Rudi's View | May 16 2019
In this week's Weekly Insights (published in two parts):
–All About Dividends
-Royal Commission: Ongoing Impact
-Quote Of The Week
–No Weekly Insights Next Week
-FNArena's Corporate Reporting Monitor
-June Rebalance For ASX200 Index
-Rudi On Tour
-AIA Conference Special
[Non-highlighted parts will appear in Part Two on Friday]
By Rudi Filapek-Vandyck, Editor FNArena
All About Dividends
Ask a share market expert what is the main force behind listed equities and you are more than likely to hear "corporate profits".
In recent years more and more experts have been pointing towards excess liquidity provided by major central banks, or to artificially depressed government bond yields, though both factors are largely intertwined.
Occasionally one might try "economic growth" or "global growth momentum" but that story would be quickly dismissed by dozens of academic papers unable to establish a reliable link between share market performances and economic growth, irrespective of day traders' unwavering focus for what might come out next in terms of economic data and indicators.
In more recent times, for obvious reasons, fingers are pointed towards US President Trump, China and the so-called "Trade Wars".
Other reasons that are occasionally mentioned include monthly PMI surveys, funds flows, corporate share buybacks, earnings revisions, and credit spreads.
Dividends, or more specifically: growth in dividends, is not often referred to.
Yet recent analysis by analysts at Citi suggests global equities move in strong correlation with growth in dividends, making this at least one extra indicator investors might want to pay attention to.
Starting off with Citi's key conclusion: global equities are up around 7% per annum since 2010 simply because global dividends are up by around 7% p.a. since that time.
Moreover, reports Citi, throughout the period since the MSCI AC World Index trailing dividend yield has traded in a narrow 90bp range oscillated around a global average yield of 2.5%, which is where global equities are at right now.
Thus while on a day-by-day basis, equity indices can trade heavily on internal and external factors, including those mentioned earlier, it appears underlying the ultimate direction stems from growth in dividends.
The graph below, courtesy of Citi, suggests the correlation between global equities and dividend growth is quite solid and reliable, even though equities can temporarily move off course in either direction.
For example, the graph clearly suggests the savage sell-off in 2008 was extreme as dividend cuts were nowhere nearly as large, and the same conclusion stands with regards the eurozone crisis in 2011-2012 (also clearly visible). The same can be said of 2015.
On the other hand, the graph also shows equity markets were overvalued in the years running up to late 2007, and the same happened in 2017 and 2018.
The first conclusion to draw is that global equities in 2019 do not seem out of kilter with global dividends that have continued to grow throughout the sell-off in late 2018 and the subsequent V-shaped recovery throughout January-April.
The second conclusion should thus be: equities might well pull back on the back of geopolitical tension and uncertainties, but unless global dividends will be affected, a gap will open up similar to late last year, and this will be closed again some time later.
Taking guidance from global dividend growth also takes care of the main worry that stems from the fact equity indices seem to have failed for a third time to break above levels that equally proved too high in September and January last year. To some technical analysts, three failed attempts, also referred to as a Triple Top formation, spells trouble ahead.
Maybe short term. Investor sentiment can turn nasty and dark any time, in particular with equity markets looking elevated on other measures of valuation, but if history is our guide, and dividends continue to grow regardless, the strong correlation of the past suggests equities remain poised for higher levels further down the track.
Wait a minute, I hear you think, if equities beneath the surface of day-to-day volatility are ultimately guided by dividend growth, how come US indices have significantly outperformed the Australian market? Aren't we supposed to be the dividend capital of the world?
Yes, we are the dividend capital of the world, but predominantly because companies including Telstra and the banks carry extremely high payout ratios, transferring most of their cash flow onto shareholders instead of spending money on securing additional growth. It is here that an all-important lesson is embedded for everyday investors: the average yield on such Australian stocks might be high, the growth in these dividends is not.
Actually, Telstra has already been forced to rebase its dividend twice, whereas AMP had to virtually annihilate its dividend while both Bank of Queensland and National Australia Bank cut their dividends recently and doubts have emerged whether Westpac should not follow next. These are but a few examples, but they are symptomatic for what has been happening with yield stocks on the ASX.
Dividends in Australia have continued to grow, including throughout the recent reporting season in February, but mostly because of the resources sector led by BHP Group, Rio Tinto, Fortescue Metals, Alumina Ltd, South32, Whitehaven Coal, and others.
