Dividend Achievers Income Fund

Strategic and Tactical Investing
Maximizing Income & Managing Risk
Presented by: Lauren Rudd
Syndicated newspaper columnist
The Rudd Report 4-5 P.M.
WSRQ Radio 106.9 FM 1220 AM
SNN Local News – Thursday 5:45 P.M.
Partner – Day Hagan Asset Management
941-346-5444
[email protected]
www.RuddReport.com
March 20, 2012
01/19/2012
1
Portfolio Management Process
It all comes down to money
How do you make it
How do you invest it
How do you keep it
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2
Portfolio Management Process
Managing for Income: Tactical
 Identify Dividend Achievers
 Determine Intrinsic Value of Individual
Companies
 Develop Optimal Portfolio of Top 20
Companies
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3
Portfolio Management Process
Managing Risk: Strategic
 Identify Systematic Risks
 Determine Risk/Reward for General Market
 Adjust Portfolio utilizing Stocks versus Bonds
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4
Dividends Matter
Source: Ned Davis Research
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5
Why Dividend Achievers?
Managing Income
 Companies that pay regular dividends tend to be
in better financial health and produce sustained
earnings and revenue growth.
 Dividends help identify well-managed companies;
every dividend declaration represents a promise
by management and a vote of confidence by the
board of directors in the company’s leadership.
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6
Why Dividend Achievers cont.
Managing Income
 Companies that consistently raise their dividend
payouts also raise the bar on their own
performance expectations.
 Shares of dividend-paying companies possess
built-in value that makes them generally more
resilient in down markets, with solid appreciation
potential during earnings-driven market upturns.
 Dividend paying companies are often less volatile.
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7
Dividend Achievers
Managing Income
Dividend Achievers™ History
 The Dividend Achievers™ history traces back to 1979,
when Moody's Investor Service developed a
proprietary model to identify best-of-breed dividendpaying companies.
 Four years later Moody's creates the first Handbook of
Dividend Achievers™.
 In 1998, Mergent acquired Moody's Investor Service
and rebranded the handbook under the Mergent
name.
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8
Dividend Achievers
Managing Income
What makes a Dividend Achiever company
unique?
 Mergent has been highlighting companies with
outstanding dividend records since 1979.
 To qualify as a Dividend Achiever a company
must have increased their regular cash
dividends annually for the past ten or more
consecutive years.
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9
Intrinsic Value
Managing Income
What Does Intrinsic Value Mean?
 The actual value of a company or an asset based on a
mathematical and fundamental analysis of its true
value.
 This value is not be the same as the market value.
 A variety of analytical techniques estimate intrinsic
value.
 Intrinsic value must exceed its current market value.
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10
Intrinsic Value
Managing Income
What Does Intrinsic Value Mean cont.
 Frequently referred to as fundamental value.
 It is ordinarily calculated by forecasting a future cash
flow generated by an asset and discounting that flow
to a present value.
 Simply put, it is the actual value of a security as
opposed to the market or book value.
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11
Intrinsic Value
Managing Income
Warren Buffett –
is known for his ability to calculate the
intrinsic value of a business, and then
buy that business when its price is at a
discount to its intrinsic value.
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12
Intrinsic Value
Managing Income
An excellent site for intrinsic
value is:
ValuePro.net - and it is free
10/13/2011
13
Managing Income
Optimal Portfolio of
Top 20 Dividend-Paying Companies
 Portfolio Reward/Risk ratio of at least 2:1
(Upside potential two times greater than downside potential)

Risk/Reward = (Portfolio Return)/(Standard Deviation)

Sharpe Ratio
 Initial individual stock weightings of 5.0%. Trim positions over 10%.
 Diversify among sectors and industries
 Minimize systematic risk (overall market risk) and factor risk (interest
rates, inflation, currency, among others)
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14
Managing Income
Asset Allocation
Large
Capitalization
U.S.
Equities
Small
Capitalization
Value
Growth
Value
Growth
Equities
(Stocks)
Europe
International
Markets
Pacific
Region
Emerging
Markets
Fixed Income
Barclay’s
Aggregate Bond
(Bond)
Cash
Equivalents
10/13/2011
15
Identify Systematic Risks
Managing Risk
Systematic risks are risks inherent to the entire market.
Determine levels and direction for the following:







Economic activity
Interest rates
Inflation
International outlook
Political risk
Country risk
Commodities
Even a well diversified portfolio cannot escape systematic risk.
The trick is to minimize it.
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16
Determine Reward/Risk for General Market
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Managing Risk
17
Tactically Adjust Portfolio for Stocks versus Bonds
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Managing Risk
18
Discretionary Spending
Managing Risk
• Consumers have been in a buying mood with
all measures of discretionary spending up.
• When spending has been on an upswing,
economic activity has been robust.
