a touch rich given its earnings growth potential. But this is a big bureaucracy – meaning there’s still plenty of room for cost cuts even if revenues don’t grow much (although they were appreciably higher in the latest six-month period). The company has cut costs already, but it’s hard to overestimate how fat an old cash cow can get.
So the question is what kind of a yield would investors accept from this company? The company aims to pay out 65 per cent to 75 per cent of its earnings in dividends. It’s at the midpoint of that range now so no worries about coverage. Should the stock yield more than three times the government’s offer, especially considering that the latter minuscule payout is basically not economically viable for most retirees? Corporate bonds offer more than governments but the argument still applies. There are people who can’t afford to rely on bond interest.
So again: What would they accept from BCE stock in order to buy it? It’s hard to answer that with precision, but let’s say the company doesn’t raise the dividend (unlikely, but just assume) and investors decide that they’ll accept, say, a full point less or 4.1 per cent to hold BCE stock. That implies a share price of $55. It’s in the $44 range today.
That’s a pretty simple analysis but simple usually works, even, and maybe especially in the unusual times such as those we live in – interesting times.