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3rd Qrt 2010 8 Page 3rd Qrt 2010 8 Page Document Transcript

  • Helping You Navigate in an Uncertain Investment World Deschaine & Company Illinois PBE Certification Deschaine & Company was recently certified as a “Person with a Disabil- ity Business Enterprise” (PBE) under the State of Illinois Business Enter- prise Program for Minorities, Fe- males, and Persons with Disabilities. For more information on our certification, please contact Mark Deschaine at (618) 397-1002. 3rd Quarter 2010 Dividend Growth Investing: It’s About Capturing Compounding Volume 11, Issue 3 Dividend yield and dividend growth make for a potent compounding machine. Inside this issue: Dividend Growth Investing 1 W E’VE BEEN ACCUSED OF EXTOLLING the vir- tues of investing in stocks that pay a growing dividend almost to the point of hyperbole. To that we Beware the Long Term Bond! Long-term bonds, as we’ve noted several times in re- cent issues, are in the throes, in our humble opinion, of plead guilty—sort of. We’ll explain in a moment. Part what could well turn out to be the biggest bubble in Front Seat, Investing and the proper of the reason behind our enthusiasm for dividend stocks attitude about stock prices 2 financial history. Why do we say that? Well for the is the fact that our EQUITY INCOME strategy, which most obvious of reasons; interest rates have never been Chart 1: Does share price matter? 2 focuses on investing in high-yield stocks(1) that pay a this low—ever. Does that mean we know when interest Table 1: If dividends are growing? 3 growing dividend has done well both at growing client rates will begin to rise and the bond market bubble will income and on a total return basis. This has been done burst spewing bond losses all over investors in an ugly, Chart 2: How income grows over time. 4 during what has been one of the most challenging in- price deflating spiral? No, of course not, but we do Chart 3: How Principal grows over time 5 vestment environments for stocks since the 1930s. know from having gone through an interest rate spike As we tend to remind folks almost on a quarterly in the late 1970s, that buying a 10-year Treasury Note Johnson & Johnson Review 6 basis,(2) every major stock market index is still down in with a current yield of less than 2.5% is simply not Equity Income Portfolio 7 price since year end 1999. Which means for every dollar worth the considerable risk. 3rd Qrt 2010 Update invested in the S&P 500 index in 1999, investors have Needless to say, hardened VIEWPOINT readers less than a dollar in their pocket today—more than a have heard all this from us many times before. But that Demystifying Mutual Fund Fees 8 decade later. That’s excluding any return from dividends. doesn’t keep us from feeling compelled to remind you. After factoring in the erosion in purchasing power from Besides, what else is there to write about? The Deschaine & Company, L.L.C. inflation, investors are down even more. Cardinals? Yeah, right. Well maybe the Rams. A REGISTERED INVESTMENT ADVISOR If there’s a silver lining in the dismal stock market price performance over the last decade or so, it’s the fact Investing for the Long Term World Headquarters that inflation has been relatively benign, by historical Is there any other kind of investing? standards, which has helped hold the cost of living in Deschaine & Company 128 South Fairway Drive check. We doubt many NASDAQ investors still feeling One of the many mistaken beliefs about investing is that Belleville, Illinois 62223 is an SEC registered there is such a thing as “short-term” investing. The way the pain from a 55% loss since 1999 would agree or Phone: (618) 397-1002 investment advisor, we see it, investing is long term, everything else should even care much about the flat inflation statistics of the mark@deschaineandcompany.com be considered “savings.” We realize that we may be managing approxi- last ten years. arguing semantics, but it would probably help most marnie@deschaineandcompany.com Our enthusiasm for dividend paying stocks, par- mately $70 million for investors meet their long-term investment objectives if Maryville Office pensions, endowments, ticularly those with the financial strength to raise them they made a distinction between saving and investing. on a regular basis, remains in full, ah, enthusiastic-ness, and individuals.Loyd Jason mode in the current financial environment for one im- When you can clearly indentify the potential use of (618) 288-2200 the money: college tuition, room addition, rainy day portant and often overlooked reason: there simply isn’t jason@deschaineandcompany.com fund, it should be considered savings and kept in liquid anywhere else to go. In other words, when you look around investments like money market funds, Certificates of Highland Office for reasonable investment alternatives in the current Deposit or other short-term, safe and stable assets (like Matt Powers zero interest rate environment, there just aren’t any treasury bills). The primary objective of savings is the viable alternatives to high yield stocks, for long-term (618) 654-6262 investment options that is. Particularly when it comes preservation of, and ready access to your capital. It matt@deschaineandcompany.com should not be put into anything that could fluctuate in to the income side of the investment equation to help We’re on the Web at: value and lose money between the time it’s socked away provide for living expenses in retirement, for example. deschaineandcompany.com (Continued on page 4) 1) For the record, our definition of “high yield” is dividend yield more than twice the S&P 500 index average. 2) Okay, how about every quarter.
