Proprietary investment strategy
401 Advisor, LLC specializes in building client portfolios using dividend paying stocks due to their long term history of providing superior returns over non dividend payers. I recently contributed to an article posted by U S News on their web site. The article highlights warning signs that a stock may be cutting their dividend in the future.
Our largest investment strategy based on assets under management is our Dividend and Growth Plus strategy. I combine for our clients stocks that pay a modest but increasing dividend with stocks that have a high dividend yield, but less likely prospects to raise the dividend consistently over time. The combination provides our clients with a relatively high, and rising dividend stream that can be used for income, or reinvested for growth. I like the idea of stocks that pay us to hold them; it’s a way to add a “company match” to an IRA account.
Below is one of our more popular holdings, Prospect Capital Corporation (PSEC). Shown is a price chart for the past twelve months. You can see that PSEC had a sudden drop in November of 2012. This turned out to be more frustrating than troubling, as the following month, (indicated by the yellow arrows) PSEC actually increased its dividend by 7.8%. Not the actions of a company in trouble as might have been indicated by the November price drop. Since that time the stock has apparently meandered along, while the stock market has risen over 10%.
Chart 1 Prospect Capital Corporation 12 Month Return
However, what the chart doesn’t show is that PSEC’s current dividend amounts to a 12.03% yield. Pretty healthy by today’s paltry interest rate standards. The stock also sports a lower than market Price to Earnings ratio (P/E) of only 8.49 based on projected 12 month earnings. These are the stocks we love, high yields and low valuations! The only question is, will earnings be stable enough to continue paying that high dividend? If recent results are any indication, the answer is a solid “yes”. The company just announced that their net investment income increased by 43%, year over year for the period ending June 30,2013.
What does this mean to our clients? Not only is the current dividend “safe”, but PSEC also announced that they plan on increasing their dividend payout beginning in March of 2014. When our “high yielders” raise their dividends, we consider that a double bonus.
For more information on how to derive high yields in a rising rate environment, please call the office for a free consultation.
All opinions included in this material are as of August 22, 2013, and are subject to change. All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. Past performance does not guarantee future results. 401 Advisor, LLC currently holds shares of PSEC in client accounts and is likely to add to those positions over the next 30 days.
At 401 Advisor, LLC one of our three investment strategies for our client assets is a model that primarily uses dividend paying stocks to produce cash flow. Dividends can be paid out to clients for income, or reinvested to provide portfolio growth through the purchase of additional shares.
The one disadvantage of choosing a strategy that narrows the investment options (only stocks that pay dividends in this case), is that different subsets of the overall market will both outperform and underperform the entire market for different periods. From the beginning of May through the end of June was one of those periods of underperformance for dividend paying stocks. Not only did we see underperformance, but we also saw uncharacteristic volatility. I wrote about this on my post on June 21, “Market Comment“.
This is when having a strategy that fits your investment goal is important. Matching strategy to objective allows us to focus on what is most important to our clients. In this case, income and preferably rising income.
I looked at 17 of our portfolios’ top holdings. While this would not necessarily represent any individual’s portfolio, every one of our Dividend and Growth Opportunity strategy investors will hold several of these stocks. For the averages I just used a simple average and looked at stocks only, none of the ETF holdings.
I first looked at each holding’s price performance from May 1, 2013 open through the close on June 21st. I then looked at the first dividend paid in 2013 and the most recent and annualized the two to look at the difference.
Taking a simple average the “portfolio” has a year to date price gain of 4.17%, but a loss of 4.67% from May 1 through June 21. For an investor on January 2nd, the portfolio yield would have annualized to 4.57% for the year based on first quarter dividend payments. But based on the most recent dividend payments, the annualized yield would be 4.69%, a raise of 2.56% (annualized to 5.12%). Plus dividend stalwarts McDonalds and Verizon typically raise dividends in the third quarter. With official inflation running at about 1.5% our income investors have received a nice raise in return for the volatility we’ve seen this year. In fact our largest loser in the portfolio, UHT has actually increased its dividend from $0.62 per share to $0.625 per share. Relatively small, but showing that a yield increase is not dependant on price appreciation.
For a retiree especially, income and income growth are their typical primary investment objectives. Well chosen stocks, based on free cash flow analysis, will continue to pay, and as we’ve seen actually increase dividend payouts, even in declining markets.
Despite recent weakness and some continuing uncertainty over rising interest rates, a focus on dividends is a long term profitable strategy. Below is a graph from Ned Davis research that shows that dividend paying stocks, and specifically stocks that increase their dividends outperform the overall market.
