My Say
BE CAREFUL WHAT YOU WISH FOR! - My Say No 40
02-07-2009 16:36:13
In 2004 I wrote a newsletter titled "Crash Test Dummies" in which I painted what was, at the time, an imaginary and rather apocalyptic scenario. Share markets had fallen sharply, CBA shares had fallen to $18.00 and they had cut their dividend. Two companies in our portfolio had gone bust and there was an across the board cut of 15% in dividends by the rest of the market.
At that time I was surmising what the impact would be on our investments if these events actually ever came to pass. In 2004 I finished that newsletter with the following: "All this is make-believe but I live in hope that the opportunity I missed in the 73-74 global market downturn arises just once more during Frieda's and my lifetimes. It would be awesome to be able to crash test your philosophy." I think the expression goes something like, 'you must be careful what you wish for'!
As we have now had the opportunity thrust upon us to 'crash test' our portfolios in real time I thought I would revisit the impact of the 'GFC' on our portfolios and especially the dividends paid during the last half year.
As I foreshadowed in my last newsletter, I have looked at a practical sample of 59 stocks from our portfolio and compared the recent dividends (March/April) to those paid at the same time last year. As one would expect it has been an 'interesting' period to say the least.
For accuracy, I did not use the last dividend period (September/October 2008) for comparison as there is often a marked difference between the interim and final dividends paid by companies. Traditionally, the March/April period tends to have a predominance of interim dividend payments.
Of the 59 companies examined during this period, 4 have suspended dividends and 13 have maintained them for the period under review. The balance have variously increased or reduced. Of the total, only 17 companies (28%) increased their dividends and interestingly, one company increased its dividend by over 100% during this difficult period.
I took the cents per share for the previous corresponding period and compared it with the current cents per share. I have ignored any special dividends to ensure the comparison is based on underlying payouts. Apart from BHP the portfolio is entirely industrials which accounts for the fact that the sample happens to be entirely dividend paying at outset.
In raw terms, i.e. cents per share, the dividends were down 13.0%. Thus, on assumed dividend payments equating to an income of $50,000 for this time last year, one would have expected to receive $43,500 in the latest period. Whilst the income has fallen, two things are worth bearing in mind. Firstly, the income has not been affected any where near as severely as the portfolio value which was down approximately 43% earlier this year and secondly, whilst lower than this time last year, an income of $43,500 is still a positive result!!
It is also worth noting that interest rates have halved so anyone earning the equivalent interest income of $50,000 would currently be looking at closer to $25,000. It has always been my contention that price volatility has never indicated risk; violent income variations are far riskier.
The result above is the theoretical and is quite different to the actual result. As I indicated in a previous newsletter, I had become the serial shopper. Displaying extraordinarily poor timing we began buying as soon as the market began to slide. In preparing this newsletter I discovered that between January and December 2008 we have made a staggering 70 purchases. Since January of this year the pace has slowed and only nine additional purchases have been made.
The vast majority of these transactions were small top-ups to existing shareholdings, a smattering of share purchase plan offerings and, more recently, rights issues. Only five were additions of brand new holdings. The ability to do this is a benefit conferred by not spending all one earns. In addition, we have never drawn the full facility available on our lines of credit that we use for our non-super portfolios.
I add this only as a counterpoint to the horror stories associated with some of the lurid headlines now appearing regarding gearing bordering on the insane by many during the preceding bull market. Gearing does not have to be risky and, as any adventurer will tell you, always keep some powder dry!
The upshot of our untoward activity is that although the pro-rata income (cents per share) has dropped, this has been counteracted by the increased number of shares we hold.
Another unanticipated side benefit has been that many of the recent rights issues have proven to be a godsend: Wesfarmers at $13.50 and the CBA share purchase plan at $26.00 are examples. As the market has recovered slightly, these heavily discounted issues have help repair the hole in the value of the portfolio as well as helping to maintain the income stream.
On further examination it is also clear that time has provided us with a solid defence against what appears to be a backward step during these difficult times. Over the last few years the companies that have increased their dividends the most are, unsurprisingly, also the ones that have produced outstanding capital growth. I noticed a brief comment in the AFR this week underlining the importance of income. It mentioned that whilst the total performance of the ASX 200 over the last decade (including the current correction) was 81%, only 25% of that was accounted for by capital; the balance, and major contribution, was dividends.