• The Fed changed its stance from expecting
"modest" economic growth to "moderate.“
• The shift was meant to speak volumes to Wall
Street. And it did.
Discretionary Spending
Managing Risk
Retail Sales
Managing Risk
• Confirming the strength in consumer
spending, the Ned Davis Research Retail Sales
model is now 100% bullish.
• Historically, when the model has been 78% or
above, real retail sales have gained at a 4.8%
annual rate.
• Given the weight-of-the-evidence, a
continuation of the uptrend has a higher
probability.
Retail Sales
Managing Risk
Consumer Debt
Managing Risk
• Debt Service Ratio, Household Debt Service
and Financial Obligations Ratios (FOR). All
three measures are moving lower, i.e.
improving.
• The most important is the Debt Service Ratio
• The debt service ratio – adds the minimum
payment required on mortgage debt plus
credit card debt and divide by disposable
income.
Debt Service Ratio
Managing Risk
• Demonstrates the amount of disposable income used to
pay mortgages and credit cards.
• The amount has declined from almost 14% in the third
quarter of 2007 to 10.9% at the end of 2011.
• Disposable personal income at the end of 2011 was
$11.7 trillion dollars. The difference between 14% and
10.9% equals 3.1%.
• 3.1% of $11.7 trillion dollars equals $363 billion of
buying power that is being put into savings and/or the
economy.
• Over 10 years, that $363 becomes $3.6 trillion of
economic support.
Debt Service Ratios
Managing Risk
Mortgage Delinquency Rates
Managing Risk
Bonds
Managing Risk
NDR Bond Trading Model has moved into
neutral territory indicating sub-par performance
expectations are warranted. A move below -2
would indicate that fixed income is
unattractive.
NDR Bond Model
Managing Risk
Bond Model
Managing Risk
• Confirming the strength in consumer
• The
S&P 500
the Barclay's
spending,
theversus
Ned Davis
ResearchCapital
Retail Sales
Intermediate-Term
model is now 100% Treasury
bullish. Bond Index favor
the S&P 500.
• Historically, when the model has been 78% or
realIntermediate-term
retail sales have gained
• above,
When the
modelatisa 4.8%
annual
rate.
favoring the S&P 500, the index has typically
at aweight-of-the-evidence,
12.7% annual rate, while
• gained
Given the
a the bond
index gained at
5.4% annual
continuation
ofjust
the auptrend
has a rate.
higher
probability.
Bond Model Favors S&P 500
Managing Risk
Inflation
Managing Risk
• Mild disinflationary pressures are currently
exerting the most influence overall.
CPI
Managing Risk
Always Manage Risk
Managing Risk
Siegel’s Paradox: Keeping losses contained is the most
important component to achieving long-term success.
% Loss
10%
20%
30%
40%
50%
60%
75%
90%
10/13/2011
% Gain required
to break even
11%
25%
42%
66%
100%
150%
300%
900%
Years required to break
even @ 10% return
1.1
2.4
3.8
5.3
7.2
9.8
15.0
25.0
33
Long Term Bond Risk
Managing Risk
Systematic risks are risks inherent to the entire market.
 Ten-year Treasuries yield 3.36%
 If, in two years, eight-year Treasuries are yielding a
mere 5%, you will lose 11% on your investment, plus the
effect of inflation
 On a 30-year bond, if rates go from the current 4.56%
to 6%
 In two years, your principal loss would be 22% plus
inflation
10/13/2011
34
Lauren Rudd’s January 28, 2011 Column. Courtesy Sarasota Herald Tribune.
To judge a company's value,
try these steps, and a website
The two most common questions I receive are how to select companies to
invest in and how to determine their potential value. My bookshelves sag
under the weight of numerous tomes that attempt to answer those two
questions. Those questions are also the core of the investment courses I
teach.
The question of selecting companies I will try to address in future columns.
However, let's slice the proverbial Gordian knot with regard to the question
of valuation and couch the answer in terms of intrinsic value. Intrinsic value is
the present value of a specific cash flow that a company could potentially
generate into perpetuity.
One thought that should immediately come to mind is that perpetuity is an
awfully long time. Yes, it is. However, there are some mathematical
techniques that address the issue. Another integral part of present value is
the discount rate used. How do you determine that rate? It is the rate of
return you demand of your investments. Regular readers know that I usually
require a 15 percent return. Finally, there is the question of what particular
cash flow we are talking about.
The flow of cash could come from a variety of sources. Two of my favorites
are earnings and free cash flow to the firm. A third commonly used
methodology, which I rarely discuss outside the classroom, is the dividend
discount model.
In every case, the intrinsic value calculation is nothing more than projecting a
specific cash flow, such as earnings per year, for some number of years and
then determining the present value of that cash flow. For example, the
dividend discount model projects dividends going forward, at a specific rate
of increase, and then calculates the present value of that dividend flow.
