Helping You Navigate in an Uncertain Investment World Year End 2010 Viewpoint Volume 11 Issue 4 We would like to take this opportunity to thank our clients for making 2010 a record year for Deschaine & Company. Thank you! Year End 2010 Viewpoint A Hodge-Podge of Stuff, From a Hodge-Podge Kind of Year Inside this issue: W ITHOUT A DOUBT, in our mind at least, the champion each year in the Super Bowl nonetheless. two top stories of 2010 were the extension of As the year moved into April, the stock market the “Bush” tax cuts by the lame duck session of Con- closed above 11,000 for the first time since the debtYield on Cost 2 gress in late December and the stock market hitting a crisis hit full force in 2008. Shortly thereafter, the FedsTen Year Stock Market 4 two year high, also in late December. You may quibble and the SEC charged Goldman Sachs with fraud which with our assessment of what con- sent the stock market down sharply.Yield on Cost Table 5 stitutes the two top stories for EIP 2010 Score Card What shocked us most about the 2010, but we’re sticking with our fraud charges was that we thoughtMcDividends! 6 choices. Like Time Magazine’s 2010 Incept* Goldman was the government. Just “Person of the Year,” each Decem- Equity Returns 23.0% 12.3% when you thought things mightBond Market Outlook 7 ber, we’ve got to write about some- settle in for a bit, the top pops off a thing from the previous year, and Total Return 17.6% 8.7% BP oil well in the Gulf of MexicoSpeaking of Dividends 8 we chose the tax cut extension and Income Growth Rate Market Summary 2009 13.8% 12.3% and millions of gallons of crude oilDividend Outlook 8 the stock market reaching a new Annual Returns spill into the Gulf before the compa- 2009 high for the most obvious of rea- S&P 500 15.1% 1.4% ny can get it capped. While every- US MARKETS 28.5 sons; it’s fresh on our minds. Now *Annualized returns since Dec 31, 2000 one was fixated on a camera shot of granted, they’re important stories GLOBAL EX-US an40.6 leak a mile deep in the Gulf, oil too, but when we began our review of the year gone by halfMRKTS EX-US DEV of Europe was 38.1 to go belly up under the about in search of meaning in what transpired in 2010, we weightMRKTS much debt. Thankfully, just in the nick of EMERGING of too Deschaine & Company, L.L.C. 88.1 stopped about mid-December. The rest of the year was time, all the Euro countries got together, passed A REGISTERED INVESTMENT ADVISOR CORE BONDS 4.6 largely a blur so we went with what was most readily around the collective government hat to help dig on our mind. LT COMMODITY 18.3 themselves out of their financial hole and agreed not to World Headquarters Oh sure there are plenty of other notable events Source: Morningstar Q4 2009 foreclose on one another, putting off the financial col- 128 South Fairway Drive lapse of the European state for another year. during the year such as the election, (where the Repub- Market Commentary Belleville, Illinois 62223 licans took back the House and made major gains in Less than a month later, in October, the Chileans Phone: (618) 397-1002 the U.S. Senate and governors and state houses, etc.) showed the rest of the world how to dig out of a real firstname.lastname@example.org and Ben Bernanke, (remember him?) getting reap- hole, as they managed—miraculously—to extricate email@example.com pointed as head of the Fed, the New Orleans Saints miners from a hole two miles deep. The miners had Maryville Office beating the Colts in Super Bowl, ah what, one thou- been stuck there since the mine collapsed 69 days earli- sand, two hundred and seventeen-something (at this er. From there the election happened, cotton prices hit Jason Loyd point does it really matter?) The Saint’s Super bowl their highest level since reconstruction and gold closed (618) 288-2200 win was significant for two reasons; well for one, we’re above $1,400 an ounce. Which brings us back full cir- firstname.lastname@example.org talking the Saints after all, and two it guaranteed a cle to our two top stories for 2010: Congress passing Highland Office good year for the stock market, and stocks delivered the tax bill and the Dow closing at 11,577. Matt Powers going up 15% on the S&P 500 index for the year. The Saint’s win foretelling an up year for stocks is based on Taxes and Stocks (618) 654-6262 the renowned “Super Bowl Predictor” This renowned What’s eerie about our two top stories is they are inex- email@example.com theory suggests that whenever a member of the origi- orably linked. That is to say, we seriously doubt the nal NFL wins the super bowl, the stock market goes stock market would’ve closed the year above 11,500 We’re on the Web at: up that year. Just so you know, we’ve never put much had the tax bill not passed. But then with the stockwww.deschaineandcompany.com stock in such foolishness, but we root for the NFC (Continued on page 4)