  • Page 2 3rd Quarter 2010 Viewpoint VIEW FROM THE FRONT SEAT by Mark J. Deschaine Investing Success Comes from having the proper attitude about prices! The point is that the stock market is “Another word for Volatility is “Opportunity” (3) viewed by most investors with fear and -- Mark Deschaine, loathing primarily because prices fluctuate. President & Chief Investment Officer Shoppers would probably view Wal- Mart with fear and loathing too if they A FTER MORE THAN 30 YEARS in the investment manage- ment business and many hundreds, if not thousands of conversations with investors of all stripes, sizes and sophistica- published the daily price changes on the merchandise they sell in their stores in the Wall Street Journal every morning. Why I can even hear the nightly news now: tion, I’m convinced that prices are at the heart of their conster- “dish-washing liquid plunged 12% today as the cleaning supplies nation with the stock market. Actually, I should clarify my department dropped the price by seventy five cents a bottle. Shoppers previous statement, I’m convinced it’s the propensity for stock withdrew buying in anticipation of further price drops.” prices to “fluctuate” that’s at the heart of most investors anxi- Obviously, I’m trying (somewhat ineptly?) to use the Wal- ety with investing in stocks. They don’t like it when stock Mart analogy to make a point about the stock prices. But the prices fluctuate, although mostly they don’t like it when prices analogy is right on point. The stock market is just that, a go down. Higher prices they’re okay with, (funny how, I never “market” of stocks. The stock “market” is open from 9:30 a.m. hear anyone complain about to 4:00 p.m. eastern stan- “volatility” on the upside) as $35.00 $32.25 $3.50  dard time, Monday rising stock prices tend to Chart 1: Does Share Price Even Matter? through Friday, except have a peculiarly soothing $30.00 Dividend growing at 8% a year. $3.00  national holidays. effect on many an inves- $25.00 Stock price going up at 5% a year. $2.50  And that’s exactly how tor’s psyche. Stock price stays flat investors should view the $3.42  Unfortunately, that’s $20.00 Stock price goes down at 5% a year. $2.00  stock “market,” as nothing not the proper way to more than a large, New view prices or the stock $15.00 $1.50  York based, super-market market—at least not if $10.00 $1.00  for buying (and of course you have any expecta- $10.00 selling) your favorite snacks, tions of making money $5.00 $0.50  oops, I meant “stocks.” $0.54  consistently from invest- $2.92 $- $‐ ing in stocks. In fact, it’s 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Smart buyers, no matter what the exact opposite way to they’re buying, want lower prices view stock prices and the place If your dividend’s going up and you want to buy more shares, should you care about stock prices. That brings me to my next Yes! You should want them to go down! one goes to buy shares of your point about investing in the favorite company, otherwise referred to as, well, the stock stock market. And I’ll confess, this is a point I tend to make “market.” rather frequently, so don’t be surprised if you’ve heard it be- When you think about it, the stock market is certainly fore. (But then let’s be honest, when all one does all day is talk, think and write appropriately named. The stock market is just that, a “market,” about one subject, and that is—repeat after me—“making money in the stock for stocks. It’s nothing more than a conveniently organized market,” one is going to naturally have a tendency to repeat oneself, over and over place where investors can go to buy, ah well, stocks. What else again repeatedly. Anyway, but I digress, as I often do in these pages.) should we call it? Yet, the fact that share prices of the thou- Back to my next point about investing in the stock market sands of stocks traded on the stock market fluctuate endlessly and it’s this: the objective of investing is to accumulate the is without question in my mind, the reason most investors do largest pile of shares of stock, (of one company or multiple compa- not do well investing in stocks. It’s fear driven by fluctuating nies) as we possibly can. Now, as you know, I don’t profess to prices that makes investors do crazy, self-defeating things. be a math whiz, but I’m pretty certain that it’s better to accu- For all practical purposes, the stock market operates just mulate 10,000 shares of Johnson & Johnson than it is to accu- like your local Wal-Mart store. Again, if you stop and think mulate 1,000 shares and accumulating 100,000 shares of JNJ is about it, Wal-Mart is a conveniently organized place where even better yet. (See Jason’s write up on JNJ on page 6.) shoppers can go to buy everything on the planet, ironically, I realize I run the risk of insulting the intelligence of our except publically traded stocks. But hey, give Wal-Mart time and sophisticated and knowledgeable readership when I use rather maybe soon you’ll be able to throw a couple of hundred shares of your simplistic examples, but I’ve found over the years, that invest- favorite stock into your shopping cart right next to motor oil, fresh ing really is that simple (and are most successful) when we stick strawberries and that 46 inch flat-screen television. (Continued on page 3) 3) Notice, I’m quoting myself now, neat huh?