The attached article was published at horsesmouth.com on 5/2/2013. While the market continues to show technical strength, key economic data is deteriorating. While we remain fully invested, we are rotating portfolios to lower risk holdings.
The data looked good until the last half of April. Now the five factors needed for a continued rally have taken a decided downturn, prompting one advisor to move into a low-beta strategy and collect dividends over the summer. His advice? Watch SPLV and JNK very closely.
Recently we’ve seen a turn in economic data that may be showing a soft patch ahead for our economy. But with a plethora of data to choose from, which data really matters?
In the past I’ve used a study by Citi equity strategist Robert Buckland that suggests that after a significant increase in the market, there are five factors that determine whether an existing rally can continue.
But before we look at that data, let’s first take a quick technical look at where we are according to three indicators: SPY (SPDR’s S&P 500 Index tracking ETF), SPLV (PowerShare’s S&P Low Volatility Index tracking ETF), and SPHB (PowerShare’s S&P 500 High Beta Index tracking ETF).
Below is a year-to-date candlestick chart of SPY, with the 200-day simple moving average (SMA) in yellow. SPY is clearly trading well within its uptrend—as indicated by the white lines—which started in November of 2012.
Despite the media’s Chicken Little reaction on every down day, the candle chart provides a quick visualization showing that volatility also appears to be well within a “normal” range. And, finally, SPY is trading well above its 200 SMA, a common indicator of the strength and future direction of the market, as long as the 200 SMA also continues to show an upward trend.
Figure 1:SPY 12 Months
Source: http://www.freestockcharts.com
In Figure 2, below, I’ve added SPLV (yellow line) and SPHB (blue line) to the graph of SPY (green and red line). I’ve also changed the time frame to a year-to-date view. The white trend line shows that SPHB has turned negative since about mid-March, while SPLV has continued to show gains.
The result has been a relatively flat SPY. This shows a definite rotation from riskier high-beta stocks to lower-risk, lower-volatility stocks. While this is a “risk-averse” move, it is significant that SPLV is still showing a positive trend. Investors to do not appear to be concerned about a broad market sell-off but are apparently (and logically) looking for the lowest-risk securities—probably as an alternative to near-zero-interest-rate bonds. More dividend-paying securities will be in the SPLV index than the SPHB index.
Figure 2: SPY vs. SPHB vs. SPLV Year-to-Date
Source: freestockcharts.com
This is a graph I look at on a weekly, if not daily, basis. We moved out of SPHB and into SPLV for our Seasonal ETF strategy at the beginning of April. I will get very defensive if SPLV starts showing a downtrend along with a continuation of SPHB’s down trend.
Back to the fundamentals
While a rotation from SPHB to SPLV could just be an indication of investors looking for yield, it could also be an early warning sign of bad things to come. Do the fundamentals warrant a continued rally or a sell-off?
Let’s use Citi strategist Robert Buckland’s five criteria for a continued rally to help us determine whether this upturn might continue. We rank each criterion as a positive, negative, or neutral development:
Assessment
When I looked at this data in February, all five criteria were positive. Looking back at the economic report tables, I’d say this data has been fairly positive until just the last half of April.
And that’s the problem with economic forecasting. At inflection points, it is impossible to know whether or not a turn in data is an aberration, a temporary blip, or the beginning of a trend reversal. The one point that keeps me mildly optimistic is that virtually every forecaster predicted a soft first quarter for 2013. So this has not been a surprise.
Investment strategy
I follow the “sell in May” strategy supported by The Stock Trader’s Almanac and their research. However, we use a low beta strategy instead of cash for the “go away” period. As I noted earlier, we replaced SPHB with SPLV a month ago. I would expect that we will have completely rotated into our summer low-beta holdings by the end of the week.
For our dividend portfolios, we have already adopted a low P/E screen to our holdings. I hope that a relatively low valuation and high dividend yield combination will prove to be a solid defensive strategy as well as providing reasonable gains over the next several months.
What I’ll be watching
For our seasonal strategy, we simply will not get more aggressive until the October/November time frame. We’ll collect dividends over the summer. However, we can—and will—get more defensive if conditions warrant. At this point, I am watching SPLV very closely. If it establishes a negative trend along with SPY and SPHB, I will be very concerned. I would look at the equity fund flow data to confirm that interest in stocks has waned to dangerous levels. In our dividend strategies, I hold JNK (SPDR Barclays Capital High Yield Bond ETF) for a combination of yield and as a tactical position. JNK continues to provide a slow but steady appreciation in its NAV. However, I am very nervous when high-yield debt is only paying a 6.01% yield (JNK yield from MarketWatch.com as of 4/28/2013). If JNK stalls or turns negative, we will move this holding to cash very quickly.
