Sunday, February 24, 2008

Warren Buffett is a Man of Great Faith

Everyday, it seems we are fed the latest dose of bad news about the economy -- from housing to unemployment to inflation. Did it ever occur to you that there might actually be good news out there? Good news that puts all of the bad in perspective and calms the bad-news blues that always seem to be accumulating in our stomachs. I believe the good news that so many people miss is that life is ticking on and it a good life, even if it never makes the cover of the New York Times or the Wall Street Journal. People are going to work, caring for their families, building lives, serving their communities and their fellow man. I would like you to let you in on a secret. Blessings abound in this world. Opportunities are everywhere and one of the greatest capitalists of all time agrees with me, or maybe I should say, I agree with him. While in Canada recently, Warren Buffett was asked if he was pessimistic about the United States in light of the subprime crisis. The following are some excerpts of his comments in an interview with the National Post of Canada. (click to read whole article) "Warren Buffett said Wednesday he is confident the U.S. financial sector can get through its troubles without a government bailout and remains bullish about the long-term prospects for the U.S. economy. "I am a huge bull on the American economy," said Mr. Buffett, in an exclusive interview with the National Post. "We'll always get through," he said. "I'm a bull on the United States. Just think about how silly it would have been to be anything other than a bull on the United States since 1790. It is not a smart thing to sell the United States short over the years -- or Canada for that matter. The world does get better. People get more productive. More human capacity is unleashed over time." I have no notion if Mr. Buffett is a person of religious faith, I hope he is, but I have noticed that he has more faith in the United States and humankind than most other financial people I have known over the last 30 years. He is constantly buying or trying to buy companies that the markets are shunning; companies investors are throwing away as being worthless; companies whose time has past, or whose problems are too daunting to survive. The following is just a short list of some of Mr. Buffett's investments in recent years: He bought a building materials company when asbestos lawsuits were filling up court dockets; he bought at least two troubled utilities; he recently bought a handful of US banks at the height of the subprime crisis; he bought a mobile home manufacturer; he bought into Lloyds of London when the risks were huge. He was active in taking on more risk in his reinsurance divisions after the devastation of 9/11 and Katrina. He recently offered to take on the risk of nearly 800 billion dollars worth of the municipal bonds of American cities and towns. In all these actions Mr. Buffett has been exhibiting faith. Faith in humankind. Faith in the laws of our country. Faith in the leadership and workers of the companies he buys. Faith in our system of private ownership and the rule of law. Somewhere along the line he learned something very valuable from which we can all profit: Everything is not going to hell in a hand basket, in fact its destination is in the other direction. This bit of wisdom has enriched him beyond measure, brought him remarkable fame, and given him a joie de vivre that few people possess. He says he tap dances to work. This does not sound like the kind of man who pays much attention to the evening news.

Tuesday, February 19, 2008

Barclay's Dividend Hike is Good News

Dividend investors always look for the bits of dividend news that go unnoticed or underappreciated. This kind of news usually occurs on a day when hot news breaks on other subjects. Stocks faded yesterday as the price of oil rose to $100 per barrel, but there was a very important piece of dividend news that went largely unreported: Barclays Bank (BCS), the third largest bank in Britain, raised its dividend nearly 10%. This is important because Barclays, like so many of the world's large banks, has had to take write-offs of subprime loans. They did so again in yesterday's report, but overall their financial results were above expectations and the market reacted favorably with Barclays US ADRs rising nearly 9%. With a price rise of that magnitude, it may seem like the market moved right in step with the good news in Barclay's report, but I believe it missed something. In the report, Barclays forecast that earnings growth over the next 5 years would be in the 5%-10% range. For Barclays to raise their dividend 10%, which is at the high end of their stated target, signals to me that they are more confident about their near-term growth prospects and remaining exposure to the subprime situation than most investors are giving them credit for. A 10% dividend hike in a tough year reveals some real moxie on the part of Barclay's top management. It shows a commitment to their shareholders to keep the dividend growing at a reasonably steady pace in spite of the ups and downs of the banking business. This is something I wish more companies would do. I'm hoping Barclay's price has seen the bottom. If it has, a little more air will have been taken out of the winds of the subprime financial storm. The bottom of the subprime mess will come company by company, as each becomes more transparent and proves to investors that they are not irreparably damaged by the bad loans they made in the subprime area. Remember that write-offs are a very serious and damaging event for a bank, but they are a paper loss. No one knows what the real loss will be until the collateral is sold. A cash dividend is real money paid at a specific time in a specific amount; cash dividends are not subject to recall, nor can they be fudged for very long. Barclays' 10% dividend hike, in my judgment, is much more important than the write-off they took. Not in terms of money, but in terms of the message the company is sending regarding its future. Barclays is one of the world's most valuable banking franchises. Their 10% dividend hike is the kind of validation I look for in tough times that the company believes better times are near. If better times, are indeed near, Barclays should play. With the 10% dividend hike they now yield over 7%. That compares pretty favorably to the yield on the average stock of about 2%.

Tuesday, February 12, 2008

Dividends Talk, Here's What We Think They're Saying

I believe dividends talk. They may speak softly or be ignored altogether, but they talk just the same. I have often noted that the voice of the dividend is the most important voice to listen to because it represents the considered opinions of a company's board of directors. In this way dividends speak as much about the future as the past.