Page 2 Year End 2010 ViewpointVIEW FROM THE FRONT SEAT by Mark J. DeschaineYield on Cost:: How Dividend Growth Grows Your MoneyWE REFER TO THE TERM “YIELD ON COST,” regularly on the- As I enumerated a moment ago, ifse pages which has prompted many folks to ask: what exactly is your initial yield is 5%, and the divi-“yield on cost?” dend grows at 8% a year, by year 25, The definition of “yield on cost” is simple: it’s a stock’s cur- your investment is yielding a healthyrent annual dividend divided by whatever you paid for the 31.7% on your initial cost. If you’restock, or your “cost.” For example, if you own a stock that pays lucky enough to find a stock yielding$1.00 a share in annual dividends and you bought it for $10.00 10% at your initial purchase (they area share in 2000, your “yield on cost” would be rare, but they’re out there10%. The $1.00 dividend divided by your $10.00 Yield On Cost Table from time to time as prices fluctuate) and thecost equals a 10% “yield on cost.” Have I managed Initial Yield: 5.0%, company grows its dividend 8% a year, by year 25to over use the “quotation marks yet?” Beginning Dividend $1:00 you’re earning a whopping 68.5% on your cost. I Annual Dividend Growth Rate: 8% Again, that’s nice and all, but why should you said, “whopping” because I think earning 68% acare? You should care because the objective of 1 $ 1.08 5.40% year on any investment justifies using the wordinvesting is to earn as high a rate of return on 2 $ 1.17 5.83% “whopping.”your money as possible. One of the best ways we 3 $ 1.26 6.30%know to do that is to buy stocks that grow their 4 $ 1.36 6.80% Finding Dividend Growth Stocksdividend over time so that as time goes on, you’re 5 $ 1.47 7.35% Not as hard as it would seemearning more money on the amount of capital 6 $ 1.59 7.93% Believe it or not, finding a company or group ofyou’ve invested in the stock. If a company raises 7 $ 1.71 8.57% companies for a portfolio that raise their dividendits dividend consistently, even at a modest rate of consistently isn’t as hard as it seems. Actually, it’s 8 $ 1.85 9.25%say 5% a year, over time the increase in return relatively easy. But then to be fair, it’s easy for usfrom a growing dividend will make a huge differ- 9 $ 2.00 10.00% because we’ve already identified a couple of hun-ence in the eventual outcome of your investment 10 $ 2.16 10.79% dred companies that have a solid history of raisingportfolio. Let me show you how . . . 11 $ 2.33 11.66% their dividends. For my purposes here, I selected 12 $ 2.52 12.59% 10 stocks from our Equity Income Portfolio, more“Yield on Cost”—the Concept at Work 13 $ 2.72 13.60% or less at random. I say more or less at randomIf you buy a stock that has a dividend yield of 5% 14 $ 2.94 14.69% because all I did was go down our list and selectat the time you bought it and the company grows 15 $ 3.17 15.86% the first 10 stocks that I thought most folks wouldits dividend by 8% a year, in a relatively short 25 16 $ 3.43 17.13% recognize. I really only used one criteria. I select-years, the stock will be yielding a healthy 34.24% 17 $ 3.70 18.50% ed companies that I knew were well-known andon your original purchase price. If your stock pays established in 1985. The reason I wanted stocks 18 $ 4.00 19.98%a $1.00 dividend in year one and the dividend that were well-known in 1985 was because I 19 $ 4.32 21.58%grows at 8% a year, by year 25 the company wanted to be able to calculate performance goingwould be paying you an annual dividend of $6.85 20 $ 4.66 23.30% back 25 years.a share. (See the handy dividend yield on table 21 $ 5.03 25.17% I also wanted the companies to be well-nearby.) If you paid $20 a share for the stock 22 $ 5.44 27.18% known because I wanted to show that it is not thatwhen you originally purchased it (again repre- 23 $ 5.87 29.36% difficult to find an acceptable group of high-yield,senting an initial yield of 5%) then your “yield on 24 $ 6.34 31.71% dividend growth companies. None of these com-cost” in year 25 would be 34.24%. The yield on 25 $ 6.85 34.24% panies would have require an unreasonablecost is calculated by dividing the $6.85 annual amount of research to find or verify. For the mostdividend by your $20 cost. Put it another way, by the time year part, they were all lying around in plain sight. At the same25 rolls around you’re earning 34.24% on your original $20 time, I wanted to show how relatively simple, yet powerful, theinvestment. And