We do our best to squeeze every little bit extra out of our returns and that normally requires very detailed analysis. But sometimes the KISS principle – Keep It Simple, Stupid – is our best friend. Which begs the question: How simple can it get?
One thing sure about investing in stocks is that the dividends are luscious. Although the Contra Guys are contrarians, investing in stocks that have been tarnished and beaten down badly, do not equate our methodology as one in which we are simply looking for the juiciest dividends. Au contraire. It is just one of the many investing pillars of our approach. And that approach has led the Contra Portfolio to sport a trailing 12-month yield of 3.7 per cent as of June 30; this is higher than the yield generated by the S&P 500 and the TSX 60.
In Benj’s “Point Tally System,” which comprises numerous facets and is outlined in his two best-selling stock books, one point is given for dividends. Some of the other points awarded are for factors including debt, book value, cash flow, insider trading, management, cash, management ownership and the overall financial position. But at the end of the day, as Benj often says when speaking at a financial conference: “Dividends allow me to be stupid longer.”
The key here is that even if the stock price is not doing well, obtaining a continuing return wonderfully greases the bottom line as we wait patiently for – hopefully – gains on our investments of 100 per cent or more. Naturally, given the enormous profits that we are seeking, it almost always takes many years, sometimes more than a decade. But if one has to wait 10 years for a double, that still works out to a 7-per-cent annualized return. Toss dividends on top like sprinkles on a sundae and that works out exceedingly well.
Of course, there are numerous aspects regarding dividends that must be evaluated. One is whether or not they are sustainable, because, when they are cut or eliminated, the stock price almost always swoons. The payout ratio, the proportion of earnings paid out as dividends, is key. If this is over 100 per cent, or anywhere close to that level, one must be wary that the dividend might not be maintained – known as a dividend yield trap.
Benj admits that in his younger investing days, he was sometimes pinched in the trap. Those spicy high yields caught his eye, and he would not delve deeply enough into the financials to see if they were maintainable. Now, if he sees a dividend over 7.5 per cent, that to him clearly indicates a red flag and the “opportunity” will likely be avoided.
We also prefer to receive dividends, rather than deal with a dividend reinvestment plan, known as a DRIP. Those plans have legions of followers who think that they are the best thing since sliced bread, but we choose to eschew them. While we recognize that stock is being acquired without a fee, and effectively it becomes a forced saving, calculating the return for tax purposes can be a pain. It is already enough of a challenge preparing for the CRA every year without adding more complexity. In addition, we prefer to acquire stock at the price we choose, rather than simply the trading value in the market when the DRIP is declared.
One central thing for Canadians to remember that makes dividends so attractive is that they are taxed at a lower rate than regular income. Thus, at the end of the day, investors will end up with more money in their pockets and, of course, that is the name of the game.
There are a plethora of companies that at least one of us owns that have lovely payouts, which we believe will be sustained. These include Black Diamond Group BDI-T, Enerflex EFX-T. General Electric GE-N, Lloyd’s Banking Group LLDTF, Orange Telecom, Quarterhill QTRH-T and Santander. But above and beyond the disbursements, we think that all of these businesses have the potential to at least double in value, except for GE, for which, though it has room left to run, that tally seems overly optimistic.
Outside of our own holdings, there are oodles of corporations known as “dividend kings.” These are enterprises that have increased their dividend payments for at least the past 25 years. There are more than 60 of these companies in the United States, all large corporations. They might be worth a look, albeit it must be recognized that even though their history is fabulous, that does not guarantee future performance. One must look ahead, rather than through the rear-view mirror.
Benj Gallander and Ben Stadelmann are co-editors of Contra the Heard Investment Letter