Now, I know what you are thinking. You have not seen the inside of a
mathematics text book for many years and you would like to keep it that
way. Not a problem.
10/13/2011
There are numerous Internet websites, such as ValuePro.net and Quicken.com,
that require only a stock symbol to spit out an intrinsic value. In the case of
ValuePro.net, the basis is free cash flow to the firm, while Quicken.com uses a
discounted earnings model.
As a rule of thumb, the intrinsic value should be, at a minimum, between 30
and 50 percent higher than the stock price. Here is another rule of thumb. If
the intrinsic value is less than the current share price, move on. There are
nearly 10,000 listed shares. You are looking to build a portfolio of 15 to 20.
While there are certainly exceptions to every rule, make your life easy and pick
the low hanging fruit.
Before you investing gurus fill my e-mail inbox with all the possible
permutations and combinations of investment criteria that should be
investigated prior to removing a stock from consideration, keep in mind that
this is merely the first hurdle but one that must be cleared to continue.
When I write about a company, I always include the intrinsic value using the
two techniques just described. I do so to enable you to duplicate what I did in
your own research. You are doing your own research, of course.
Let's look at an example using a company that has been in the news recently.
General Electric has disappointed investors over the past several years,
although its most recent earnings news was encouraging.
The intrinsic value of the shares, using the discounted earnings model, is a
negative $8.09 using a 5-year average earnings growth rate of 10.33 percent
and a discount rate of 15 percent. If we reduce the discount rate to the current
30-year Treasury bond rate of 4.56 percent, the intrinsic value increases to
$17.38, a number that is still below the recent share price of $19.98.
Moving to the discounted free cash flow to the firm model, the intrinsic value
is $7.28. The discount rate being used is the average cost of capital, which in
this case is 5.67 percent.
At the risk of irritating Jeffrey Immelt, the company's CEO, GE would not meet
my initial criteria to continue an analysis of the company. Remember: low
hanging fruit.
35
Lauren Rudd’s September 30, 2011 Column. Courtesy Sarasota Herald Tribune.
Perhaps a little WD-40 can help you slide
through this October
A good example is WD-40 Corp. (WDFC). WD-40 lays claim to three nearly
indispensable brands of lubricant, WD-40 in the ubiquitous blue-andyellow can, 3-IN-ONE household oil and BLUE WORKS, a high-performance
dry lubricant. Other products include X-14 mildew remover and Carpet
Fresh.
With sales in more than 160 countries, WD-40 recorded revenues of
$321.5 million for its 2010 fiscal year ended Aug. 31. My earnings estimate
a year ago for the 2010 fiscal year was $2.17 per share, with a 12-month
target price on the shares of $42, for a capital gain of 12 percent.
So how did WD-40 do? The company posted 2010 earnings of $2.15 per
share, leaving me 2 cents light. The shares recently closed at $40.25, as
compared with $37.71 a year ago, for a capital gain of 6.2 percent. Added
to that was a 2.7 percent dividend yield for a total return of 8.9 percent.
As was the case with many companies, WD-40's share price was
accelerating upward until the latter part of last July, when the market as a
whole declined. For example, July 21 saw WD-40 trade as high as $47.75.
The market rout was psychological in nature and the subsequent
reduction in share prices often had no correlation to an individual
company's financial performance.
Much of the decline in earnings can be attributable to higher commodity
prices, which the company is dealing with by raising prices itself.
Looking at the company's guidance going forward, net income is forecast
at $34.9 million to $36.6 million on revenues of $330 to $340 million.
Earnings guidance is $2.05 to $2.15 per share, with about 17 million
weighted average shares outstanding.
The intrinsic value of the shares, using a discounted earnings model with
an earnings growth rate of 12 percent applied to earnings of $36.1
million and with a discount rate of 15 percent, is $48 per share. The
more conservative model of free cash flow to the firm yields an intrinsic
value of $66 per share. As mentioned previously, the shares recently
closed at $40.25.
My earnings estimate for the 2011 fiscal year is $2.15 per share and
$2.40 per share in 2012, with a 12-month target price on the shares of
$45, for a capital gain of 12 percent. In addition, there is an indicated
dividend yield of 2.9 percent, for a total gain of 14.9 percent
Meanwhile, third-quarter sales for the period ended May 31 were $85.5
million, an increase of 4 percent over the same period a year ago. Year-todate sales were $245.7 million, up 2 percent over the same period a year
ago. Earnings for the third quarter were $8.1 million, a decrease of 12
percent compared with the prior year, while year-to-date earnings were
$26.2 million, also a decrease of 10 percent when compared with a year
ago.
10/13/2011
36
Lauren Rudd’s October 7, 2011 Column. Courtesy Sarasota Herald Tribune.
Investing comes with a handbook
“When this old world starts a getting me down...,” (James Taylor, 1998).