that goes for each and every year the company concept of dividend growth and reinvestment is to growingpays you the $6.85 a share dividend. Needless to say, at a your wealth and income and achieving excellent long-term34.24% annual return, your money grows quite nicely and investment results.quite quickly, more than doubling every three years. The two Without further ado, the ten companies I selected are: Abbottimportant variables in the yield on cost equation are the stock’s Labs, Altria Group, AT&T, Colgate Palmolive, Coca Cola, Cono-yield at the time you buy the stock and the company’s subse- coPhillips, Consolidate Edison, Johnson & Johnson, McDonald’squent dividend growth rate. The higher the yield at the time Corp, and Procter & Gamble. I expect most of you will be familiaryou purchase the stock and the faster the dividend grows over with most, if not all of the companies selected.time, the higher your “yield on cost” eventually grows to be. As I think it’s fair to say that the companies I selected, whilethe dividend grows obviously so does your income and your“yield on cost.” And that’s exactly what we’re shooting for. (Continued on page 3)
Page 3 Deschaine & Company, L.L.C.(Continued from compoundedpage 2) 10 Stock Sample Measuring Yield on Cost Yield On Cost annual return. Current Dollar 25 Year Pretty out-all certainly fine Dollar Current Dividend Dividend standing at leastand upstanding Company Ticker Dividend Yield 1985 Growth Year 5 Year 10 Year 15 Year 20 Year 25 on a rate of returncompanies, they Abbott Labs ABT $1.76 3.8% $0.08 12.82% 5.1% 5.4% 12.4% 26.3% 76.9% basis. The portfo-aren’t going to Clorox CLX 2.20 9.1% 0.16 10.63% 4.3% 7.9% 21.6% 39.4% 72.4% lio would haveget the average ConocoPhillips COP 2.20 3.5% 0.48 6.11% 4.8% 11.1% 21.5% 34.5% 82.7% generated a totalinvestor’s heart Consolidated Edison ED 2.38 3.7% 1.20 2.78% 6.1% 9.6% 15.6% 29.4% 53.6% of $48,315 in divi-rate jumping Johnson & Johnson JNJ 2.16 4.5% 0.08 14.09% 3.4% 4.2% 11.1% 29.2% 109.1% dends that wewith excite- Coca Cola KO 1.76 2.8% 0.12 11.22% 7.0% 5.1% 8.8% 30.4% 82.2% would have spentment. I mean; McDonalds MCD 2.44 3.8% 0.05 16.57% 5.2% 5.6% 8.7% 28.0% 77.0% along the way.Colgate Palmol- Compare that to Altria Group, Inc. MO 1.52 1.9% 0.13 15.86% 14.1% 24.9% 46.5% 93.3% 563.0%ive, Procter & the Vanguard’sGamble, AT&T, Procter & Gamble PG 1.93 3.1% 0.16 10.30% 3.8% 6.2% 12.7% 27.2% 79.3% S&P 500 indexConsolidated AT&T T 1.68 5.9% 0.49 5.04% 8.9% 5.6% 10.7% 26.9% 69.7% fund whichEdison, Cono- Totals 4.2% 9.92% 6.5% 8.9% 17.5% 38.0% 126.6% would havecoPhillips. Well, Data source: Morningstar grown to onlyyou get the idea. $50,378 and But that’s kind of the point. It Scenario one: a one-time $1,000 in- would have generated $18,435 in totaldoesn’t take flashy, high octane, super- vestment in each of the ten stocks at year end dividends over the 25 year period.sexy growth companies to do well at 1985. Total investment $10,000. Spend the Under scenario two where we rein-investing in stocks. In other words, you dividend income. vested all of our dividends, you would’vedon’t have to get lucky and buy Mi- Scenario two: same as one but instead more than doubled the outcome for thecrosoft or Google at their initial public of spending the dividends, we reinvested all portfolio. By reinvesting all the dividendoffering to grow your wealth and gener- the dividend income. income, the portfolio would’ve grown toate a nice healthy flow of dividend in- Scenario three: reinvest all dividend $297,858, generated a total of $86,909 income to provide a comfortable retire- income plus invest an additional $250 in dividends and would be generatingment. All it takes is the combination of a each stock at the end of each quarter for a $12,107 in annual dividends today.decent dividend yield, a decent annual total additional investment of $10,000 each However, those numbers pale individend growth rate and a modicum of year over 25 years. Total investment in sce- comparison to the portfolio value oftime and discipline reinvesting your divi- nario three: $260,000. $1,814,583, total dividends of $463,957dends to let it all percolate and before I also ran the same three scenarios and annual dividend income of $72,604you know it, you’ve got yourself a highly for the Vanguard S&P 500 Index Fund the portfolio would be throwing off to-efficient compounding machine that’ll as a proxy for the stock market to give day had you reinvested all the dividendsconsistently build your wealth and in- us some idea of how our 10 stock portfo- and thrown in an additional $250 a quar-come for years to come. From there, lio did compared to the