In contrast, and despite widely held criticism US companies have been, and still are spending billions of dollars on share buybacks, the US market has developed into a solid provider of yield in recent years, with (still) rapidly growing, maturing technology companies at the forefront of this.
The graph below, from an earlier analysis published by Citi, shows that while US companies have been spending most of their cash on share buybacks, capex and dividends are also in a steady uptrend since 2009.
Looked at it from a macro, top-down perspective, the post-GFC, lower-for-longer bond yield environment has pushed up the average yield available from US equities to circa 2%. Prior to the GFC, this average yield was all over the place. While volatility has by no means disappeared, the correlation between US equities and the average 2% yield has become a lot narrower.
The same phenomenon can be observed in other markets too, including Emerging Markets and Australian equities. In Australia, the correlation with yield was already more prevalent pre-GFC with the market's average yield trending up and down between 3% and 4%.Post GFC, that average has reset between 4% and 5% with occasional overshoots beyond 5% (2011-2012 and 2015-2016 when equities diverged significantly from underlying dividend growth, as also explained earlier with the global example).
Right now, believe it or not, the average yield from Australian equities sits smack bang on the post 2010 average; not that dissimilar from Citi's observation about where equities are in general vis-a-vis global growth in dividends.
The not so good news, for investors in Australian equities, comes in the form of growth expectations. These remain at low single digits on average for the next few years, well below expectations elsewhere, including for US companies. If these growth projections prove accurate, it is difficult to see how Australian equities can manage to sustainably outperform overseas markets.
The current out-of-season reporting season in Australia, for instance, has led to analysts further reducing expectations for Australian banks. Most forward projections are now working off stable dividends from all major banks in coming years, down from minor growth assumed prior to the latest market updates.
In plain English this translates into: no growth.
While many a pensioner or retiree in Australia thinks this is good enough as it is plain impossible to find similar yield outside Australian banks, or even the Australian share market, without taking on excessive risk, this should also translate into low expectations in terms of total investment returns achievable.
Meanwhile, greater returns will continue to be achieved from companies that are able to continue to grow their profits, and dividends, as witnessed through performances of Goodman Group ((GMG)), Charter Hall ((CHC)), Transurban ((TCL)) and even CSL ((CSL)), REA Group ((REA)) and Aristocrat Leisure ((ALL)).
Whereas the average growth in dividends for all the banks looks rather tepid (if not negative) over the past five years, growth in dividends per annum over that same period for the companies mentioned in the previous sentence has been respectively 8%, 9.5%, 11.9%, 12%, 15.9% and 39.45%.
(Paying subscribers can look up these dividend growth numbers through the dividend calculator in Stock Analysis on the website).
Given all of these shares have significantly outperformed in years past, I think we can safely say there is a strong correlation between dividend growth and share price performances. Thanks to Citi's analysis we know now this relationship holds for individual stocks as much as it does for share market indices.
Below: US equities as assessed on the basis of dividend yield and deviation from the mean by US newsletter Investment Quality Trends (IQT). Here too the conclusion is that, overall, the market's valuation is closer near the top than near the bottom of its natural range, but it looks by no means excessively over-valued.
No Weekly Insights Next Week
Next week, starting Monday 20th May, I am visiting Toowoomba in Queensland (first time ever) to present to local investors. Hence there will be no Weekly Insights that week. The next update will be written and published in the week May 27-31.
Also, in case you missed it, Australia's one and only business & finance TV channel, Your Money, will broadcast its final hour on Thursday this week (16th May). This also gives me the opportunity to move back to the original rhythm of writing Weekly Insights on Monday.
FNArena's Corporate Reporting Monitor
Just a reminder to all, FNArena is running a Corporate Results Monitor, which gets extremely busy throughout February and August, but the overview with regular updates runs all-year around and can be visited (even without a paid subscription) at its designated section on the website:
For those who like to go back to, and analyse, past Reporting Seasons, there is a special section with past reports, data and updates. This section is accessible by paying subscribers only.
"Market-leading student management, attitudinal assessment and profiling systems for tertiary education and training providers";"Mission-critical people management software for educators and employers" and "Ready for the Future of Work" are just a few quotes from the corporate website of newly listed ReadyTech Holdings ((RDY)).