  • Page 3 Deschaine & Company, L.L.C. (Front Seat, continued from page 2) the dividend increases by 8% per year such returns? And the answer is; for a to the basics. It’s when we lose sight of over the 25 year period, which is a reason- host of reasons. Not the least of which is the most basic objectives--like accumulat- able dividend growth assumption. that over the years, investors have given ing lots of shares--that we tend to under- The question we’ve asked before in little credence to the combined com- mine our own long-term investment ob- these pages is this: if you’ve got money to pounding power of dividend yield and divi- jectives. invest from dividends and interest income dend growth. And, as we mentioned ear- That once again brings me back to or from new contributions and savings; lier, investors are usually scared out of prices. If our primary investment objec- would you rather have stock prices go up, buying more shares when prices drop— tive is to accumulate as many shares of stay flat, or go down? The answer when which is the exact opposite of what inves- our favorite high-yield stocks as possible, investing $1 million in a stock with a divi- tors should be doing. Those two reasons the best way to do that is for stock prices dend that grows at 8% per year over a 25 alone account for most of why investors to go down. Or barring a steady decline, year period is shown in table 1, below. don’t achieve investment returns any- at least not have stock where near the ones prices go up a lot. What’s Table 1. If your dividends are growing, shown here. that you say? Declining stock do you really want stock prices to go up? Not if you reinvesting them! One important point prices are good? What are 1) Stock price Annual 2) Stock Annual 3) Stock price Annual in case you missed it. When you some kind of anti- goes up by Growth price Growth drops by Growth it comes to reinvesting dividends capitalist? Geez, everybody— 5% a year Rate unchanged Rate 5% per year Rate that grow at a healthy rate over a long period of time, share price even rookie investors know Annual Dividend income in year 25 $1,627,617 14.9 % $6,915,014 21.8% $148,900,335 37.7% means almost nothing. that bull markets are good Position Market Value in year 25 $18,183,615 12.3% $28,724,878 14.4% $286,027,048 25.1% At the end of the day, and bear markets are bad. The results of a $1 million dollars invested in a stock with a 5% dividend yield with a dividend that grows at 8% whether the stock market Talk about not understand- annually for 25 years. Under three share price scenarios: a 5% rising price, a flat price, and a share price that goes up, stays flat, or goes ing one of the most basis in- declines 5% a year for 25 years. We’re always happy to send the data behind the numbers. Just let us know. down while we’re buying vestment tenets. stocks will obviously determine our an- In the “Front Seat” column in this No, the numbers in column 3, (in red) nual investment returns, but it really only year’s 1 st quarter issue, I used the price are not typos nor are they incorrect. I’ve means the difference between earning analogy of a Corvette for sale on my lawn double and triple checked them. Just to be 12%, or 14%. Or in the case of a steadily to make the point about how most folks clear, a rising dividend combined with a declining stock market, some magical tend to view prices differently when it declining stock price is the ideal invest- compounding number like 25%! So why ment environment for accumulating stocks, comes to stocks. I included three scenar- growing income, and getting rich! sweat stock prices? ios of stock prices over a 20-year period. Lucky for us investors in buying Better yet, if your dividend income One included stocks dropping in half over mode, we’re in such an environment to- exceeds your income needs, why sweat the first ten years, a second where prices day, as many stocks are flat or have even the stock market at all? In fact, if you’ve stayed flat and three, where prices double declined significantly since the stock mar- got extra income to reinvest, you ought to over the 2o-year period. The totals after ket peaked in March 2000. be rooting for prices to go down—not up! 20 years for both annual dividend income What’s notable about each of the Now, admittedly, my reasoning could and portfolio values confirmed that a three scenarios is that when investing in a be rendered kaput if you’re forced to sell share price that drops over the first ten stock with a yield of 5% and a dividend off a sizable chunk of your portfolio to years (before doubling) allows an investor that’s growing at 8% a year, your total fund some unforeseen emergency, but the ability to accumulate the largest num- returns (while they will vary greatly depend- except for something like that, which by ber of shares for every dollar invested. ing on what the stock price actually does) are definition you can’t foresee anyway, you When combined with a growing dividend, all exceptionally good compared to his- shouldn’t care what the stock market does the compounding effect can be amazingly torical stock market returns. from day to day, week to week or month powerful. I think intuitively every investor For example, the worst outcome is to month, other than to bargain hunt for knows that when buying stocks we want to when the stock price goes up 5% a year.(4) higher yields. pay the cheapest price possible. It’s just hard to Under that scenario, you’re forced to One final point about the stock mar- implement in real life when share prices drop. chase higher prices. As a result, you’re not ket, prices and dividend income. If your able to buy as many shares with your divi- portfolio is producing a growing income A longer look at prices dends. Yet the 12.30% annual com- stream from growing dividends, year in This time I’m going to extend the three pounded return earned over 25 years in a and year out, and you’re regularly rein- pricing examples to 25 years and have the rising market environment still signifi- vesting your dividends, you win no mat- stock price either rise every year for 25 cantly exceeds the long-term stock mar- ter what prices do. If prices go up, you years by 5% a year, have the share price ket returns which are somewhere in the win with higher portfolio value, if prices remain flat for 25 years or the price de- 9% neighborhood historically. stay flat you’re able to buy shares at a cline by 5% a year for the 25 year period. Such splendid results begs the ques- reasonable price. If they go down? You The chart on page 2 depicts the three tion; why aren’t more investors realizing get rich that much faster. scenarios. In each of the three scenarios, Now do you view stock prices differently? 4) Yes, you read that correctly, the worst case scenario is when the share price in my example goes up 5% a year. What a whacky concept! The more we’ve explored the process of building wealth, the more we’ve come to realize that a rising stock market is the enemy of investors looking to grow income and build wealth. Unfortunately, we, like every other investor on the planet have been subjected to the endless onslaught of capital returns and the desire to get rich from latching onto a Microsoft, Wal-Mart (or now Apple?) and watch it grow 10 fold in market value. The problem with that strategy is that it is simply extremely rare and next to impossible to find early enough in its growth cycle for an investor to catch a meaningful part of the ride up. Dividends win through relentless slow growth.