overall stock ter into each stock. Doing the sameabout all you would’ve had to do was market over the last 25 years. thing with Vanguard’s S&P index fundsign up for each company’s automatic would be worth $849,944, generateddividend reinvestment pro- 10 Stock Hypothetical Portfolio 1985 to 2010 Results total dividends of $193,738gram and hang on for 25 Current Market Total Dividend Annual Yield on Current over the last 25 years andyears while you watched these Income Value Income Rec Comp TR Cost Yield would be producing a modestfine companies raise their Scenario 1 $ 5,474 $ 147,741 $ 48,825 15.87% 54.36% 4.06% $14,152 in annual dividends,dividends collectively by al- or a measly 1.94% currentmost 10% a year compound- Scenario 2 $ 12,107 $ 297,858 $ 86,909 14.58% 14.04% 4.53% dividend yield.ing your money into a sizable Scenario 3 $ 72,604 $ 1,814,583 $ 463,957 12.90% 11.23% 4.60% You might be wonder-nest egg. Vanguard S&P 500 Index Fund 1985 to 2010 (Ticker VFINX) ing why the annual com- To really turbo-charge pounded total return numberyour returns, all you had to Scenario 1 $ 855 $ 50,378 $ 18,435 10.88% 8.55% 1.91% goes down under each scenar-do was consistently and regu- Scenario 2 $ 1,728 $ 102,989 $ 29,721 9.77% 4.50% 1.93% io even though it’s over thelarly throw more money at Scenario 3 $ 14,152 $ 849,944 $ 193,738 7.84% 7.33% 1.94% same 25 year time period.them. Shown above is the That’s because scenario one isyield on cost table for the ten stocks go- So, how did we do? The summary a one time investment that compoundsing back to 1985 and some other rele- table above shows the results. In scenar- over the twenty five year period, whilevant investment returns and data. io one, a single $1,000 invested in each of the other two scenarios involve reinvest- the ten stocks on December 31, 1985 ing dividends and or new cash that maySo, how did our 10 stocks do? would have grown to $147,741 by year or may not have been invested at theI ran three scenarios to show the results end 2010. That works out to a 15.87% best time in the stock market cycle.for the 10 stocks since 1985. (Continued on page 4)
Page 4 Year End 2010 Viewpoint Stock Market Returns Since 1999$1.30 Chart 1: Stock Market still below 1999 levels Dow Jones .70$1.20 The Dow Jones, S&P 500 Index and The NASDQ Composite Index: December 31, 1999 to December 31, 2011) S&P 500 - 14.40$1.10 NASDAQ - 34.281$1.00$0.90$0.80$0.70$0.60$0.50$0.40$0.30$0.20 Dec‐99 Dec‐00 Dec‐01 Dec‐02 Dec‐03 Dec‐04 Dec‐05 Dec‐06 Dec‐07 Dec‐08 Dec‐09 Dec‐10 Dow - 34.52% 87.20% - 52.98% 74.70% S&P - 45.51% 95.08% - 56.24% 84.03% NQ - 71.99% 146.13% - 53.88% 105.04% (Continued from page 3 (Continued from page 1) pany by cap size on the New York Stock Exchange. Front Seat column.) market reaching new interim highs since the real On the other hand with interest rates near all-time high reached in October 2007, there must zero, (see page 7) $70 billion in cash is one gigantic So while compounding under be more going on than an extension of a asset that isn’t remotely earning its keep for share- scenarios two and three grow our “temporary” tax cut for another two years. And holders. While Apple gets an A+ for creating portfolios and our dividend income there was, it’s called earnings growth. shareholder wealth over the last decade, share price greatly, we earn a slightly lower While the economy was doing the best it is up 45% per year since 2001 (compared to the S&P overall percentage annual rate of could to pull itself off the mat, most of corporate 500 which is up a mere 1.41% over the same period) return because of the timing of America was trimming the fat and getting its prof- unless it does something productive to maximize investing and reinvesting the cash itability and cranking its cash flow house in high the return on its growing mountain of cash, it’s flows. (i.e. through regular invest- gear. As a result, most of corporate America, at liable to get an F from shareholders going forward. ing sometimes we buy when prices least the part that makes up the publically traded Fueling the cash controversy, Apple hasn’t are high and therefore don’t al- stock market, showed huge gains in profits and has indicated what it plans to do with the cash but ways earn the maximum rate of been piling up mountains of cash. Giving at least management doesn’t seem all that interested in return.) Note our money pile some economic justification for the current level of giving it back to shareholders anytime soon. So far, grows quite nicely from regular stock prices company executives, including the ailing Steve reinvesting nonetheless. Apple is leading the way in cash accumulation