The shares listed on the ASX on April 17 with a price of $1.78 only to subsequently fall to $1.65 but, apparently, appearances do mislead or maybe this is simply a case of bad timing? Earlier press reports had it that the company had been aiming for a listing in 2018, but a severe change in the overall investment climate put that idea to bed at the time.
Analysts at Wilsons initiated coverage this week and immediately added the stock to their select list of Conviction Buys. Wilsons sees double digit growth and expansion in PE multiples ahead.
At face value, the company does have several buzzwords to offer that sound extremely attractive in the present context, including 85% recurring revenues, Software-as-a-Service (SaaS), mission critical nature of software, uncommonly high operating margins and, not to be dismissed, provider of education and employment software.
Wilsons sees a robust growth outlook, starting from an attractive valuation. The maiden Buy (with Conviction) rating is accompanied by a twelve month price target of $2.35. The two lead managers of the company's float were Macquarie and Wilsons. It'll be interesting to note whether Macquarie's initiation -no doubt not far off- is able to match the bullish enthusiasm at Wilsons.
ReadyTech Holdings is profitable and on Wilsons projections will grow earnings per share (EPS) by 114% and 34.7% in the two years ahead (FY20 and FY21) while the company is also expected to start paying out annual dividends from next year onwards (100% franked).
Meanwhile, portfolio managers at stockbroker Morgans reported they have been reviewing several positions, including in major banks, Transurban ((TCL)), Cleanaway Waste Management ((CWY)), Corporate Travel ((CTD)) and Rio Tinto ((RIO)), and ultimately decided to not make any changes, at least not for the Balanced Model Portfolio.
In addition: "Cash holdings remain flexible enough to capture any opportunities on weakness."
AIA Conference Special
Following on from my regular attendances in years past, I shall be participating in the upcoming Australian Investors Association's (AIA) National Conference at the Marriott Resort and Spa, Surfers Paradise, Qld, July 28-31.
I will be busy too. Apart from a one hour presentation on the approaching August reporting season, I am part of the share market panel "Buy, Sell or Hold" on Monday evening, as well as co-host of the Conference Dinner on Tuesday.
FNArena subscribers and readers who like to attend can do so through a Special Promotion offered by the AIA, but which expires on May 31st. The Special Offer includes three months of free AIA membership and a discount on entry tickets to the Conference.
To take up this offer, investors need to Join using this link https://administration.investors.asn.au/civicrm/?page=CiviCRM&q=civicrm%2Fcontribute%2Ftransact&reset=1&id=3.
After you have joined, you'll need to Register for the conference using this link https://administration.investors.asn.au/civicrm/?page=CiviCRM&q=civicrm/event/ical&reset=1&list=1&html=1
This year's Conference Theme is Boom. Boom. Boom…?? Investing beyond the boom.
Rudi On Tour In 2019
-ASA Toowoomba, Qld, May 20
-U3A Investor Group Toowoomba, Qld, May 22
-AIA Adelaide, SA, June 11
-AIA National Conference, Gold Coast, Qld, 28-31 July
-AIA and ASA, Perth, WA, October 1
(This story was written on Tuesday 14th May 2019. Part One was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. Part Two appears on the website on Friday).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: firstname.lastname@example.org or via the direct messaging system on the website).
BONUS PUBLICATIONS FOR FNARENA SUBSCRIBERS
Paid subscribers to FNArena (6 and 12 mnths) receive several bonus publications, at no extra cost, including:
– The AUD and the Australian Share Market (which stocks benefit from a weaker AUD, and which ones don't?)
– Make Risk Your Friend. Finding All-Weather Performers, January 2013 (The rationale behind investing in stocks that perform irrespective of the overall investment climate)
– Make Risk Your Friend. Finding All-Weather Performers, December 2014 (The follow-up that accounts for an ever changing world and updated stock selection)
– Change. Investing in a Low Growth World. eBook that sells through Amazon and other channels. Tackles the main issues impacting on investment strategies today and the world of tomorrow.
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Subscriptions cost $420 (incl GST) for twelve months or $235 for six and can be purchased here (depending on your status, a subscription to FNArena might be tax deductible): https://www.fnarena.com/index2.cfm?type=dsp_signup
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)