DEC 16
Mark Mahaffey Ben Davies Aalok Sathe
“The beauty of me is that I’m very rich.” ― Donald Trump
OVERVIEW
Long-term readers will have heard my big number maths before, back in 2012. At the time, it was in reference to the extraordinary cost of the London Olympics and G4S’s contract for security at the Games. A million seconds is 11 days, a billion seconds is 32 years and a trillion seconds is 32,000 years. Since Donald Trump’s unexpected election in the United States, there has been an ‘announcement’ of a U$1 trillion infrastructure program, which will include rebuilding roads, rails, shipyards, you name it, in order to ‘Make America great again’! The immediate effects in the marketplace have been truly astounding, especially since the most important thing about any announcement is realising that you don’t really need to have a plan to show anyone straight away. Any stock that is connected with rebuilding – whether it be concrete, copper or something more random – has seen spectacular gains.
Nobody can argue that the US needs to upgrade their infrastructure. Any first-time visiting foreigner, from Europe or Asia, will be particularly surprised at the crumbling, archaic state of the transport system, which obviously dates from the 1960s and 1970s, at best, compared to the modern feel of most transit hubs in the rest of the world. The surprise is why it hasn’t taken place sooner. Standard Keynesian economics would suggest that the government should have embarked on a program after the 2008 financial crisis, rather than leave all the work in ‘re-igniting’ the economy to the huge money printing policies of the world’s central banks. While the stocks boosted by Trumpanomics enjoy their moment in the sun, embarking on an infrastructure program when the unemployment rate is back to its lowest level in 10 years has rattled
HINDESIGHT DIVIDEND UK LETTER / DEC 16 1 inflation concerns and, as a result, the world’s bond markets have taken a huge bath. The Bloomberg Barclays Multiverse Index has lost $3.5 trillion in market value in a month. Big numbers again!
The utopian belief in the common good of government infrastructure spending is widespread but, unfortunately, the real world doesn’t seem to agree. While it may create jobs (obviously not necessary at this economic juncture), one thing it definitely does do is add to the debt load of countries.
As most countries are struggling to restrain their Debt-to-GDP ratios with their ageing populations, adding an infrastructure program is going to blow these even higher. Donald Trump’s team have clearly not studied the ineffectiveness of these programs in Japan over the last decade or seen the roads to nowhere in Europe, especially in Spain. A part of the ‘plan’ is the financing of these activities from corporate tax breaks and public-private enterprises. With the level of actual tax paid by businesses at minuscule levels relative to GDP, we can laugh quietly at this as well.
Of course, one of the best ways to reduce the level of debt is to inflate your way out and make those debts worth a lot less in real terms. Trump favours issuing 50-100 year bonds, probably for this very reason. It is much easier to inflate away these than the current bond market of 5.8 years average duration.
We are left with the conclusion that ‘The Donald’ is going to give us plenty to talk about in the financial markets for the foreseeable future, but we should learn that his announcements, whether they are ‘Tweeted’ or contained in actual
HINDESIGHT DIVIDEND UK LETTER / DEC 16 2 interviews, should be taken with the understanding that was the way the wind was blowing that particular day. The US will not spend $1 trillion on infrastructure in his presidency any more than our own UK government will spend £500 billion. It will be watered down and argued against, as we worry about the national debts again, and then no doubt forgotten altogether.
Human nature is tremendously fickle, swinging between pessimism and optimism at the stroke of a hat. The election of a previously thought ‘unelectable loose cannon’ saw the stock market down 5% on the morning of the result, and then rise to an all-time high within a month. In time, I fear that the original pessimism about a Trump victory will come home to roost big time, and while there will be huge financial worries, these may not be our biggest worry.