Jobs, have offered only vague, dismissive comments The lesson from this exercise and market valuation. The company currently about the need to remain flexible and conservative. is that basket of stocks with a rela- sports more than $50 billion in cash on its balance Given the uncertain economic environment, we tively modest dividend yield of a sheet and is expected to generate an additional $20 would generally concur with management’s call for little more than 4%, but with a billion in excess cash this year. Apple’s current cash caution when it comes to spending and reinvesting dividend growth rate of more than total exceeds the total market value of all but 36 of capital. However, not to the extent of holding 9% annually can compound into a the stocks in the S&P 500 index. many times the amount of cash than the company quite a nice nest egg while doing On the one hand, it speaks well of manage- can possibly utilize efficiently or while earning such so with very little fuss and without ment’s ability to grow sales at such a high rate of a low rate of return on the money. sweating the daily gyrations in the profitably to produce such excess cash. Bravo to Bernstein Research analyst Toni Sacconaghi stock market. Steven Jobs and his team for such a stellar perfor- hammered home on the cash issue in a report on Now that sounds like a plan to mance over most of the last decade. And the stock Apple issued late last summer. In it he calculated help insure your financial and market agrees which is why Apple’s stock is trad- that Apple could pay out a 4% dividend, buy back mental health. ing over $340 a share giving it a market cap of $20 billion in stock and still add $10 billion to its $320 billion. That makes it the second largest com- (Continued on page 5)
Page 5 Deschaine & Company, L.L.C.(Continued from page 4) allocate the company’s growing cash horde. The government’s claim of making a prof-cash pile this year. Even a $15 billion acquisi- Many financially strong companies dont pay a it for taxpayers on the “investment” of our taxtion of a company like Netflix Inc., could be dividend but most should. Robert Maltbie, dollars, while technically true, is disingenuouseasily financed, leaving room for a big buy back managing director of Singular Research opined to say the least to the former equity and bondand a dividend. “I think Apple’s cash position is that a change in dividend policy for many com- holders who were wiped out to the tune ofbeyond the point of being rational,” says Mr. panies would revive investment flows into more than $70 billion when the governmentSacconaghi. equities. He states: “A shareholder revolt may forced the company into a pre-packaged bank- If anything, Mr. Jobs, Apple’s CEO, sur- be in order to make them behave like the ma- ruptcy. This kind of “creative accounting” ofprise leave of absence, announced on Tuesday, ture slow-growth mega-caps that they really gains and losses would land most CEOs in theJanuary 18, 2011, only heightens the tension are.” The directors of such companies “must be slammer. But hey, it’s our friendly federal gov-over Apple’s cash management approach. Ap- prevented from chasing old dreams of glory ernment, so what are we going to do?ple’s stock dropped the day they announced and wasting their cash hoards of billions on Treasury Department Automotive TaskJobs’ leave of absence. That’s partly because the childish and usually fruitless mergers and ac- Force chief Ron Bloom declined to comment onmarket still views Apple purely as a growth quisitions that do not increase shareholder the IPO and how soon the government mightstock, making its share price more volatile. value over the long term.” Ah, Amen to that! divest its remaining 33% interest in GM. HisAdding a dividend would put the stock in office continues to monitor the U.S. tax-the hands of a wider base of shareholders Yield on Cost with an 8% Annual Dividend Growth Rate payer “investment” in the automaker, atwith some seeking income which would Initial Yield Year 5 Year 10 Year 15 Year 20 Year 25 arm’s length.help stabilize the shareholder base. 1.0% 1.5% 2.2% 3.2% 4.7% 6.8% In an IPO-day press conference GM While it’s hard to argue with Apple’s 2.0% 2.9% 4.3% 6.3% 9.3% 13.7% chief financial officer Chris Liddellstellar shareholder performance over the 3.0% 4.4% 6.5% 9.5% 14.0% 20.5% summed up the progress GM has madelast ten years, the fact is shareholders are 4.0% 5.9% 8.6% 12.7% 18.6% 27.4% in the 16 months since the company exit-owners of the company right next to Ste- 5.0% 7.3% 10.8% 15.9% 23.3% 34.2% ed bankruptcy. We used to be a $100ve Jobs and the management of the com- billion finance company with a small car 6.0% 8.8% 13.0% 19.0% 28.0% 41.1%pany and are entitled to any cash the com- company attached. Thanks to the Section 7.0% 10.3% 15.1% 22.2% 32.6% 47.9%pany can’t justify retaining. 