The following post originally appeared at MarketWatch.
In my last post I made the point that there is no reason to extrapolate that the market is going higher or lower simply because it is approaching all time highs. My plan is to look at several indicators that do matter, and see if we can find solid reasoning for the market to continue its advance or correct.
While I had planned on this being a fairly optimistic post, one development over the past week has the potential to be signaling imminent trouble in the equity markets.
Below is a graph of JNK, the SPDR High Yield Bond Index ETF. I follow this closely as it makes up a large percent of our Dividend Plus strategies. As you can see since June of last year it has formed a nice upward trend. The yellow line is its 30 day moving average (SMA), the average price over the past 30 days. The graph shows that not only has JNK been moving up, but it has been doing so with a fairly low level of volatility as its price has meandered around the 30 day SMA. Just looking at this chart, the recent downtrend is not worrisome, as it is still within its 8 month uptrend.
However, if we look at the next chart we see a reason for concern. The red and green line is JNK again, but this time I’ve added SPY, the SPDR’s S&P 500 Index ETF. While SPY is much more volatile than JNK, in general they do move in the same direction. Until about two weeks ago. SPY has continued to rally, while JNK has turned decidedly negative.
While in the short run it would not be uncommon to see a divergence, in the longer term JNK and SPY will trend in the same direction. Meaning that over this coming week I’d expect either SPY to start following JNK down, or JNK to reverse and start to rally back up to the top of its trend channel.
Fundamentally, JNK is an index of lower quality corporate bonds. In a softening economy companies are less likely to be able to make interest payments on their debt and JNK will go down. In a strengthening economy JNK will tend to rise, as even lower quality companies will obviously perform better in an improving economy. What we have seen over the past few weeks is that corporate earnings have come in and have been slightly better than expected. More importantly most companies have been giving pretty solid guidance s to their expectations for earnings in 2013. This should be an ideal environment for JNK.
The question I will be trying to answer this week is whether investors in high yield bonds are seeing something that stock investors have so far ignored, or has the two week sell off just been a natural short term correction? If so I expect a rally in JNK. If not, we will look to sell JNK and sit in cash until the markets sort themselves out.
I am of the firm belief that the only way for a retiree to invest with an anticipation of receiving a life-time income from their investments is to buy dividend paying stocks. Ideally, big blue chip stocks with not only a history of paying dividends, but of increasing their payouts as well. We know the names; IBM, P&G, Coke a Cola (KO), Exxon… Unfortunately, many retirees having seen incomes frozen for a decade and portfolios ravaged by two bear markets, find that the 2%-3% dividend yields offered by these companies is just too little to pay today’s bills and enjoy even a modest retirement. To accommodate retirees with higher income needs I try and mix in a combination of the tried and true blue chips with a few “high yielders” to bring up the overall portfolio yield. I define “High Yielders” in today’s market place as stocks with a minimum of a 5% yield (more than double the S&P 500) and still hope to stretch that into the 7%+ range without adding too much risk.
So with that in mind here are two of my top picks, one in each category for 2013.
McDonald’s (MCD)
When looking for sustainable and increasing future dividends stodgy and boring, and needed is a very good thing. While food in general is a need, some might question the “need” behind a Big Mac. But ask any working single mom, and “Kid’s Meals” is on the need list. While third quarter 2012 saw an uncharacteristic slow down in earnings, for retirees we are looking at cash flow. Even with a drop in share price over 17% at its lowest, MCD announced an increase in their quarterly dividend in November from $.70/share to $.77/share. This marked the 36th consecutive year of increasing their payout.
Fundamentally MCD is an all weather stock. In poor economic times harried workers “downsize” their eating out bills by going from the mid-tier Applebee’s and Olive Gardens to McDonalds. Also expect more competition for Starbucks as MCD develops their “Café” identity. MCD has a strong international presence for growth in developing markets, and offers a currency hedge to the dollar.
Their payout ratio is modest at 52%, P/E at the market level at 15.35 for 2013, and modest growth expectations in the high single digits for 2013. MCD is a solid 3.47% yielder providing income stability and a likely raise well into the future.
SeaDrill Limited
While SeaDrill Limited (SDRL) provides a wild ride (Beta 1.97) it can be worth it for the investor needing a little extra juice in their dividend payouts as SDRL has a current yield of 9.21%.
SDRL is in a solid and growing business. They provide deep water and submersible rig platforms for oil and gas drilling and exploration. Their largest division “Floaters” are fully leased for 2013.
Of course no company sports a (%+ yield without their being question marks. For SDRL there are two major market concerns. The first is debt. Simply put SDRL is considered a “highly leveraged” company.