While we fear that the tumultuous events of Brexit and Trump which defined 2016 will produce great challenges in future, we look forward in the short term to the holiday season and wish all our readers a Merry Christmas and Happy New Year.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 3
Our main investment ideas this month are: 1. ITV PLC
CONTENTS
Inside this edition of the UK Dividend Letter you’ll find:
OVERVIEW 1
INVESTMENT IDEA #1 ITV PLC 5
INVESTMENT INSIGHTS 12 PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS 16
HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (DECEMBER 2016) 18
APPENDIX I THE WAY WE THINK 20
APPENDIX II HOW WE THINK 21
HINDESIGHT DIVIDEND UK LETTER / DEC 16 4
INVESTMENT IDEA #1 ITV PLC by Mark Mahaffey
ITV PLC
Price (£) 169.0 Turnover (£mm) 2,972.0 Net Income (£mm) 495.0 Market Cap (£mm) 6,762.7 Fwd P/E Ratio 10 Dividend Yield (%) 3.80% Payout Ratio (%) - Total Debt to Total Equity (%) 106.9% FCF to Market Cap (%) 7.0% ROIC (%) 28.2%
ITV PLC (ITV:LSE) is considered to be a leading media group that controls 13 of the 15 regional television licences that make up the ITV network in the UK. It is the oldest and largest commercial television network across the British Isles. The company is based out of The London Television Centre (London) and led by its chief executive Adam Crozier. ITV’s focus is solely in the United Kingdom, where it competes with the British Broadcasting Corporation (BBC) for viewership status. ITV PLC, the company, was effectively formed when Granada PLC purchased Carlton Communications in 2004, although Granada PLC has been listed on the London Stock Exchange since 2000. In 2015, ITV PLC generated over £2.9bn in revenue with a current market capitalisation of £6.8bn.
The Television Act 1954 was a British law that enabled the creation of the first commercial television network in the United Kingdom, which was branded as ITV. Up until the early 1950s, the only television service in the UK was operated by the BBC, which ran a monopoly. It was financed by the annual television licence fee paid by every household, which continues to this day. The Conservative government that was elected in 1951 wanted to create a commercial television channel to offer an alternative. This was still considered to be a controversial topic at the time, as the only other example of commercial television was found in the US. Unfortunately, US commercial television was deemed to be vulgar and so there was significant push back on the UK introducing its own.
The solution to this problem was to create the Independent Television Authority, which would closely regulate the new commercial channel so that it would televise shows of a certain quality and award franchises to commercial companies for fixed terms. The act that was put into place stipulated that no advertisement would be aired during broadcasts featuring the Royal Family.
The first commercial franchises were awarded in 1954 and commercial television started broadcasting in stages between 1955 and 1962. ITV first began broadcasting in 1955 on Channel 3 in the London area, and their first advert promoted the Gibbs SR toothpaste on 22nd September 1955. By 1973, there were 15 separate channel 3 regional licences, and each was run by a separate company.
The 1960s saw the launch of BBC2, at which point the ITV regional groups started to lobby for their own second channel. Unfortunately, the Thatcher government opted to create Channel 4 at that time, which it saw as an independent commercial/public services broadcaster. The situation became such that ITV had to settle for selling Channel 4’s advertising and make some of its programmes, such as ‘Countdown’. Older readers will well remember a time when there were not enough programmes to fill the day and the static test card appeared for hours on the screen, a far cry from today’s onslaught of every type of program imaginable.
The Broadcasting Act of 1990 allowed regional companies to merge and consolidate under specific conditions. The act saw the introduction of a controversial auction system for ITV franchise renewal that resulted in the Independent Broadcasting Authority being replaced by the Independent Television Commission. In 1994, the first industry merger went through when Granada bought LWT (London Weekend Television).
HINDESIGHT DIVIDEND UK LETTER / DEC 16 5
In 1998 Granada and Carlton launched a digital terrestrial pay-TV service called ONDigital in order to compete with BSkyB. By 2000, Granada PLC owned six regional licences, Carlton owned five and Scottish Medial Group owned two. The remaining channels were with independent providers. The digital service offering went bust in 2002 with too much debt. As a result, Granada and Carlton proposed a merger. To allow this move to happen, legislation changes were introduced through the introduction of the Communications Act. In February 2004, ITV PLC was born and owned 11 out of 15 commercial licences.