363, that problem is now behind the com- Just as with McDonald’s in 2002 (see 8.0% 11.8% 17.3% 25.4% 37.3% 54.8% pany. No kidding, the old GM did littlepage 6) where management came to the 9.0% 13.2% 19.4% 28.5% 41.9% 61.6% more over the past three decades thanrealization that its growth prospects 10.0% 14.7% 21.6% 31.7% 46.6% 68.5% pile up debt and UAW liabilities. Thewere running low, if Apple’s piling up The table above demonstrates the power of “yield on cost” calcula- company struggled to make a profitcash at such a prodigious rate; maybe it’s tions based on various yields at initial purchase and using a divi- building cars while saddled with $100time to distribute some of it to sharehold- dend growth rate of 8%. The table shows how a growing dividend billion in related liabilities. Most quar-ers in the form of a dividend. It may seem earns you a higher yield on cost over time as a dividend grows. ters, profits or losses depended on thealmost foolish to suggest that Apple may Here’s how to read the table. Pick an initial yield, say 1.0%. fortunes of the company’s finance armbe running out of growth opportunities, Now move across the table from left to right. In year five, a stock General Motors Acceptance Corp., asbut if the company can’t efficiently utilize you bought with an initial yield of 1% that grows it dividend at 8% a company management paid little atten- year will be yielding 1.5% in year five; 2.2% in year 10; 3.2% inall of the cash it generates, it’s time to year 15; and so on. By year 25, even a stock that starts out with a tion to the car business. Bankruptcy cutconsider paying some of it to sharehold- very modest 1% dividend yield at initial purchase will be yielding a GM debt to almost nothing allowing it toers. Ideally in the form of a regular quar- respectable 6.8% your original investment or “yield on cost” by year make money on a much lower level of carterly cash dividend. 25. Thus the power of a growing dividend. production. Being able to make a profit And, just as McDonald’s sharehold- Look what a stock yielding 5% that grows it dividend will pay after having the government unceremo-ers have found out since 2002, paying a you in year 25: how does 34.2% sound? niously wipe out $70 billion in debt overgrowing dividend can drive shareholder the short run really isn’t that big of areturns just as well, if not better, than using the Selling Government Motors deal. The real test will be if they can make thecash internally to grow the company. Indeed, if IPO Reduces Treasury’s Stake in GM to 33%. kind of cars that people will buy in largethe company can’t efficiently use the cash, The overhauling of General Motors continued enough volume to rake in huge profits at thethere’s no better place to put it then in the apace last year after GM launched its initial peak of the next automobile cycle.hands of shareholders. In most cases, all the public offering of common stock in November. Long time Viewpoint readers might re-shareholders are going to do is turn right Actually, can it be called an initial public offer- member that we called for a possible GM bank-around and buy more shares with the cash, ing? After all, GM actually went public for the ruptcy in first quarter of 2005, never anticipat-further cementing their long-term relationship first time around 1920. ing the government would be the one to investwith the company to everyone’s benefit. The government went out of its way to in the car business. Alternatively, at the time, extol its investment acumen by boasting of we suggested there were ample assets in theCash is the Problem having made a “profit” on the sale of 359 mil- company to motivate the private equity crowdAs the Apple example indicates, we think the lion shares of GM common at the offering price to gang up on the company and divvy up thechallenges for investors going forward is to see or $13.5 billion, reducing its ownership stake pieces at a tidy profit. We didn’t think they’dthat company managers don’t waste or poorly from 60.8% to about 33% in the process. (Continued on page 8)
