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Yield Hog

Dividend-seeking investors: Beware Trader Nation Add to ...

Welcome to Yield Hog, a new weekly column geared to income-seeking investors.

Why Yield Hog? No, it has nothing to do with trading pork belly futures. Yield – whether it’s from common or preferred shares, bonds, real estate investment trusts or an ever-expanding menu of exchange-traded funds – is of growing importance to investors, many of whom are looking for ways to supplement their retirement incomes.

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And while we’re not suggesting you should be a pig about it – outsized yields are often a danger sign, as any Yellow Media investor can tell you – having a healthy appetite for stable, income-producing securities is a prudent strategy.

Every Wednesday, we’ll explore a topic of interest to income investors. It could be an analysis of a promising dividend growth stock, an in-depth look at a bond ETF or a discussion of the tax implications of REITs. We’re also open to hearing your ideas. (Note: I’ll still be answering your investing and personal finance questions in my Investor Clinic column, which is moving to Fridays).

At Yield Hog, we’re big fans of dividends, especially companies with growing dividends. That brings us to today’s interview with Daniel Peris, author of The Strategic Dividend Investor: Why Slow and Steady Wins the Race. Mr. Peris, a portfolio manager with Federated Investors in Pittsburgh, makes a strong argument for buy-and-hold dividend investing, a time-tested strategy that’s been pushed aside in recent decades by a casino mentality he calls Trader Nation.

What is Trader Nation and how is it hurting people?

Trader Nation is what I call the environment of very short holding periods and a fundamentally speculative nature to the stock market, where people are in it to buy low, sell high, repeat frequently. It’s an environment in which people are constantly looking at their brokerage accounts and they have CNBC on every minute. You’re certainly welcome to do that, but it ends up not working most of the time for most investors.

Your book argues that a dividend-based approach yields superior returns with less volatility. What do you look for in a dividend company?

The primary thing that we’re looking at is free cash flow, which is technically cash flow from operations minus capital expenditures. And that can be adjusted for types of companies in specific industries. We’re looking at the ability of the company to service the dividend and whether the company’s business prospects are such that it can modestly grow the dividend over time.

What is the “5+5 Portfolio”?

We talk about having portfolios that have a 5-per-cent yield. That’s the current income stream. And if we’re doing our job well, that income stream will grow about 5 per cent a year. That’s useful in offsetting inflation as well as generating capital appreciation. Together, the yield and growth should produce a total return of about 10 per cent, before fees.

Investors have been led to believe that stock buybacks are a good thing, but you’re critical of them. Why?

As a business owner, the last thing I would want my partner to do is to take the profits of the corporation and head to Atlantic City or Las Vegas, and that’s more or less the equivalent of what a share repurchase program is. The board is allowing the company to take the profits and purchase stock with them, their own stock, mind you, but stock. Basically there’s an arrogance there that assumes the company managers can play the stock market better than other people. But the historical record is absolutely clear: Not only do they not do it better than others, they actually do it worse. Share repurchase programs are generally executed when the share price is high, not when it’s low.

What would you prefer companies do with the cash?

Rather than speculate in the stock market with shareholder funds, if they cannot reinvest in the business at a good rate of return, then they should return the cash to shareholders in the form of a cheque. Share repurchase programs are not returning cash to shareholders. They are quite the opposite.

Do the funds you co-manage have any Canadian content?

Yes. They’re the usual suspects – the larger-cap, higher-quality corporations, stable businesses that have profits and can reliably distribute them. Canada is blessed with, frankly, an abundance of those types of names and we own businesses in the communications sector and also in financial services. The Canadian banks are to be applauded for not having cut their dividends, and that did not go unnoticed down here.

You make the point that over the past 25 years dividend payout ratios have fallen to about 30 per cent of profits from about 50 per cent, but you expect payout ratios to rebound. Why?

The greatest single cause of falling payout ratios was the decline in interest rates from 1982 to the present. With rates now at record lows, the capital markets interpret that and say companies don’t need to pay as much in order to attract capital. But interest rates can’t go any lower, so now the question to ask board members and treasurers is: Where do we go from here in terms of payout ratios? And as far as I’m concerned the only logical answer is up.

We are facing a low-return environment for financial securities and more muted economic growth in Canada and the U.S. So what are companies going to do with their cash? Clearly, investor demand is there for higher dividend payouts. Eventually the demand side, plus the limited reinvestment opportunities, are going to push the boards in the direction of bringing up their payout ratios.

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Federated Strategic Value Dividend Fund

Author and Federated portfolio manager Daniel Peris looks at the ability of a company to service its dividend and whether the company’s business prospects are such that it can modestly grow the dividend over time.

Top Holdings as of Aug. 31

Company

Ticker

Dividend Yield (%)

AT&T

T-NYSE

6.1

Verizon

VZ-NYSE

5.5

Abbott Labs

ABT-NYSE

3.8

Bristol-Myers Squibb

BMY-NYSE

4.3

Johnson & Johnson

JNJ-NYSE

3.6

Eli Lilly

LLY-NYSE

5.4

Procter & Gamble

PG-NYSE

3.4

Unilever

UL-NYSE

4.1

Altria Group

MO-NYSE

6.3

Royal Dutch Shell

RDS.B-NYSE

5.3

 

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