Today, ITV PLC sells advertising on behalf of all 15 regions and produces a significant proportion of all the programming. The ITV family now consists of:
ITV1 ITV4 ITV2 CITV ITV3 ITVBe.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 6
It generates revenues through two main routes:
ITV Studios Broadcast & Online
ITV Studios ITV Studios and Broadcasting account for 37% and 63% of total revenue generation respectively. ITV Studios is a television production company that is primarily based out of Manchester and London, but also has operations in Los Angeles and New York. Its roots can be traced back to Granada Productions. The company makes, distributes and sells over 40,000 hours of high quality television around the globe. ITV studios do not solely make programmes for its parent company ITV, but also for other rival networks, such as BBC and Channel 4. ITV Studios has created a number of leading shows over the years, including:
‘Coronation Street’ ‘Parkinson’ ‘Emmerdale’ ‘Ant & Dec’s Saturday Night Takeaway’ ‘Come Dine With Me’ ‘The Jeremy Kyle Show’ ‘Agatha Christie’s Poirot’ ‘This Morning’ ‘I’m a Celebrity… Get Me Out of Here!’ ‘The Voice’
In the past year, ITV Studios has secured a four-year British horse racing deal which will see the Cheltenham Festival, Grand National and Royal Ascot being broadcasted on ITV after Channel 4’s disastrous three years fronting the sport’s TV coverage.
ITV Studios has been expanding over the years and is now producing shows across the world through its production offices in:
Australia Norway France Sweden Germany Denmark Finland
HINDESIGHT DIVIDEND UK LETTER / DEC 16 7
ITV Broadcasting & Online ITV broadcasting provides viewers with content through both the TV and online platforms. They have a strong slate of programmes with numerous dramas and documentaries, as well as major rugby and football tournaments. The company continues to build their offering to capitalise on the strong demand for high quality content, with a particular focus on investing in scripted projects and sporting events. ITV recently launched its HUB service, which is now the home for all its channels and services, both live and on demand. With online demand for ITV content growing strongly, the HUB service is available on 27 platforms (research has shown that viewers spend 42% more time watching ITV shows online compared to previous years).
ITV’s share price has suffered significantly over the past 12 months, trading lower as investors have grown concerned over the impact of this year’s political and economic instabilities. Shareholders are particularly worried about the impact that Brexit may have on the behaviour of advertisers and their ability to spend, which is still seen as the main revenue source. The firm has seen its market capitalisation fall by over 39%. Despite all the negativity, ITV PLC continues to produce strong numbers, growing its topline year-on-year. Furthermore, the company has always reported positive, free cash flow numbers throughout the business cycle and has once again reported strong data in recent months.
ITV PLC enters the HindeSight Dividend portfolio this month with a score of 57.28. We believe that the worries over Brexit and its impact on advertising revenues are well established in the firm’s depressed share price. The company currently trades with a forward P/E of 10x and offers a strong dividend yield of 3.8%.
The underperformance in its share price can be mainly attributed to the impact of Brexit on advertising revenues
ITV has built itself into one of the biggest broadcasting giants in the world and has generated a significant part of its sales through advertising revenues. Investors are fully aware of the fact that during periods of political and economic uncertainty throughout history, advertisers’ cautious behaviour quickly sees advertising budgets contract. The
HINDESIGHT DIVIDEND UK LETTER / DEC 16 8 broadcasting firm suggested that there might be further pain for those dependent on advertiser revenues, as many commercial decisions taken by those seeking to advertise will be made in the final quarter of the year.
While declining advertiser revenues are an issue for the broadcaster, it is important to highlight that the investment community has majorly overlooked the changing nature of the business model at ITV PLC. The firm built its reputation in the broadcasting industry with advertising, but following Adam Crozier’s appointment, the company has started to shift its focus, becoming more diversified through the generation of content.
It is evident that the content generated through ITV Studios is becoming a larger part of ITV’s revenue generation, making the firm less dependent on sales that are produced through TV advertisers. During 2016, ITV PLC reported that revenues through its ITV Studios production arm rose by 18% in the third quarter, reflecting the firm’s ambitious global diversification drive. This also helped to negate a slowdown in advertising sales that has been observed. With ITV PLC focused on owning as much of its own content as possible, it is helping to change its own long-term business model. Over the past few years, it has acquired several television producers and transformed the ITV Studios business into a major revenue centre. Adam Crozier’s vision of the future is centred on ITV PLC owning its own content and expanding their online/on-demand services. The benefit of owning its own content is that, rather than paying royalty fees (as they have done in the past) to other producers, ITV PLC is able to collect royalty fees by reselling its shows to other networks.