Page 6 Deschaine & Company, L.L.C. spending capital pushing top line sales ing to be ashamed of, but when you McDividends! was beginning to show diminishing re- compare it to Vanguard S&P 500 index We’re lovin’ it! turns to shareholders, so they set out to fund (ticker VFINX) which was up By Jason M. Loyd return more of the company’s cash to 13.83% over the same period, the re- Vice President & Portfolio Manager shareholdings by increasing dividends. turns suddenly look almost mediocre. Over the last eight years they’ve more Since 2002, and their new shareholderI F YOU’VE BEEN A LONG-TERM inves- tor in McDonald’s stock, chances areyou’re as happy as a little kid tearing than doubled the company’s dividend focused dividend and cash flow manage- payout ratio. As a result, since 2002 the ment policies, however, MCD is up dividends have increased from a rela- 24.61% compounded annually comparedinto a Happy Meal. Since the two tively modest 24 cents a share to over to 6.65% for the VFINX.McDonald brothers (Richard “Dick” and $2.44 per share as the payout ratio was And this is a nice reminder for us—Maurice “Mac”) kicked things off flip- systematically increased from 18% of patience is required for exponentialping burgers in their drive-up restau- net income to about 50%. Over the same compounding to really take effect. Asrant in 1940, McDonald’s has methodi- period, earnings per share grew from the stock market goes through its typi-cally grown (mostly at the helm of ham- $.70 in 2002, (a rare off year for the cal daily gyrations it’s very easy to be-burger tycoon Ray Kroc) to be the world’s company) to $4.59 a share in 2010. Who come short sighted and glued to thelargest restaurant chain. With over says a company can’t grow earnings if fluctuating market values of our portfo-32,000 locations serving 60 million cus- they pay out a big chunk of cash in divi- lios. We shout with joy one quarter ortomers a day, you’d be hard pressed to dends at the same time? McDonald’s gasp in fear the next. From our experi-find anyone in the developed world that management has to be commended be- ence, such short-term focus on marketdoesn’t recognize the fluctuations almostgolden arches. $5.00 always leads investors Under brilliant $4.50 to do precisely themanagement, McDon- McDonald’s Earnings & Dividend Growth $4.00 wrong thing at exactlyald’s Corporation has 1985 to 2010 the wrong time. As $3.50been dishing out divi- investors with one eyedends as efficiently as $3.00 on dividend growth, wetheir hamburgers. $2.50 seek to leverage the McDonald’s management commits power of compoundingMoreover, they have to increasing dividend payouts to $2.26 $2.00raised their dividend by reinvesting a grow- $2.05 shareholders in 2002every year since they $1.50 ing dividend over the $1.63 $1.50started paying them in $1.00 long-term. To do so successfully, we need to $1.001976. To put the com- $0.50 $0.40 $0.55 $0.67pany’s dividend payout keep in mind that time $0.00history into perspec- is the key ingredient 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010tive; for folks that for success.bought 100 shares back when the com- cause it took a lot for them to change a McDonald’s has apany went public in 1965, it would’ve business model that’s worked extraordi- long and solid history of providing op-cost them a hefty $2,250. However, narily well for over 30 years to head in portunities for shareholders to com-simply holding these 100 shares and an almost completely different direction. pound our money, and given all the fac-reinvesting all dividends would tors we analyze, we expect thehave grown their total shares to McDonalds Stock Performance 1985‐2010* golden arches will continue to dowell over 75,000. At the year-end EPS Annual Stock Price Pay Out what it has done over the last 40share price of $76.76 a share that Period Growth Dividend GR Change Ratio years which is to grow profits andequates to roughly $5.7 in million 1985-2002 4.7% 9.1% 9.4% 18.0% increase their dividend, at doublemarket value, and about $183,000 digit annual rates, all to the benefitin annual dividend income. Not bad 2003-2010 26.5% 33.6% 21.56% 49.2% of us shareholders.for a $2,250 investment. Instead of focusing on top line growth, Here is your compounding quiz of the they’ve been focused on improving the quarter: How tall would a piece ofManagement refocuses in 2002 bottom-line (or profitability) and cash paper be if you could fold it 50Since 2002, management has taken an flow growth.even more aggressive, pro-shareholder times? Hint, it doubles in size on eve- So how has the new dividend pay-approach to their management of the out policy worked out for shareholders? ry fold. Answer: 95 Million Miles (Aboutbusiness. For starters, they recognized Well consider that from 1985 through the distance from the Earth to the Sun)the company had reached a point where 2001 MCD provided shareholders withaggressively building new stores and a total return of 12.65%. Certainly noth-* Data source, Morningstar