  • Page 4 3rd Quarter 2010 Viewpoint $22,000,000 $21,000,000 Chart 2: How Income Grows over time. $19,863,269 $20,000,000 $19,000,000 Compounding $1,000,000 at 5% $18,000,000 Compounding $1,000,000 at 5% with a 5% annual growth in income. $17,000,000 $16,000,000 Compounding $1,000,000 at 5% with an 8% annual growth in income. $15,000,000 Compounding $1,000,000 at 5% with an 8% annual growth in income $14,000,000 plus $100,000 a year in new savings/contributions $13,000,000 All income reinvested over 25 years. $12,000,000 $11,000,000 $10,000,000 $9,000,000 $8,000,000 $6,915,014 $7,000,000 $6,000,000 $5,000,000 $4,000,000 $3,000,000 $1,344,412 $2,000,000 Chart Deschaine & Company Research© $161,255 $1,000,000 $- 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (Continued from page 1) stock prices do not change. Instead, we make the return than 5% thus creating a bigger pile of and the time you expect to need the money. Par- assumption that each account grows from simply money in the end. Certainly, the potential to earn ticularly in the current investment and economic piling up dividend income that’s reinvested back 10% compounded (the long-term stock market return environment where capital seems more at risk into the account. The portfolios build “at cost,” often quoted in Wall Street marketing material) is a than ever. Earning an acceptable return on your like a savings account where the interest earned strong incentive to invest in stocks. Consider savings in today’s world is a challenge, but you simply accumulates in the account over time. that $1,000,000 compounding at 10% a year should not lose sight of your primary object of The value of the portfolio doesn’t change would grow to $10,834,710 in 25 years. cash, which is preserving principal in the pursuit from any change in price like a share of stock. Of of a little extra (in today’s interest rate environment, course, this assumption cuts both ways as a port- Here’s Where Dividend Growth Kicks In very little extra) return. You just have to get it in folio would benefit if it were invested in stocks Now let’s say this time when you walked in the your head that the trade-off between risk and and share prices double. Yet, as we show in the bank, your friendly banker decides he likes you so reward in today’s interest rate environment is front seat column, the portfolio would also bene- much he’s going to cut you in on a great deal. too great to risk the capital for any modest incre- fit more if share prices dropped over time so we The bank is selling common stock in the bank at mental return. It’s just not worth it, period! could buy more dividend producing shares at $10 a share and they’re going to pay a cash divi- cheaper and cheaper prices. dend of 5% a year. Your banker also offers that as “There seems to be some perverse human characteristic an incentive to buy shares that if you agree to that likes to make easy things difficult.” Dividend Growth, The Real Compounding Wonder keep you stock for 25 years, they’ll raise the divi- –Warren Buffett Let’s start with the most basic compounding dend 5% a year. Under such a scenario, example, a bank certificate of deposit account. $1,000,000 grows to the princely sum of When it comes to investing, we like to stress the Let’s say you stopped into your local bank and $9,681,594, and generates annual income of basics and nothing gets more basic than com- your friendly banker offers to sell you a $1,344,412 in year 25. Quite a jump from simply pounding. Charlie Munger, Vice Chairman of $1,000,000 Certificate of Deposit with an annual adding a dividend that grows at a modest 5% per Berkshire Hathaway, says that truly understand- interest rate of 5%.(5) A bit unrealistic in today’s year into the mix. ing compounding and the difficulty in getting it interest rate environment we’ll admit, but hey, Next, let’s say the bank does real well and consistently is the root to understanding invest- play along. The catch is that you have to keep the actually increases the dividend by 8% annually. The ing. We concur. We’ll even go one step further money and all the interest earned in the bank for returns now jump to $6,915,014 in annual income in and suggest that having faith in the power of 25 years to allow for compounding. year 25 on a portfolio value of a whopping money to compound over time is the very foun- After 25 years, earning a positive 5% a year, $28,724,878! Or more than 42 times the amount of dation for investing in dividend stocks. your account would grow to $3,386,355 dollars annual income from our basic 5% savings account We recently created a series of charts and and would be generating $161,255, in annual example. Thus the power of a growing dividend! examples in an effort to illustrate the power of income in year 25. Not too awful bad, or as the Just for grins we also calculated what would compounding, particularly the power dividend saying goes, “It sure beats a sharp stick in the eye.” happen if we threw an additional $100,000 in growth too, as we like to say, “turbo charge” The outcome is the direct result of com- new savings or contributions into the equation returns over time. pounding from consistently positive returns of each year. Those are the ridiculous numbers in The first thing you need to know about the 5% per year. Most investors should do as well black or $19.8 million in annual income and a outcomes shown in the charts discussed here is because sadly most don’t. portfolio value north of $58 million. the returns do not take into account any return Of course, the appeal of the stock market is At this point, the question you have to ask is from stock price change. That is, we assume the potential to compound at a higher rate of (Continued on page 5) 5) We’re realize we’re talking about investing $1,000,000, but if we can’t visualize our portfolio at that level, how can we make it happen.