Furthermore, while television advertising revenues may be falling, ITV PLC has demonstrated knowledge across different media platforms by focusing its efforts on the firm’s Online, Pay and Interactive division. Its intense focus on this particular platform illustrates that the management team are well aware of current and future trends. Even though TV advertising revenues may be falling, the same cannot be said for online advertising, which has been one of the firm’s core focuses, given the changing times that we live in (see table below). With ITV PLC committing further resources towards its Online offering, these efforts have paid off. The media group reported that this division has seen a 22% increase in revenues in its most recent reporting statement.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 9
The current management team has changed both the group’s business model and focus, and created a diversified business that is less susceptible to changes in the advertising industry. Its strategy of strengthening and rebalancing the business is clearly working, although has been potentially overlooked by investors. With a strong balance sheet and the capacity to invest in its rebalancing process, it is hoped that this will help guide the media group’s market capitalisation higher, with better than expected results going forwards.
Takeover Target ITV PLC, through its new rebalanced business model – which looks to offer premium content – is starting to catch the eye of large cap companies, particularly in the U.S. With the company down over 39% this year, it has caught the attention of Liberty Global, who is currently ITV’s largest shareholder. Although the company has previous stated that it has no intention of taking over the media group, Liberty Global has increased its stake to over 9%. John Malone, who founded the US-based cable operator, suggested that this was an opportunistic investment and one that is in Liberty Global’s largest market. However, statements made by John Malone relating to any acquisitions should be taken with a pinch of salt, as he has previously suggested that the group’s interest in Ziggo was only an ‘attractive opportunity to make a strategic investment’, similar to what was said about ITV PLC. Despite keeping at an arm’s length, investors saw the following headlines a year later:
HINDESIGHT DIVIDEND UK LETTER / DEC 16 10
With the recent takeover bid for Sky by Fox News at a significant premium in price to pre-announcement, we are reminded of how cheap in dollar terms some of our large long-term successful companies are currently, as a result of the collapse in the sterling price. Not only is ITV’s value lower by 39% in GBP terms since January, but almost 50% in dollar terms. It certainly makes for an attractive takeover target in 2017 at these depressed levels.
Analysts’ Corner ITV PLC is a leading content provider globally. The stock offers investors with a strong dividend yield. It is well covered by the analyst community, with 24 out of 25 analysts giving the stock a buy or hold rating. Our scoring system suggests that the stock has an average 12-month target price (TP) of 221p, representing an upside of over 26%.
Summary ITV PLC has been a leading broadcaster in the UK and is very quickly being positioned as a dominant content provider. Although the company only has channels in the UK, it is producing and reselling shows to TV networks globally. ITV’s share price has taken a hit over the past 12 months and currently trades at a discount to its peers. The investor community seems to have overlooked the fact that ITV PLC is significantly less reliant on advertiser revenues and has repositioned itself as a content provider.
The share price has traded down due to the general global political landscape and investors are worried about the impact on advertising revenues. ITV PLC is still a strong and high quality business that has shown its ability to weather difficult situations throughout its history. It is a business that generates high quality returns and produces significant free cash flow throughout the economic cycle. The current level at which it trades and the firm’s leading position in the global content market makes ITV an excellent selection for the portfolio.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 11
INVESTMENT INSIGHTS
As an investment manager to a bullion based gold fund for the last 10 years, I often get asked about the price of gold and whether it is a good time to buy or sell it. As I believe that gold should be a permanent part of any portfolio, I am often concerned that most people view gold rather like a runner in the 3:30 at Newmarket. We have written in the past about the ‘Permanent portfolio’ or ‘Cockroach portfolio’ that has survived most crises, and a portfolio we believe should really be the starting basis for any investor. www.hindecapital.com reports. 2011 Gold Portfolio Management.
25% gold, 25% equities, 25% bonds and 25% cash. Of course, these assets are going to move in price terms and clearly, there is an economic cycle where one should favour a larger percentage in those assets at times, as well as being respectful to the need for rebalancing. When gold was at its $1900 highs in 2011 and stocks were trading poorly, most permanent portfolio adherents should have trimmed their gold holdings and increased their stocks accordingly. But the need to have at least a starting portfolio allocation is key. Far too many people invest far too much in their ‘favourite’ stuff with scant regard for not only diversification, but also the need to adjust at crucial times.