Page 7 Year End 2010 Viewpoint 18.00 Chart 5: 10-Year Treasury Yield 17.00 3-Month Treasury Bill Yield Yes, eventually this is the next “Bubble” 16.00 15.00 The area in Gray is inflation With interest rates at record lows the next logical 14.00 13.00 major move is UP! 12.00 All that has to happen for an investor to lose big in 11.00 50 year average 10-year bonds is for interest rates to rise to their 50-year 10.00 Treasury Rate average. Ouch! 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 ‐1.00 ‐2.00 ‐3.00Apr‐53 Apr‐54 Apr‐55 Apr‐56 Apr‐57 Apr‐58 Apr‐59 Apr‐60 Apr‐61 Apr‐62 Apr‐63 Apr‐64 Apr‐65 Apr‐66 Apr‐67 Apr‐68 Apr‐69 Apr‐70 Apr‐71 Apr‐72 Apr‐73 Apr‐86 Apr‐74 Apr‐87 Apr‐75 Apr‐88 Apr‐76 Apr‐89 Apr‐77 Apr‐90 Apr‐78 Apr‐91 Apr‐79 Apr‐92 Apr‐80 Apr‐93 Apr‐81 Apr‐94 Apr‐82 Apr‐95 Apr‐83 Apr‐96 Apr‐84 Apr‐97 Apr‐85 Apr‐98 Apr‐99 Apr‐00 Apr‐01 Apr‐02 Apr‐03 Apr‐04 Apr‐05 Apr‐06 Apr‐07 Apr‐08 Apr‐09 Apr‐10 BOND MARKET went down, the modest commitment to interest rates or for that matter, in fore- bonds we had in client accounts at the seeing the extraordinary economic cir- REVIEW & OUTLOOK 2011 time would benefit from higher prices— cumstances we find ourselves in today. Once Again: Caveat Emptor albeit only modestly. On the other hand, For the record, we never predicted “Bond & Bond Fund Buyers Beware!” if interest rates spiked, like they had when interest rates would actually rise. several times in the recent past, any We would never be so foolish to actual- “Probably the biggest lesson of the last ten years bonds (or bond funds) with a maturity ly predict something that could be for the bond market is to never underestimate the longer than ten years were likely to get measured so succinctly and held against Federal Reserve’s power (or determination) to hammered enough to cause potential us. We just know rates will eventual hold interest rates artificially low.” capital losses ranging from 25 to 40%, have to go up as history and economic VIEWPOINT Bond Market depending on the maturity and quality reality so clearly suggests. With the 90- Review & Outlook of the individual bond or bond fund. day Treasury Bill rate (denoted in red in January 2010 As we also noted last year, our bond the chart above) hovering near zero, we strategy at the time was to take a very think we’re on solid ground when weT HE QUOTE ABOVE IS THE OPENING line from last year’s year-end VIEW-POINT Bond Market Review & Outlook. conservative approach to any invest- ment in bonds by staying very short in maturity, (oh, and always buy high quality suggest they have to go up from here— eventually. Do we know when exactly, of course not, but then as our interest rateWhen we went back and reviewed our merchandise). Essentially, take a wait and forecast record of the last ten yearsinterest rate forecast, it was painfully see attitude toward interest rates and clearly indicates, we’ve never known.obvious to us, as it should be to you too the direction of the bond market. Client We’re just trying to point out theby now, that we haven’t exactly been on assets not committed to stocks were potential financial hazards to bond in-the mark on our outlook for interest invested in money market funds, certifi- vestors when interest rates finally do,rates. As we also noted last year: “When cates of deposits and short-term bonds. well, rise?we launched the asset management business First, the idea was to minimize any po-in the fall of 1999, one of the primary in- tential capital losses when interest rates Don’t Fight the Fedvestment assumptions we made at the time rose. Second, to be in a position to bene- An old investment adage says “neverwas that low interest rates posed a sizable fit from said rising interest rates as fight the Fed,” which means never un-risk to bond investors.” money market funds were able to roll derestimate the Federal Reserve’s abil- Again quoting from last year’s maturing assets into higher yielding ity to manipulate interest rates in theVIEWPOINT, “Given the relatively low securities. short term. Or, as the last ten yearslevel for interest rates in 2000, we made Well, here we are one year later and shows, in the intermediate, and or thewhat we thought was a reasonable assump- we’re still waiting for interest rates to long term.tion in expecting that interest rates were rise. But then in defense of our interest Still, with interests near zero, buying or rate forecasting record these last ten holding long-term bonds or long-term bondequally likely to go up as go down.” years, no one else we know has done any funds right now is probably the riskiest First, we figured if interest rates better job of calling for a reversal of thing an investor can do.