Back To The 60s |
Date: Wednesday, May 30, 2012
Author: Brian Bollen's Blog
Q: How have recent political developments in the Eurozone impacted on your portfolio strategy?
A: There has not been much impact on the way I have been managing portfolios because I had expected more turmoil in the Eurozone - if not necessarily as soon as we are seeing it. The portfolios have been positioned to cope with this for a year or more now, which is why I am not now doing much adjustment.
Q: Could you discuss your core strategy for producing income? How much emphasis do you put on current yield as opposed to dividend growth?
A: To my mind, the most important element of the income strategy is dividend growth, because it is dividend growth that ultimately drives capital values. As an equity investor, we want to see companies paying dividends and growing those dividends over the long run. If you just target a static yield and that yield does not grow then you end up with a stock price which is likely to go nowhere. I have always said that I am really much more interested in finding companies that can grow dividends sustainably over the long term, even if from today that might be from a very low base. Over the long run, those are the companies that the market values the most highly. It is important to note that yield is actually not under a company’s control. What companies do control is their pay-outs and their pay-out ratios. Yield is simply the dividend pay-out over the price. That is why it is much more important to focus on the growth of the pay-out, because companies control that growth, rather than just looking for yield in the market.
Q: How likely it is that the companies which are paying out dividends will be able to generate total returns similar to companies, often smaller and midsize, that reinvest in their business?
Q: Do you agree that we may be entering a period similar to the 1960s when the market was broadly flat, but the income was everything. If so, what are the prospects for equity income delivering inflation-beating returns?
A: I certainly think the income for the foreseeable future will be a larger proportion of total return. If a company is yielding, say, 5% today, and it is growing its dividend by 10% per year, it is not going to be yielding 8 or 9% in five years’ time as the stock price will have increased in the interim. For companies that can consistently grow their dividends, that value will be recognised at some point. In the short term, it looks like a high proportion of return is coming out of income, but, over time, capital will catch up.
Q: Government bond yields being so low means that equity yields look very attractive. But government bond yields are artificially low because of quantitative easing. Are equities therefore as cheap as people think?
A: I do think they are as cheap as people think. There has been, without question, a de-rating in equities over the last decade, up to the peak in the valuations. If you look at just a very simple valuation of the stock market over the last 10 years, you see the decline, certainly in the UK, from mid-20s to say, 10 times forward-looking earnings. Therefore we have seen a de-rating.
I therefore think that, everything else being equal, equities are much lower risk now than they were a decade ago. Comparing the types of yield on offer in the equity market versus other asset markets, the relative attraction of equities is clear to me. Clearly there is volatility in the market, and when people want to sell something, they go to the most liquid asset, which is equities. But volatility aside, I think there is a huge store of value in the equity market. I believe over the medium term that will be realised.
Q: Pharmaceuticals have always been a good source of income, but they have been coming under pressure recently. How will that situation pan out?
A: From an income perspective I still remain very confident that the ability to grow dividends is still very strong for these companies. The pressure that we have seen recently – referring to some recent quarterly figures, particularly for the UK stocks – I think reflects a number of one-offs. The case of AstraZeneca, I think, is a very special situation. The company has announced management change, and I hope the company’s strategy is also going to change. There are some challenges facing that business but I do not think these are going to imperil its ability to pay dividends for the foreseeable future.
Q: We have seen companies like Tesco and Astra Zeneca take some pretty hefty hits recently. Do you see this as a developing trend, or, taking those two stories on our list together, an oddity within an otherwise continuing story of strength? Are these typical? Should we judge the market by these two events?
A: No we should not. The reason for this, I think, is that through this volatility, this kind of fog that we have seen, the stock market has started to re-rate companies with a number of characteristics. One of those is the ability to grow earnings reliably. If the stock market expected that a company was going to be able to do that and it does not deliver then the penalty in share price terms is harsh.
The economic circumstances that we find ourselves in, particularly in the developed world, mean that the market is prepared to pay a higher price for reliability and assured earnings and cashflow growth. I think the rating on those companies will continue to improve.
Q: Is the price investors are now paying for tobacco firms and utilities too high?
A: My portfolios are still as exposed as they have been to tobacco, although it is no longer the largest sector - pharmaceuticals is actually slightly larger now. I still think there is value in tobacco. The point I made above about certainty of earnings is, I think, a very good one for tobacco companies. My portfolios own fewer regulated utilities than they have had in the past, but they still have quite heavy exposure to unregulated utilities. I think there is a very interesting dynamic within the UK power generation market, which is very specific to the UK, to do with the age of the assets and the government’s desire to have 20% renewable generation by 2020. I think that power prices in the UK are likely to go up over the medium term.
Q: Will you be investing in financials when the high street banks start to turn on dividends again? When is that moment going to come?
A: They will start to become more interesting when they start paying dividends, but that does not mean I will definitely invest. This goes back to the earlier point about whether a dividend is just a token, or is it sustainable and going to grow? Calculations around that kind of outcome are important, certainly for that sector, in order to get me interested in it. I suspect one day my portfolios will hold shares in a bank, but we need to get into a place where they are a lot less risky than I think they still are today. There will be time when they are able to pay dividends again, but I do not see that in the near term.
Q: Are you using your 20% allowance into overseas stocks because you cannot find enough opportunities in the United Kingdom?
A: Not necessarily. I can find enough opportunities in the UK. But there are some sectors which provide quite easy international comparisons. For example, in the tobacco sector – if you are looking at British American Tobacco or Imperial Tobacco, it is not a big leap to look at Altria or Reynolds American. To make investments in those areas made sense to me, similarly in the pharmaceutical sector. There are a number of characteristics that I think are, and have become, increasingly relevant for the market: globally diversified businesses, very strong balance sheets, a certain amount of pricing power, and non-cyclical earnings, if you like. These kind of characteristics are replicated in all sorts of companies around the world, and not just in the UK markets. So I felt to widen the brief would be an appropriate way to go, and to expose my portfolios to opportunities in other markets.
Q: Which regions and sectors do you expect to produce the most robust income stream in the medium term?
A: To my mind, the best income earners will continue to be companies with very strong cash flows that can benefit both from continued demand for their product from the developed world, and increasing demand for their product in the emerging worlds. The FMCG (fast moving consumer goods) sectors fit into that, as do pharmaceuticals. I think telecoms is the other area, certainly specifically in the UK, and the story for well-managed fixed line telecom companies is a very powerful one as the data wave grows. As the use of data by both businesses and consumers grows, investing in the telecom industry is, I believe, going to be very interesting.
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