When I was asked the same old question by an investor last week, ‘What do I think of gold here?’ (at a price of $1150/oz), I replied: “I would hold some gold at this level at a reasonable % allocation in your portfolio; it is not really rich or really cheap. It is 17% lower than earlier in the year, 42% lower than in 2011 and 8% higher than January 1st this year”.
At the end of last year, it became very clear that as gold dropped to close to $1050/oz, most gold mining firms were fast going out of business with supply and exploration totally drying up, so it is probably closer to the cheap side, if you put a gun to my head. I ended the conversation with, “As a current holder of gold of a standard % allocation in your portfolio, you don’t really have to make a decision on it. It is not a short-term bet.”
However, there are times when you definitely need to make decisions on your portfolio, when the valuations, the economic cycle and the environment demand it. Some recent extreme valuations have included:
Anyone who has owned London prime real estate in the last two decades will know that the peak prices of 2014 are unlikely to be challenged for years to come. The stamp duty changes and the disappearance of many of the overseas buyers have seen offering prices drop 10-20% but more importantly, the level of transactions has fallen off the proverbial cliff, suggesting that willing exchange prices are far lower. Bonds, especially government bonds saw their yield lows in the summer, the true extreme peak was no doubt the negative yield issuance of some European corporate bonds. The long 30+ year bull market is over and the price drop looks only just to have begun. The US bond market is leading the rout, but I expect others to follow in due course, including all corporate bonds.
We believe that world stock markets, which have benefitted from ultra-low interest rates, are potentially at risk of a reversal in fortunes as a result of the struggle with very high price/earnings multiple valuations and rising rates. None is more at risk than the US stock market, which in currency terms is the richest in the world by far.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 12
The USD dollar against world currencies is back to the highs of 2000.
As a foreign holder of US stocks, you may be well advised to cash in your chips here and move to increase your cash holdings. The current frenzy has all the hallmarks of a blow-off top similar to historical peaks in 1987, 2000 and 2007.
Source: Damodaran
Closer to home, I am surprised that little has been written about the new rules, which I believe will bring the bull market in buy-to-let property investments to an abrupt end. For as long as I can remember, anyone and everyone could have become a landlord. The strategy was simplicity itself:
Find a willing bank to lend you as much of the purchase price as you could at a good rate, albeit higher than a residential mortgage ‘Do up the property’, market it and rent it out at an ever increasing rate Offset the lower mortgage finance against the rental income, say -3% and +5%, net +2%
HINDESIGHT DIVIDEND UK LETTER / DEC 16 13
Sit back and enjoy the positive cash flow, paying a small amount of tax and watching the value of your capital grow every year Repeat, by mortgaging some of the increased equity of the existing properties to buy another property.
Many buy-to-let empires have been built over the years and have been staggeringly lucrative, and there has been more than enough space for the smaller investor. But as with most great business ideas, either competition or the government move in and the game changes. Newcomers to the market enter to try and replicate the obvious success, but the government usually moves in because it sees an easy tax revenue to collect or it wants to ‘protect investors’ in some guise.
In April this year, 3% stamp duty was added to all second home purchases. This tax grab has wide-ranging implications, not only for buy-to-let investors, but also for marrying couples who change their residences. Not content with that, the government has decided to tax more of the golden goose by reducing the ability to offset mortgage interest against rental income over the next three years.
Source: UK Government
The final nail in the coffin was when the Prudential Regulation Authority announced new stress tests for lenders for BTLs, raising the current levels of lending limits from 125% of rental income at 5% to 145% at 145%. This means a yearly rental income of £12,000 that previously allowed a loan of £192,000 (12000/1.25/ 0.05), will only allow a loan of £150,000 (12000/1.45/0.055) under the new rules.
The new tax and regulatory regime means that the landscape will be different within a few years. As a result:
Costs of purchases have increased The amount of loan potential has dropped substantially All rental income will be taxed with no finance offset.
The buy-to-let investment will now be negative carry (annual loss) because after tax income will be lower than the mortgage costs, so this shortfall will have to paid by the landlord, who will continue to hope that the capital value of the properties goes up. The assumption that landlords will just increase rent is flawed as rental levels are subject to affordability, and with wages unlikely to immediately rise this needs to be taken this into account. This is not ideal for the banking sector either, as 15% of the current UK loan books are buy-to-let mortgages.
I think the smart move is to steer clear of this for the time being or exit completely as one of the largest investors has done very recently. (Until possibly the government realises the error of its ways and reverses some of these changes.)