  • Page 5 Deschaine & Company, L.L.C. $60,000,000 $58,007,859  $55,000,000 Chart 3: How Principal Grows over time. $50,000,000 Compounding $1,000,000 at 5% Compounding $1,000,000 at 5% with a 5% annual growth in income. $45,000,000 Compounding $1,000,000 at 5% with an 8% annual growth in income. $40,000,000 Compounding $1,000,000 at 5% with an 8% annual growth in income $35,000,000 plus $100,000 a year in new savings/contributions. All income reinvested over 25 years. $30,000,000 $28,724,878 $25,000,000 $20,000,000 $15,000,000 $9,681,594 $10,000,000 $3,386,355  $5,000,000 $- 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 (Continued from page 4) folks at CSFB Holt, and now just recently at to give credit where credit is due which is to the how reasonable are our assumptions? First, a 5% IronBridge Capital Management. original brain trust at HOLT but also to draw dividend yield. Our current EQUITY INCOME Bob Hendricks, the “H” in HOLT, taught your attention to an article Sam Eddins wrote in portfolio yields 5.85% as of September 30, 2010. us much of what we know about valuing compa- 2009 under the innocuous title: “Tax Arbitrage Its been as high as 7.05%. Second, how reason- nies using economic or cash flow returns, rather Feedback Theory.” You can assess the article directly able is an annual dividend growth rate of 8%? than misleading accounting data. As we extolled at: http://ssrn.com/abstract=1356159 The EQUITY INCOME portfolio’s annual divi- before, “accounting data lies, the question is how Quite simply, Sam argues that it was ill- dend growth rate since 2000 is about 12%, much, and secondly, accounting data lies differ- conceived U.S. federal tax policy (is there any which includes 2008 and 2009 when the portfo- ently for different companies.” Obviously, we other kind?) going back more than 20 years that lio had 13 stocks—all financial related—that cut believe that relying on accounting data to evaluate was the direct cause of the global credit crisis. or eliminated their dividends. Dividend growth and select stocks is an exercise in delusion and Sam’s argument is based on the axiom that all so far in 2010 for the EI portfolio is about 13%. fraught with peril. In many ways, dividends, investors seek the highest, after-tax, rate of re- For the record, our annual dividend growth because they’re paid in cash, serve as an excel- turn when making investment decisions. Sam rate target is 8%. Anything above that we’ll lent proxy and a quick measure of cash flow in explains, in plain English I might add, how the consider a bonus. We do feel dividends will the valuation of stocks. different tax rates for different investor groups, grow over the next decade despite the economic Recently, we had the opportunity to chat individuals, tax-exempt institutions, etc., produced challenges the country faces for a number of with Chris Faber, President and Chief Invest- different incentives that contribute to instability reasons, including the fact that companies are ment Officer of IronBridge Capital Management and boom/bust cycles in the economy and the generating record levels of discretionary cash a Chicago based asset manager with more than financial markets. from having reduced overhead during the reces- $8 billion in assets under management. The Sam’s work shows that one, if not the main sion. They also have a record amount of cash on connection between HOLT and IronBridge is a purpose, of debt securitization was tax minimiza- their balance sheets for the same reason. It’s our direct one as Chris worked at HOLT right out tion. In other words, credit default swaps were hope and expectation the managers will do the of college in the 1980s just as HOLT was get- created simply to shift huge amounts of govern- smart thing and increase dividends rather than ting going. Another HOLT alum is Sam Eddins, ment tax receipts to Wall Street bonus pools many of the other less efficient things they who is IronBridge’s Director of Research. through security losses (think Goldman Sachs) might do with the extra cash. After spending about 15 years at HOLT which necessitated the creation of huge amounts As charts 2 and 3 show, earning 5% and telling investment managers like us how to use of low-quality debt designed to purposely go bad having that 5% grow at 8% a year over 25 years the HOLT data to pick stocks, Chris, and Bob to create losses, (think billions in bad mortgages.) will produce quite acceptable investment results. Hendricks founded IronBridge to manage assets Sam notes, poignantly, that not a single dollar of Any boost from stock prices or dividend yields and utilizing the HOLT research. The success of “credit default swaps” has ever been used for any higher dividend growth rates will just add to our IronBridge speaks volumes about the validity of economic propose other than as a tax write-off. pile of money in the end. the research and the talent and skill of Chris We encourage anyone who wants to truly Faber, Bob Hendricks and Sam Eddins. understand the causes of the credit mess of the “Tax Arbitrage Feedback Theory” (Say What?) In addition to the ground breaking work last 20 years, to access the article and spend 15 We’ve had the privilege over our long career to on cash flow returns, HOLT had done extensive minutes reading it. Just ignore the math and the meet some truly smart folks and associated with research on the impact federal taxes have on formulas. Those aren’t required reading and some genuinely nice people in the investment asset prices, particularly stock prices. weren’t meant for us mere intellectual mortals. management business. Two such groups are the We take the time to note all of this in part, As always, thanks for reading. MJD 6) Of course, the contribution of interest income to total return for bonds over the long term is 100%.