This correlation has been explored many times by academics and is what underpins our whole reason for investing. Those companies that haven't cut, or have increased their dividends, now have by far the largest weighting in our portfolios.
What this means is that with time, the greatest amount of income comes from the largest (best) part of the portfolio. The weaker performers whose dividends have been suspended or reduced form the smallest part of our portfolio. Having said that, two holdings that had grown many times in value, have now slipped substantially with a commensurate cut in dividends.
I cannot let the opportunity pass and not comment on our managed investments, the old fashioned listed investment companies (LIC's). Argo, Milton, Sylvastate and Australian Foundation Investment Company all maintained their dividends. When reporting in February this year Rob Paterson (Argo Managing Director) said "We have paid dividends for 63 years and we are not about to stop". Wisely, he did add the caveat that the immediate future was uncertain.
AFIC managing director Ross Barker said that despite the difficult times, "the company had sufficient reserves, including retained profits of $420 million, to maintain its own dividend payouts". However, he also added a cautionary note regarding the future.
Angus Gluskie, CEO of Sylvastate, in his report to shareholders said, "Sylvastate continues to hold cash at levels significantly higher than normal, and will be seeking to use suitable points of market weakness to further expand our investment holdings. While we expect that some companies in which we invest will be reducing their dividends in the current year, at this time Sylvastate considers that it will have sufficient reserves and income to be able to maintain its dividend to shareholders in the upcoming year".
Ah, how delighted I am with all this boring common sense! I think one of the reasons I am attracted to the older LIC's is the similarity in the way they invest with our own view of investing.
As the GFC is a global phenomenon I thought I might also make a passing comment about our international exposure. In structure it mirrors our Australian holdings with the exception that we do not have any individual shareholdings: We have chosen instead to hold the overseas equivalents of our Australian LIC's.
In the interim report from one they commented that they were maintaining their interim dividend. The report goes on to say, "The Company has 7.1m pounds in its revenue reserve roughly equivalent to last years total dividend. This reserve allows the dividend progression to be smoothed. It is the portfolio manager's view that the underlying holdings in the portfolio will resume dividend growth in 2010. This gives the board confidence to use the revenue reserve in the short term and not to reduce dividend payments".
The second of our UK holdings had the following to say: "Many companies will conserve cash by reducing their dividend distributions. We recognise that income is very important to our shareholders and we have set as a priority for our manager to ensure that sector and stock selection takes into account the need to protect our income flow and reflects the longer term impact of the credit crunch. We have increased our dividend in every year for the last 42 years and that is a track record that we aim to extend into the future".
I don't know about you but I get a warm fuzzy feeling when I read this sort of thing. As a consequence we remain 'alert but not alarmed' as the GFC continues to roll on around us like a thunderstorm. As is the case with the human race, the same pathetic cycle is being repeated again: Increasing hubris as natural good fortune (a rising tide lifts all boats) is eventually attributed to our own clever efforts followed by the inevitable humbling.
It may sound a little 'I told you so' but now that the crash test is underway I offer the following personal observations on wealth creation.
Don't spend all you earn.
Borrow less than you can afford.
I offer these blindingly obvious gems irrespective of your stage in life. Like many of us, Frieda and I earnt very little when we first married at the ripe old age of 22 but we still managed to save. This savings habit, whether nature or nurture, has never left us and with hindsight has been the singularly most important factor in the transformation of our financial fortunes.
Wealth creation, when based on common sense investment principles, is not risky; speculation of any kind always is. We must recognise that humankind will never change and one can only try to remain aloof from the hubris as it occurs and just be prepared to cope with the inevitable collateral damage that results.
An outstanding exposition of this was the recent series by the ABC called "The Ascent of Money". It sits up there with the best 'bodice rippers' as riveting watching. I have the book and was delighted to learn when the series finished that the DVD will be made available in ABC stores. This is a must for my archives.
In the meantime we continue to enjoy all that is delivered by our diversified share investments and despite the emotional 'wet blanket' provided by the media, look forward with optimism.
My next full day course for Sydney University Centre for Continuing Education is scheduled for the 15th August. It runs from 9.00 until 4.00 and is a great days value as numbers are restricted and I have much more time for interaction; so bring all your issues, prejudices and questions.
Here's the link: www.cce.usyd.edu.au/cce/course.do?id=000223&course=013581