HINDESIGHT DIVIDEND UK LETTER / DEC 16 14
Summary Our portfolio holds 16 stocks but has a higher cash holding, which reflects our belief that there is less value at this time in many stock markets and their components. The Hinde dividend value strategy, as the name suggests, has parameters based on buying companies that are cheap where the future value is perceived to be higher than the current share price. With stock indices buoyed by zero interest rates and election euphoria, the number of investments that meet the parameters is quite small at the current time, despite the dispersions of gaining and losing stocks being ominously high.
We generally believe that at this juncture in the economic cycle and level of valuations that the risk of capital losses far outweighs the meagre income (often paid out of capital anyway) or capital gains. This includes bonds, stocks especially US ones, and indeed buy-to-let properties.
As such, we will be viewed as having a very defensive strategy because we hold large safe cash equivalents, such as UK T-Bills and a reasonable percentage of gold, while having low allocations of stocks and bonds. Generally speaking, we believe we will be able to buy many asset classes and stocks in the future that are cheaper than they are today and patience is warranted.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 15
PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS
UK Market Valuations
UK INDICES PRICE/EARNINGS PRICE/BOOK DIVIDEND RATIO RATIO YIELD (%)
FTSE 100 INDEX 59.73 1.82 4.04% FTSE 250 INDEX 23.25 2.09 3.09%
HINDESIGHT DIVIDEND UK LETTER / DEC 16 16
HINDESIGHT DIVIDEND UK LETTER / DEC 16 17
HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (DECEMBER 2016)
Portfolio Update and Construction
HINDESIGHT DIVIDEND UK LETTER / DEC 16 18
PORTFOLIO UPDATE
Sainsbury (J) PLC Mitchells & Butlers PLC had an ex-dividend date on 17th of November 2016 for 3.60p.
Vodafone PLC Vodafone PLC had an ex-dividend date on 24th of November 2016 for 4.00p.
Mitchells & Butlers PLC Mitchells & Butlers PLC had an ex-dividend date on 1st of December 2016 for 5.00p.
Britvic PLC Britvic PLC had an ex-dividend date on 8th of December 2016 for 17.50p.
Next PLC Next PLC had an ex-dividend date on 8th of December 2016 for 53.00p.
Babcock International PLC Babcock International PLC had an ex-dividend date on 8th of December 2016 for 6.50p.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 19
APPENDIX I
THE WAY WE THINK
We passionately believe that dividends really, really matter.
William Thorndike in his fascinating book ‘The Outsiders - Eight Unconventional CEOs and Their Radically Rational Blueprint for Success’ examined one of the most important aspects of running a business a CEO must undertake: Capital Allocation. He summarised how a CEO deploys capital in order to best utilise cash flow generated from his or her business operations. Essentially, CEOs have 5 ways of deploying capital:
Investing in existing operations Acquiring other businesses Repaying debt Repurchasing their own stock (buybacks) Paying dividends
Dividend payments are a crucial operation in creating stakeholder wealth. It is this aspect of a business that we are so fixated by – the propensity for a company to produce and continue to grow dividends so that we may accrue wealth over a generation. But as readers will know we can’t just grab stocks with the highest yield for fear that this signals some cash flow or even solvency issues for the firm. So it is with this very real threat in mind we explore only well-capitalised FTSE 350 companies.
This letter’s purpose is to help inform readers on dividend investing so that they can construct a portfolio of sound UK dividend stocks based on our recommendations.
Our prerequisite is that any stocks selected for this letter must be liquid, well-capitalised with a strong free cash flow and a progressive dividend policy.