  • Page 6 3rd Quarter 2010 Viewpoint 300% 292% 2.30 2.20 275% 2.10 2.00 Year End “Yield on Cost” & Dollar Annual Dividend 250% 1.90 1.80 225% 214% 204% December 1979 to 2010 1.70 1.60 200% 1.50 1.40 175% 1.30 1.20 150% 1.10 1.00 125% 0.90 100% 0.80 75% 0.70 75% 0.60 0.50 50% 0.40 32% 0.30 25% 8% 0.20 4% 0.10 0% 0.00 Dec‐79 Dec‐80 Dec‐81 Dec‐82 Dec‐83 Dec‐84 Dec‐85 Dec‐86 Dec‐87 Dec‐88 Dec‐89 Dec‐90 Dec‐91 Dec‐92 Dec‐93 Dec‐94 Dec‐95 Dec‐96 Dec‐97 Dec‐98 Dec‐99 Dec‐00 Dec‐01 Dec‐02 Dec‐03 Dec‐04 Dec‐05 Dec‐06 Dec‐07 Dec‐08 Dec‐09 OH MY-LANTA! Ticker: JNJ 9/30/10 Price: $61.96 It’s the yield you’re earning on the stock based on today’s annual dividend divided by what JNJ’S HISTORY OF SLOWLY MAKING you originally paid for the shares you own. In the case of the EIP, we paid $52.62 for our Current Dividend Yield: 3.5% SHAREHOLDERS WEALTHY 5-Year Dividend GR: 10.9% shares in March 2009. If we divided JNJ’s current $2.16 annual dividend by our $52.62 By: Jason M. Loyd 40-Year Dividend GR: 19.0% per share cost, we get a “yield on cost” of 4.1% Vice President & Portfolio Manager on our JNJ shares. That’s as in 1963, when John F. Kennedy was Now a “yield on cost” of 4.1% may not J OHNSON & JOHNSON MAY SEEM out of in the White House.(7) To put the power of seem like a big deal, but what if we’ve bought fashion in today’s frivolous, hyperactive, growing a dividend for such a long period of JNJ in January 1979 and held onto those and alpha starved investment environment; time into perspective, if you invested $10,000 shares until now. JNJ’s 1979 year-end share but this $170 billion dollar health care and in JNJ back in 1970, you would’ve received market price was—get this—$0.85 (as in cents) personal product empire has been a wealth about $167 in dividends that year. If you then after adjusting for three 2/1 splits along the creating, income producing, compounding held onto the stock all these years and rein- way. Now, if we divided JNJ’s current annual machine for well over a century. vested all your dividends, you would now see $2.16 dividend by our 1979 cost and we get a The company was founded in 1886 by $138,000 in annual dividends hit your invest- “yield on cost” of—drum roll please—254%. In Robert, James, and Ed Johnson. They had a ment account each year. The annual dividend other words, for every share you might have simple idea—yet utterly revolutionary for the having grown from $.01 a share to $2.16 a share bought in 1979 at $0.85, you would now be time—to create sterile dressings and ban- in that time or an annual growth rate of 14% receiving $2.16 in annual dividends or more dages. Obviously, their idea went over rather since 1970. Reinvesting all the dividends grow than 2.5 times your initial investment—each well to the point where I couldn’t even con- total dividend income better than 18% a year. and every year— and growing to boot! sider providing my kids with anything other Oh, by the way, the shares you would’ve Going forward, you can be sure we do not than the latest and greatest “Princess, or Buzz acquired along the way would now have a anticipate this kind of supercharged income Lightyear” “bandage.” market value in the neighborhood of $3.6 mil- growth. However, our analysis indicates that With over a hundred subsidiaries, John- lion dollars as of September 30, 2010. Johnson & Johnson should be able to continue son & Johnson makes and markets thousands to generate positive cash flow from its stable of diverse health care and personal care prod- What Is “Yield on Cost” of products and continue to pay and increase ucts including such household medicine cabi- We’ve held Johnson & Johnson in the EIP their dividends for years to come. As long as Portfolio since March 2009. The only reason net staples as Tylenol or Listerine. As well as that’s the case, and the price of the stock re- some of the world’s most sophisticated medi- we didn’t buy JNJ sooner was because the mains reasonable by our valuation measures; cal devices and diagnostic equipment. stock was rarely cheap enough for us to justify we’ll continue to utilize the dividend and divi- committing a significant amount of capital to dend growth attributes of JNJ to provide grow- Johnson & Johnson the company. For the record, we paid $52.62 a ing income to our clients. A Dividend Growth Compounding Machine share in March 2009, giving us a “yield on Of course, we are always watching for JNJ has been paying a dividend since 1944 and cost” of 4.1% on our position. price drops allowing us to buy JNJ on the has increased it annually for over 47 years. So what’s “yield on cost?” As you can cheap to augment the income growth process. imagine, it’s very much what is sounds like. JML 7) And Mark was a mere pup of seven years old. So that ought to give you a good idea of just how long ago 47 years is!