Most of us do not invest in the actual US economy. It has recently become a parlor game of sorts to bet on whether or not the US economy is in recession. I don’t think it matters much whether the US has an official recession in the coming year or not. I think it's clear that our economy will slow, and the assumption could easily be made that earnings and dividend growth will also slow in the year ahead.

Here is where an important distinction needs to be made. We live in a global economy. Indeed the stocks we invest in derive nearly 60% of their revenues and earnings outside the United States. Thus, there is no hardwired relationship between our US economy and the earnings and dividends of most major US corporations. It is not a direct route from a weak US economy to a weak US stock market. Indeed, Wall Street analysts are currently estimating mid double-digit earnings growth for US stocks in 2008.

I am going to start a new feature I’ll call "Dividends Talk." Dividends Talk will report periodically on important dividend increases and decreases. I will not try to analyze all companies; I'll leave that to S&P and others. I’ll just show a short list of recent dividend actions and analyze the growth trends, or lack of them.

The table at the right (click to enlarge) shows 10 dividend actions of large corporations that occured in the last two weeks. There were no dividend cuts and 10 dividend hikes. The growth rate of each hike can be found in the eighth column.
I have compared the company's most recent dividend hike to an average of its 3 and 5 years growth rates, which can be seen in column 7 (I'm doing this to eliminate any huge increases that would skew the data). The actual data for the 3 and 5 year averages is shown in the previous two columns.

The bottom line: Of these 10 companies the average dividend increase is 15.2%, just slightly higher than their 3-5 year average of 14.7%. With double-digit dividend increases of this magnitude, these companies sure don't think their businesses are facing hard times.
I'll be keeping a cumulative running average of this year's hikes versus the 3-5 year average. This will give us a strong clue how US companies are faring compared to the last 3-5 years, which was a time of strong dividend growth.

I believe dividend growth will remain strong in 2008, which would indicate that large US companies may well be doing better than the US economy. Again, the reason is simple: Most US companies are active players in the global economy, and, the softness in the US economy will be more than offset by the strength of the global economy.

From the table above, I believe there are three companies of note: Aflac (AFL), Praxair (PX), and Prologis (PLD). AFLAC and Praxair continue with their remarkable 25% dividend hikes. Both of these companies are very international, and their global business strategies are paying off with no signs of letting up.

I have highlighted the third company in yellow: Prologis. Prologis is a logistics company that is involved in every phase of the movement of the merchandise of international trade. The company is organized as a REIT, thus their dividend hike of 12.5% for 2008, up from an average of a 6.7% over the last 3-5 years is quite impressive. PLD's dividend hike speaks volumes about the global economy. The global economy does not have the subprime mortgage issues we have and it is growing, in some cases two or three times as fast as the US's.

When these three companies are taken together, they suggest that the global economy is alive and well. This will be a major help to American companies with international exposure. It's a big world out there, and many of these companies have been there for a long time, and it's paying off.
We own or have owned almost all of these stocks. We will not concentrate only on stocks we own. It just so happened that this week most of the actions were among companies we own and follow.

I'll update the running list in a week or so.

Thursday, February 07, 2008

Uncovering Value with Total Dividend Return

At our firm, we believe in the concept of TDR, the acronym for Total Dividend Return. TDR is important to us because we believe it can offer a rough approximation of the total return (TR) of a stock over the long-term. We define Total Dividend Return as dividend yield + dividend growth. Total Return, on the other hand, is defined as dividend yield + capital appreciation. Total Return is the standard way of measuring rate of return, but it implies that today’s price is the only measure of a company’s value. We believe that is shortsighted, especially in volatile times like today's market.

Please note in the definitions above that "dividend yield" is contained in both. It should be because dividends are real money and have represented almost 40% of the total return of stocks over the long-term. Yet, just because dividends have been nearly 40% of the return for stocks over the long-term, what is our rationale for thinking that they can also explain the other 60% of total return?

Oddly, our research shows that for most companies, TDR doesn't work. For the average stock there is not enough of a correlation between price growth and dividend growth, thus TDR is of no help in determining value. However, for about 25% of the companies in the S&P 500 and about 15% of the major companies of Europe, there is a strong relationship. In some cases, the correlation is near 90%. For this short list of companies, an old adage we like to use is: So goes the dividend, so goes the stock.

Where a correlation exists between a company's price and its dividend, TDR is an important tool in uncovering value. The reason is simple: dividends for most companies are far less volatile than earnings, sales, or any other financial data. If a company's dividends are easier to predict than these other variables, then by extension over the long run, so are their prices.

Total Dividend Return then becomes our compass. It is our means of understanding where we are in the market’s vast universe of stocks, and which direction to go to find the best and most predictable values.

The table below shows a few companies whose dividends have been highly correlated to their prices over the last 20 years.

I chose these companies because they represent a wide range of industries and have long histories of paying and increasing dividends.

As the table shows, the average price growth of among these companies has been about 13% over the last 20 years. Remarkably, dividend growth has averaged only slightly less at 12%. A look at some of the individual members of the list is even more remarkable. The respective price and dividend growth data for Wells Fargo, GE, and Pepsico are almost identical over this 20-year period.

Now think about this for a moment. Are the boards of directors of these companies raising their annual dividends to match the annual price growth of their stock? Or is it the other way around; Is the price growth of the stock getting its cues from the board's dividend increases? We believe it to be the latter.

Next time we will compute the projected Total Dividend Return over the next three to five years for the aforementioned companies, using their current data.