Our System
Every month we will provide a write up of 1 to 3 stocks until we create a portfolio of 25 UK dividend stocks. This will be the HindeSight UK Dividend Portfolio #1 You will be alerted by subscriber email intra-month when these stocks become a buy. Timing is critical to the strategy, not only buying quality stocks but buying them at the right time The entry points will then be recorded in the next monthly in the HindeSight UK Dividend Portfolio section and the stock(s) written up in full We will run our winners but tend to rotate every 6 months depending on specific criteria which would elevate cheaper companies into the portfolio relative to stocks that had performed The basis for stock and portfolio selection is derived from our quantitative systematic methodology which screens these companies using the Hinde Dividend Value Matrix®, (HDVM®), a proprietary stock-rating system In the section on ETPs we will highlight our investment philosophy and the investment process behind our stock selections. This is the basis of our dynamic risk and money management in our portfolio construction for you. You can also read the stand-alone Hinde Dividend Value Strategy document to see the methodology behind our stock selection
HINDESIGHT DIVIDEND UK LETTER / DEC 16 20
APPENDIX II
HOW WE THINK
“We have met the enemy, and he is us.” Walt Kelly
Our key to long-term performance investing is premised on the following:
Systematic rule-based strategy Systematic risk and money management Occam’s razor, aka ‘K.I.S.S.’, Keep It Simple Stupid Consistency Discipline
All our investment ideas are rule-based methodologies driven by systematic and quantitative models.
Hinde Dividend Value Strategy Hinde Dividend Value Strategy seeks to generate a total return from an actively managed basket of UK dividend-paying stocks. The strategy selects 20 highly liquid, mid-to-large capitalised stocks on an equally-weighted basis, which offer the highest total return potential. The 50% Hedge version of the strategy would then be subject to a strategic Beta Hedge*, which is designed to cover 50% of the value of the UK stock basket at all times.
The 50% hedge is maintained using UK equity benchmark indices to reduce exposure to overall market volatility, but without reducing overall total returns to the market over the long run. The Hinde Dividend Value Strategy (100% Hedge) would deploy a full beta hedge at all times.
Hinde Dividend Value Matrix® The strategy employs a quantitative, systematic methodology, whereby FTSE 100 and FTSE 250 constituent stocks are screened using the Hinde Dividend Value Matrix®, a proprietary stock-rating system. We use the same system to select stocks for any of our strategies, long-only, 50% Hedge or 100% Hedge. The only difference is clearly the extent of the hedge on the exposure to the overall market.
The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks which offer the highest potential for capital revaluation. The dynamic rotation of stocks each quarter enables us to sell stocks where the capital revaluation and dividend has been captured, and use this additional capital to invest in more undervalued quality companies. If successful, this cycle of capture and re-investment offers the chance to significantly improve the total return generated by the Dynamic Portfolio.
The basis of the stock selection process is the Hinde Dividend Value Matrix®, which is a derived process that looks at 3 crucial variables:
* Beta is the stock’s sensitivity to market movements, e.g. if a share has a beta of 1.5 its price tends to move by 1.5% for each 1% move in the index
1. Dividend Screen The top ranking stocks will be those offering a relatively high dividend. A composite of the following criteria comprises the Dividend Rank:
Relative Dividend Yield Dividend Capture Payout ratios
The Relative Dividend Yield assesses if a company pays a higher dividend than the Index it derives from (the FTSE 100 or FTSE 250). The Dividend Capture criteria explain how quickly and how much of the dividend is paid at any point in time. The Payout Ratio gives a snapshot of whether a company will be able to maintain and grow its dividend. It helps us to assess how much of a company’s revenue, profit or cashflow is paid out in dividends.
The lower the amount of dividends paid out as a percentage of profits, the healthier future dividend potential will be. History is for once a good guide as to whether companies will continue to pay and grow their dividends. A stock with an excessively high yield relative to its sector or the overall market is invariably showing signs of heightened risk to its dividend sustainability and often the viability of the company itself. The screen incorporates a limit on yield dispersions from the overall market.
The strategy is emphatically not a yield chaser. It is the Performance and Value screens that are used to assess the total return potential of a stock by analysis of how undervalued it is relative to its fundamentals, sector and overall market index.
HINDESIGHT DIVIDEND UK LETTER / DEC 16 21
2. Performance Screen The top ranking stocks have the poorest relative performance to their index over multiple time horizons.
A composite rank of the following criteria provides the Performance Rank:
Stock relative performance ranked over multiple time periods Average of time periods taken to select rank of stocks
3. Value Screen The top ranking stocks by key fundamental criteria show stable fundamentals and exhibit upside momentum growth potential. The following are some of the criteria that provide the Value Rank:
Value - Price to Book (intangible book adjustment), Free Cash Flow metrics Quality - Return on Investment and Earnings metrics Financial Stability - Debt levels, Coverage and Payout ratios Volatility - Stock variance, Dividend variance Momentum - Sales Growth, Cashflow metrics Liquidity - Minimum market capitalisation relative to index, Shares outstanding
Implementing the Hinde Dividend Value Matrix® The FTSE 100 and FTSE 250 stocks are ranked using the Dividend, Performance and Value screens. An equally- weighted composite rank is then taken of these 3 ranks, which provides a final ranking from which a selection of 20 stocks is made for the portfolio.