  • Deschaine &Viewpoint L.L.C. Year End 2009 Company, Page 7 Equity Income Portfolio Data Update   EQUITY INCOME Portfolio 5‐Year    Long‐term   # of   L‐T Annual    Recent    Current   Average  Dividend   years of   Return from  3nd Quarter 2010 Update Company  Symbol  Price   Yield   Dividend Yield  Growth Rate  Data  Dividend Only  Abbott Laboratories  Arthur J Gallagher & Co.  AllianceBern Global High Inc  ABT  AJG  AWF  52.84  27.28  15.17  3.33  4.69  7.91  2.60  4.70  7.95  18.48  5.77  11.66  20  17  20  4.30  5.36  12.06  T HE EQUITY INCOME Portfolio current holdings as of September 30, 2010 are shown on the table to the left. B&G Foods, Inc.  BGS  11.14  6.10  5.10  9.10  20  6.67  The third quarter was quite a good one for Black Hills Corporation  BKH  32.60  4.42  4.20  19.31  20  5.61  Bristol‐Myers Squibb Co.  BMY  27.11  4.72  4.80  8.11  20  4.61  most equity investors. Investors actually invested Colgate‐Palmolive Co  CL  76.70  2.76  2.10  17.05  3  6.01  in equities that is. One of the notable stories of Clorox Company  CLX  68.00  3.24  2.50  7.04  20  4.81  2010 is the massive move by investors into bonds ConocoPhillips  COP  61.12  3.60  2.70  11.83  20  3.72  and bond funds of all types. For the last 30 CPFL Energy Inc.  CPL  72.86  7.77  6.50  20.97  20  3.43  CenturyLink, Inc.  CTL  40.47  7.17  4.00  10.11  20  4.73  months in a row, inflows into bond mutual funds Chevron Corp  CVX  84.25  3.42  3.10  16.53  20  5.25  have topped flows into stock mutual funds. Un- Dominion Resources Inc.  D  44.74  4.09  3.80  15.01  20  4.24  fortunately, like real estate speculators of the last DuPont de Nemours & Co.  DD  47.13  3.48  3.90  14.61  20  4.92  half of the decade and tech investors in the late Diamond Offshore Drilling Inc.  DO  68.63  0.73  3.90  10.38  20  4.37  ENI S.p.A.  E  45.26  5.67  4.70  0.90  12  5.61  1990s, we think bond investors are in for a rude Consolidated Edison, Inc.  ED  48.88  4.87  5.10  20.51  5  13.76  awakening when rates start to tick up as they Elbit Systems Ltd.  ESLT  52.84  2.73  1.60  10.29  13  2.26  surely will sooner or later. Energy Transfer Partners LP  ETP  50.05  7.14  7.10  3.10  10  3.55  Dividends Keep Growing EV Energy Partners, Units  EVEP  36.27  8.35  8.90  7.18  20  4.36  Federated Investors Inc  FII  24.31  3.95  3.00  0.90  12  13.43  Fifth Street Finance Corp.  FSC  11.40  13.30  8.75  11.95  20  3.91  Investors looking for income might gander at the Frontier Communications Corp.  FTR  8.78  8.54  9.90  11.20  12  10.13  list of stocks to the left. Stocks are showing nice Gladstone Investment Corp  GAIN  7.27  6.60  8.96  14.02  14  10.08  income yields on growing dividends. Standard General Mills Inc.  GIS  37.12  3.02  2.70  16.17  3  7.26  Great Northern Iron Ore  GNI  120.50  12.45  8.90  28.07  12  4.41  and Poor’s reported that dividends showed a 6% Genuine Parts Company  GPC  47.58  3.45  3.40  11.20  2  12.94  increase on average over the prior year period, Glaxo Smithkline ADS  GSK  40.50  4.52  4.00  12.25  6  7.29  albeit the comparison is relative to a low quarter Health Care REIT Inc  HCN  50.88  5.42  5.80  9.02  20  3.74  for dividends in the 3rd quarter of 2009. HCP, Inc.  HCP  37.18  5.00  5.80  12.41  20  4.04  Coca‐Cola Company  KO  49.40  3.64  3.40  9.66  20  9.60  The table to the left shows two columns H.J. Heinz Company  HNZ  63.99  3.38  2.60  35.12  4  5.81  we’ve not shown before. The long term dividend Johnson & Johnson  JNJ  31.82  3.65  3.60  15.24  9  2.73  growth rate column is the annualized dividend Kraft Foods Inc  KFT  66.86  3.95  3.40  10.48  20  10.38  growth rate for each stock going back anywhere Kimberly‐Clark Corp.  KMB  61.47  2.86  2.80  12.44  20  3.83  Leggett & Platt Inc.  LEG  22.99  4.70  4.10  9.66  20  7.51  from 3 to 20 years depending on the stock. Most Linn Energy, LLC  LINE  32.57  7.74  6.50  11.88  16  5.17  notably is the fact that the average dividend Eli Lilly & Co.  LLY  35.50  5.52  3.80  16.90  20  5.12  increase for the stocks shown here is better than Main Street Capital Corp  MAIN  16.69  8.99  8.70  14.11  20  3.98  17% annually. McDonald's Corp.  MCD  78.44  3.11  2.80  27.53  9  2.13  Microchip Technology Inc  MCHP  30.68  4.47  3.30  20.03  20  6.48  The far right column shows the annual Mercury General Corp.  MCY  43.24  5.46  4.40  21.67  4  5.99  return each of the stocks earned from dividends Altria Group Inc  MO  24.95  6.09  6.80  65.65  3  7.21  “alone,” no capital returns factored in. Again, the Middlesex Water Co.  MSEX  17.69  4.07  3.90  58.58  8  0.97  average annual return from just the dividend for MLP & Strategic Equity Fund  MTP  17.26  4.87  5.50  21.40  20  4.34  the group is a healthy 5.87%. How’s that for a Maxim Integrated Products  MXIM  19.08  4.40  2.60  27.82  14  4.22  Norfolk Southern Corp  NSC  61.56  2.34  2.00  22.36  8  2.66  nice rate of return and from just part of the re- Realty Income Corp  O  35.56  4.86  6.50  5.76  20  5.74  turn equation. Compounding your money at just Paychex, Inc.  PAYX  27.92  4.44  2.70  18.88  3  5.40  shy of 6% while growing your annual income at a Pitney Bowes Inc.  PBI  22.06  6.62  4.20  8.49  20  3.38  healthy 17% from a diversified portfolio of quality Plum Creek Timber Co.  PCL  37.25  4.51  4.25  34.31  20  13.24  PepsiCo, Inc.  PEP  65.18  2.95  2.30  19.45  20  3.50  stocks. Now that sounds like a good strategy for Procter & Gamble Co.  PG  63.51  3.03  2.50  48.32  2  3.61  any stock market environment! Progress Energy Inc  PGN  44.96  5.52  5.50  14.83  17  4.51  Note, past performance is not a guarantee of Philip Morris Intl  PM  57.56  4.45  4.20  11.97  20  5.39  future returns and all that. Pinnacle West Capital  PNW  42.20  4.98  5.20  3.59  11  5.22  Prospect Capital Corporation  PSEC  10.02  12.07  11.80  14.30  20  4.39  QWest Communications  Q  6.43  4.98  3.30  9.18  10  3.77  Market Summary 3rd Qrt 2010 Reynolds American Inc  RAI  63.05  3.11  6.00  59.11  6  7.63  Southern Company  SO  38.13  4.77  5.50  0.00  2  8.44  Quarterly Returns 3rd Qrt 2010 Suburban Propane Partners LP  SPH  55.02  6.14  8.00  13.50  16  10.13  US MARKETS 11.63 AT&T Inc.  T  28.34  5.93  4.80  38.82  6  5.52  Integrys Energy Group  TEG  53.35  5.10  5.20  6.05  20  7.29  GLOBAL EX-US 16.91 UIL Holdings Corp  UIL  28.40  6.08  5.40  7.71  14  7.48  Unilever PLC ADR  UL  29.21  3.77  2.60  8.01  9  4.43  DEV MRKTS EX-US 16.78 Vector Group Ltd.  VGR  18.58  8.61  9.40  19.64  11  3.53  EMERGING MRKTS 17.75 Vectren Corporation  VVC  27.00  5.04  4.90  36.05  8  10.22  Verizon Communications, Inc.  VZ  32.52  6.00  4.50  6.16  10  3.76  CORE BONDS 2.37 Wayside Technology Group  WSTG  10.25  5.85  6.20  9.63  20  4.04  LT COMMODITY 12.14 Aqua America Inc  WTR  21.06  2.94  2.40  10.41  7  6.00  World Wrestling Entertainment  WWE  13.89  10.37  7.90  51.12  7  5.38  Source: Morningstar Q210 Market Commentary