This is fine as long as cash flow can support the debt. Recently SDRL’s stock took a tumble when they agreed to sell their tender rigs division. While accounting for a small portion of cash flow, any disruption is seen as a concern. However, SDRL also announced that they plan on using the proceeds to invest in more floaters – a higher revenue source per rig, and as mentioned above, their current inventory is fully leased. Bottom line, by the end of 2013 revenues should be up, not down without an increase in debt.
Market concern two is that SDRL paid two dividends in December 2012. Their normal December dividend and a prepayment of the March 2013 dividend. For new investors, if SDRL maintains their 2012 payouts, this would mean a yield of about 6.14% vs. the reported yield of 9.21%. However with a projected P/E of 11.61 for 2013, and earnings growth potential, I see SDRL as a way to boost income in a very solid industry and a very solid capital gain potential as new rig development and leasing accrues revenue to their earnings.
Yesterday I received a “query” from a writer for the Wall Street Journal’s online edition for information on a story. A “query” is typically sent out by a writer looking for an expert opinion. For this query the writer was asking for suggestions on ways that a near-retiree could add risk to their portfolio, in an effort to boost returns. The idea is that so many retirees have suffered such poor investment performance for years that soon to be retirees need to play a little “catch up.” My response was basically that that was one of the stupidest ideas I had ever heard! So assuming I won’t be quoted in that piece, and there is no reason to wait for the article to be published, let me share some thoughts on this subject.
Investors (and apparently financial writers at wsj.com) have been misled on what risk is, and how it affects portfolios, for years by the mutual fund industry and the financial planning community. The theory goes that by increasing the risk of a portfolio, the investor also increases their return. As if this is a foregone conclusion. But if that is the case than where is the risk? If by definition you change investments and you, by definition increase return, than there is no “risk.” So everyone would be stupid not to have “high risk” portfolios. Heck the more the better, let’s dial up a little more “risk.” Just turn up the heat on the oven and the bread will be done sooner. Right?
Last night I was watching Extreme Pawn Stars. If you haven’t seen the show, it’s about a pawn shop in Detroit. It offers entertainment on two levels, first it’s interesting to see the stuff that gets brought in, and second the characters that bring in the stuff! Last night, this guy brings in a Cabbage Patch® doll and wants $100 for it. The pawn shop owner asks him simply, “How did you come up with that number?” His answer, now pay attention here, was, “Because I’m being evicted and need $100.” The store owner offered him $10. The moral of the story is that neither the pawn shop owner, nor future buyers for the Cabbage Patch doll, really care that this guy needs $100. The just want to pay what the thing is actually worth. $10.
This made me think about the whole premise behind the query from the WSJ writer. Investors, for whatever reason, think there is a correlation between needing a higher return on their investments and actually getting a higher return on their investments. The fact is the “market” doesn’t really care that you, or any other investor actually needs anything. And just because an investor needs a high return does not mean that there is some dial that can be turned to turn up the returns as well. The sad truth is, neither owner of the pawn shop nor the market, really cares what anyone needs for their Cabbage Patch doll, or from their portfolio. Each is worth exactly what someone else is willing to pay for them. No more, no less. Personal circumstances just don’t matter.
I will go a step further and explain that this is the difference between the professional investor and the amateur. The amateur is always “long” or fully invested, expecting high returns, because they need those high returns. They typically take risks, at the wrong time. The professional understands that just because he or his clients need return, it is not always possible to get them.
I’ll close with a sad but true example. Almost exactly a year ago, my partner and I went out and made a proposal to manage a company’s pension plan. They had lost a lot of money in the plan and had to add $1 million from the company account to the pension plan. I recommended using our dividend value strategy. In a shaky economy dividends would add stability and provide cash flow to pay out benefits down the road. The owners were noticeably upset that they had lost a significant amount of money and had to now fund the losses. I thought this was a prudent strategy. Instead, the owners went another direction. Determined to “make up” their losses they went with a rather high risk/high return strategy (in their minds) choosing a “specialist” in small company stocks for their existing balance, and self-directing $1.4 million equally divided between Wells Fargo, Citi, and Bank of America. In their attempt to catch up, because they needed the return, they have lost probably another million dollars in 12 months. Instead of catching up, they will need to somehow find another $1 million from company coffers, in this economy, to fund their pension plan or risk penalties from the Department of Labor.
Turning up the heat on the oven is more likely to result in burned bread, instead of simply finishing it sooner. Similarly turning up portfolio risk is a good recipe for being burned as well. In baking and investing, patience is truly a virtue.
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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.
Bill DeShurko 