I cannot testify as to the world, but for many of you Wall Street’s seemingly never
ending volatility is getting you down. Do not despair, I have an answer you might find
extremely useful in today’s capricious investment climate.
However, let me preface what follows with the mantra that stocks are and always
have been the best investment for increasing your wealth. The key questions of
course are what to buy and when. The last point is easy, anytime. Therefore, the only
remaining issue is which companies do you invest in?
Let me offer you a short-cut you might find extremely useful. I am reminded to bring
it up every year at this time because it is part of my teaching curriculum.
Suppose for a moment you had a list of about 280 solid high quality dividend paying
companies that have withstood the test of time...would that help? Well such help is
available by means of the Mergent Handbook of Dividend Achievers and it remains, in
my opinion, the single most useful tool for individual investors.
I was once asked the question that if you took away my computer systems, access to
the Internet, my telephone and only allowed me the use of one item with which to
select investment candidates, what would it be? This book would be my answer. In
fact, at one time I was quoted on the back cover making just that statement.
No, I do not have and never have had any financial ties to Mergent other
than receiving an occasional review copy, although as a matter of complete
disclosure they do offer my students a quantity student discount.
The book profiles those companies that have increased their regular annual
cash dividend for a minimum of 10 consecutive years. To put things in
perspective, less than 10 percent of 3,300 listed dividend paying companies
make the Dividend Achievers list. If a company misses a year, it is off the list
and must again increase dividends for 10 consecutive years to be added back
on.
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Mergent is not content to simply list the stellar dividend performers. Rather it
takes the list and proceeds to slice and dice it in a variety of ways. For example,
it ranks the entire list by total return based on 1, 3 and 5 year increments. Then
it lists the top 20 companies in 12 different categories such as total assets,
return on assets, return on equity and dividend yield.
Yet, the various lists comprise only about 36 pages of the book. The remaining
pages are devoted to a detailed description of each company, including 6 years
of annual financial data along with the two most recent quarters and a chart of
stock prices covering a 10-year period. A web site address for each company is
also included as are a number of financial ratios.
I have been using and writing about the Handbook for over nineteen years and I
believe it to be one of the few true bargains in the arena of independent
investment research. Moreover, you do not need any form of assistance to
benefit from what Mergent has put together. Some of the companies discussed
in this column were initially brought to my attention via the Handbook.
If you are interested in knowing which company has the longest record for
increasing its dividend every year, it is a three way tie. American States Water,
Diebold and Procter & Gamble have been increasing their dividends for 57
consecutive years. And you say you cannot figure out what to invest in.
What do I not like about the book? There are two things. The first is that
Mergent has become quite commercial with what used to be a relatively
inexpensive investment tool. Four issues per year is probably overkill for many
investors and the price of a single issue, while not prohibitive, is also not what I
would call inexpensive.
The other point is relatively minor but annoying nonetheless. The print is rather
small. This is a result of having to incorporate as much data as possible in a
relative small space. Personally, being a bit long in tooth I keep a magnifying
glass nearby, just in case.
Mergent is selling the book both as a one year subscription for $199 or as a
single copy for about $50 plus a $6 shipping charge. If you would like to obtain a
single copy or a subscription, contact Mergent at 1-800-342-5647.
37
Day Hagan Asset Management
Dividend Achievement
Income Portfolio
1000 South Tamiami Trail
Sarasota, Florida
34236
Phone:
Fax:
10/13/2011
1.800.594.7930
1.941.330.1702
1.941.684.0723
38
Disclosure
The data and analysis contained herein are provided "as is" and without warranty of any kind,
either expressed or implied. Day Hagan Asset Management (DHAM), any of its affiliates or
employees, or any third party data provider, shall not have any liability for any loss sustained
by anyone who has relied on the information contained in any Day Hagan Asset Management
literature or marketing materials.
All opinions expressed herein are subject to change without notice, and you should always
obtain current information and perform due diligence before investing. DHAM, accounts that
DHAM or its affiliated companies manage, or their respective shareholders, directors, officers
and/or employees, may have long or short positions in the securities discussed herein and may
purchase or sell such securities without notice.
DHAM uses and has historically used various methods to evaluate investments which, at times,
produce contradictory recommendations with respect to the same securities. When evaluating
the results of prior DHAM recommendations or DHAM performance rankings, one should also
consider that DHAM may modify the methods it uses to evaluate investment opportunities
from time to time, that model results do not impute or show the compounded adverse effect of
transactions costs or management fees or reflect actual investment results, that some model
results do not reflect actual historical recommendations, and that investment models are
necessarily constructed with the benefit of hindsight. For this and for many other reasons, the
performance of DHAM’s past recommendations and model results are not a guarantee of
future results.
The securities mentioned in this document may not be eligible for sale in some states or
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fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.