  • Deschaine & Company,Page 8 Deschaine & Company, L.L.C. Page 8 L.L.C. World Headquarters 128 South Fairway Drive Belleville, Illinois 62223 Phone: (618) 397-1002 Maryville Office (618) 288-2200 Highland Office (618) 654-6262 DEMYSTIFYING MUTUAL FUNDS Over the years, mutual fund companies have devised numerous and ingenious ways of funds for the client, while at the same time being charged an annual management fee by By: Matt Powers obscuring the load from investors. One way is the advisor, right? to break fund shares into different “classes” and While this is correct, let’ not forget about Vice President & Portfolio Manager charge different fees depending on the class of what was left unstated in the previous para- shares purchased. The three most common are graph. The mutual fund company also has their E ACH TIME WE PREPARE an article for VIEWPOINT, it usually stems from a topic we’ve received the most recent questions or listed in the chart below. Make no mistake, mutual fund companies are in business to generate fees; there’s no free fund management fees and expenses. So, in order to get an accurate tally on the total an- nual cost an investor incurs to own a fund which topic we think is under-covered or not lunch. Separate from the commissions and fees through an advisor, the client will need to com- openly discussed in polite company. a client pays the broker or advisor, is the ever bine the two ex- When it comes to compensating someone present mutual fund expenses known collec- penses (the advi- Combined Annual for selling a mutual fund for example, it’s clear tively as the fund “expense ratio.” These are the sor’s fee for selecting Advisor & Mutual Fund Fees that many investors are often caught by sur- costs related to the investment management the funds, and the Fee For: Fee Rate prise when the curtain is pulled back to reveal and operating of the stock or bond fund. These mutual fund fees for the total costs they incur when buying them. Advisory Fee 1.75% additional cost are deducted from your fund managing the fund) A mutual fund can be purchased in one of and paid to the fund company. The average in order to under- Mutual Fund two ways. 1) No-Load: Simply purchasing the 1.15% stock fund’s annual expense ratio, for example stand their true Expense Ratio mutual fund without a commission. is somewhere in the neighborhood of 1.15% of overall costs. Or, 2) with a Load: Which is usually Total Annual the fund’s total value. Remember, that is in Here’s a typical 2.90% Account Expenses when a fund is purchased through a brokerage addition to the loads and 12b-1 fees you’re combined annual firm. The load is the commission paid to the charged just to buy the fund. advisory & mutual fund advisory account fee broker or your financial advisor. example we’ve seen from a number of broker- Mutual Fund Share Class Loads Mutual Fund Advisory age and advisory firms over the years. Accounts The bottom line is this. While we’re in a 12b-1 fees Mutual fund advisory low interest rate, highly volatile stock market Fund Shares Front Load Back End (ongoing accounts allow you to Classes (commission) Load environment, fully understanding the costs commission) purchase mutual funds associated with your investments and your Usually 5.75% of .25% without a load or sales managers is crucial. One of the reasons we Class A None charge through an advi- work to keep it simple in our fee and commis- the purchase value annually sor, while paying an sion structure here at D&C, so you know ex- Typically begins at .25% annual advisory fee. actly what you are being charged. Class B None 6% in year 1, and (We’ve seen this fee as high To help better understand the expenses reduces 1% each year annually as 1.75%!). involved with your mutual funds you can visit The “advisor” fee is FINRA’s mutual fund analyzer, which can be 1.0% to compensate the advi- found at: http://apps.finra.org/ Class C None None annually sor for selecting the best fundanalyzer/1/fa.aspx. MTP PUBLISHER: MARK J. DESCHAINE EDITOR: JOHN H. DESCHAINE CONTRIBUTING EDITOR: TOM O’HARA STAFF CONTRIBUTORS: MATT POWERS, JASON LOYD COPY EDITOR: MARNIE E. DESCHAINE TECHNICAL ADVISOR: Joseph M. Deschaine. VIEWPOINT is a complementary publication of Deschaine & Company, L.L.C. a registered investment advisor in Belleville, Illinois. This information has been prepared from sources deemed reliable, but its accuracy is not guaranteed. It should not be assumed that any securities discussed will be profitable or will equal past performance, or is it an offer to buy or sell any security mentioned. Deschaine & Company and/or one or more of its clients, employees, family or friends may have a position in the securities dis- cussed herein. © 2010. All rights reserved. Reproduction of this publication is strictly forbidden without written consent from Deschaine & Company. This issue was published on October 20, 2010. If you would like to receive a complementary copy each quarterly, simply send us your address and the preferred method of delivery: snail-mail or email, to: 128 South Fairway Drive, Belleville, IL 62223 Or email us at mdeschaine@charter.net and we would be happy to add you to one of our mailing lists.