The stocks with the highest ranking are compiled for the FTSE 100 and the FTSE 250. The top 10 from each index are then taken, subject to diversification rules, which entail that normally only 1 stock per sector per index can be invested in. For example, if the top 10 stocks are all mining companies, the selection process would take the first of these and then move on to select the next top stock from another sector. As long as a stock has the highest score in its sector, the fact that it has appeared in the final ranking means it is already eligible for investment. In exceptional circumstances, it may be that more than one stock has to be selected from an individual sector.
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External Analyst Score (EAS) This score is derived from 3 inputs that have been obtained from all the external analysts at leading institutions who are covering the stock:
1. The 12 month target price in relation to current price
2. The number of analysts covering the stock
3. The recommendation analysis, e.g. STRONG SELL, SELL, UNDERPERFORM or HOLD
This score is used to observe the other analysts’ view of the stock and is helpful when understanding the methodology that other analysts use to determine their 12-month target price. We ultimately get a blend of price targets that is based on different valuation metrics.
EAS Score Output: 1. The combined score will vary from 30-70
2. A stock with a lowest score of 30 shows the majority of analysts not only have a full sell/underweight recommendation, but also a low 12-month target price in relation to current price.
3. A stock with the highest score of 70 shows the majority of analysts not only have a full buy/overweight recommendation, but also a high 12-month target price in relation to current price.
Note:
- On a standalone basis, the EAS score must be viewed in the following context:
Equity analysts issue far more positive recommendations than negative If all analysts are overwhelmingly bearish or bullish, then this can signal a contrarian position be held, but this is determinate on the where the stock is valued.
- However, in conjunction with the HDVM®, we have found the score to be useful when it is high or momentum is turning higher, as this suggests that the stock offers deep value.
Disclaimer This newsletter is intended to give general advice only on the importance of dividends within the equity space. The investments mentioned are not necessarily suitable for any individual, and you should use this information in conjunction with other advice and research to determine its suitability for your own circumstances and risk preferences. The value of all securities and investments, and the income from them, can fall as well as rise. Your investments may be subject to sudden and large falls in value and you may get back nothing at all. You should not buy any of the securities or other investments mentioned with money you cannot afford to lose. In some cases there may be significant charges which may reduce the value of your investment. You run an extra risk of losing money when you buy shares in certain securities where there is a big difference between the buying price and the selling price. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, particularly if the securities have an element of gearing. In the case of investment trusts and certain other funds, they may use or propose to use the borrowing of money to increase holdings of investments or invest in other securities with a similar strategy and as a result movements in the price of the securities may be more volatile than the movements in the price of underlying investments. Some investments may involve a high degree of ‘gearing’ or ‘leverage’. This means that a small movement in the price of the underlying asset may have a disproportionately dramatic effect on your investment. A relatively small adverse movement in the price of the underlying asset can result in the loss of the whole of your original investment. Changes in rates of exchange may have an adverse effect on the value or price of the investment in sterling terms, and you should be aware they may be additional dealing, transaction and custody charges for certain instruments traded in a currency other than sterling. Some investments may not be quoted on a recognised investment exchange and as a result you may find them to be ‘illiquid’. You may not be able to trade your illiquid investments, and in certain circumstances it may be difficult or impossible to sell or realise the investment. Investment in any of the assets mentioned may have tax consequences and on these you should consult your tax adviser. The opinions of the authors and/or interviewees of/in each article are their own, and are not necessarily those of the publisher. We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material respects. All data is from sources we consider reliable but its accuracy cannot be guaranteed. Investors should seek appropriate professional advice if any points are unclear. Ben Davies and Mark Mahaffey the editors of this newsletter, are responsible for the research ideas contained within. They or any of the contributors or other associates of the publisher may have a beneficial interest in any of the investments mentioned in this newsletter.
Disclosures of holdings: None relevant to any content discussed within this issue of the newsletter
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