NOV 14

DIVIDEND UK LETTER Mark Mahaffey Ben Davies

“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.” Mark Twain

Overview

In October 1987, the Dow Jones Industrial Aver- In Views Ben Davies will explore why markets have age plunged more than 20% in one day, an unlikely experienced such sclerotic behaviour, citing what the 20-standard deviation event whose probability of oc- brilliant mathematician Mandelbrot once referred to currence is less than one in ten to the 50th power. Fast as the (mis)behaviour of markets. Ben suggests such forward 27 years and global devel- behaviour should be attributed oped stock markets experienced a to man. fall of 10 to 15% over a course of 3 We’re keen to to 4 weeks, with a rebound in some The Philae bounce is undoubt- markets as ‘stellar’ in magnitude as hunt down edly another huge leap for the European Space Agency’s (ESA) stocks which mankind as it could provide Rosetta mission success to land a confirmation that comets once robotic space probe on the surface benefit not brought water and amino ac- of a comet. ids (protein) to our barren Earth only from to make life possible. But right On the 12th November 2014 - some here on Earth Ben writes about 10 years after it was launched - market vol- how we are experiencing anoth- lander module Philae which ac- atility, but er remarkable experiment which companied the Rosetta space- is highly ingenious in its unor- craft touched down on Comet 67P/ also the geo- thodoxy and will require careful Churyumov-Gerasimenko (67P). navigation for private investors. The on-board telemetry commu- political fall- nicated back to Earth some 28 Meanwhile Mark Mahaffey looks light-minutes away revealed that out... at 3 high dividend paying stocks the lander had bounced twice off to build out our portfolio. We’re the surface of 67P. The first bounce may have lasted keen to hunt down stocks which benefit not only from two hours and over 1 kilometre and is considered the market volatility, but also the geopolitical fall-out which largest space bounce in history which we would put comes hand in hand with such volatility. on a par with the incredible bounces in the US and Japanese stock markets! Lastly we look to introduce a consumer staple stock with both domestic and foreign exposure into our Hin- deSight Dividend UK Portfolio.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 Our three main investment ideas this month are: 1. IG Group 2. Kingfisher 3. Rolls-Royce

CONTENTS Inside this edition of the UK Dividend Letter you’ll find:

VIEWS (Mis)Behaviour of Markets & Men, by Ben Davies 3

IG GROUP Spread Better to Stock Broker, by Mark Mahaffey 5

INVESTMENT INSIGHTS Bubble Babble, by Ben Davies 8

KINGFISHER A ‘Defensive’ World Superstore, by Mark Mahaffey 11

WHAT HAPPENED? Market & Sector Analysis 16

ROLLS-ROYCE Defensive? ‘Yes M’lady’, by Mark Mahaffey 18

HINDESIGHT Dividend UK Portfolio # 1 23

HALF.L ETN 25

APPENDIX I The Way We Think / Our System 26

APPENDIX II How We Think 27

HINDESIGHT DIVIDEND UK LETTER / NOV 14 52 Views (Mis)Behaviour of Markets and Men by Ben Davies “Of course, well-behaved price changes are not the only assumption underlying the standard financial model. Another is that each flip of the coin, each quiver of price, should be independent of the last. There should be no predictable pattern Ben Davies on which you could trade and profit. Alas for the financial establishment, this is also a fairy tale... Stock prices are not independent. Today’s action can, at least slightly, affect tomorrow’s action.” Benoit B. Mandelbrot

Man’s ingenuity knows no bounds. We have to acknowl- This is not just sensationalist proselytising on my part. At edge the quite literally cosmic achievement of the Europe- Hinde Capital we have provided a very coherent dialogue an Space Agency, that of landing a probe on a comet. The over the last decade as to the follies of policymakers but ESA has far exceeded the epic voyages of discovery and others such as Gavyn Davies, the ex-Goldman Sachs chief feats of navigation by the Iberian economist and former chairman of trio of Columbus, Vasco da Gama the BBC recently upped his rhetoric and Magellan - the ESA scientists Governor when he wrote in his FT editorial: succeeded in effectively throwing a dart and landing it on top of the Kuroda’s mon- “Japan is now conducting a laborato- Empire State building. And this real- ry experiment...and Governor Kuro- ly understates the achievement. etary exper- da’s monetary experiment has in effect morphed into a strategy of de- Whilst this leap for mankind could iment has in valuation plus financial repression.” provide confirmation that comets effect mor- once brought water and amino ac- I will touch on Japan shortly, but for ids (protein) to our barren Earth to phed into a anyone who wants to comprehend make life possible, we are about to the extent and impact of financial find out the extent of another re- strategy of repression please read our pres- markable experiment but this time entation at the website home page right here on Earth. devaluation or click here for the full speech.

Except this experiment far from be- plus financial In October 1987, the Dow Jones ing a source of celebration as some Industrial Average plunged more dismal scientists (Krugman) would repression. than 20% in one day, an unlikely have you believe could be highly 20-standard deviation event whose destructive to the well-being of man. It is already prov- probability of occurrence is less than one in ten to the ing so - with wealth inequality continuing to rise, which in 50th power. In September 2008, the Dow once again turn is primarily a function of the accumulation of housing dropped significantly, declining by more than 7% in one stock as well as unsound public and private structures day, a probability of 1 in 50 billion. Under conventional not being allowed to fail. It is this experiment that helped financial theory such as the Efficient Market Hypothesis propel many global stock markets back to new highs in (EMH) these sharp drops in the stock market were not recent weeks leaving a growing gap between financial supposed to happen. markets and economic realities. This alarms me. Fast forward to October 2014 and the global stock mar- I refer of course to an experiment which I believe is unpar- kets fell precipitously over a three to four week period alleled in financial history. It is one of the most ingenious from mid-September to mid-October whereupon many but crudest methods of coordinated economic destruc- markets exhibited a selling climax and a ‘V-shaped’ re- tion ever attempted, although the opposite outcome is covery. Most developed stock indices such as the FTSE intended. Central bankers globally have been dialling up 100 and S&P500 initially fell 10 to 12%. unconventional monetary policy, which when it ends will be known posthumously for what is - unashamed coun- Some markets roared back whilst others merely wit- terfeiting of a nation’s currency, otherwise known as mon- nessed a dead cat bounce and have since resumed their ey printing. It has the potential to bring untold economic falls below the October lows. misery beyond the inequality of riches it has already be- stowed upon nations.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 53 Source: Variant Perception

The FTSE 100 has subsequently managed an impressive NIKKEI 225 (2013 – 2014) rally covering 75% of the initial fall whilst the S&P 500 has rallied to make new highs. The frequency of such declines is an occurrence which happens on average about every two years. So it’s fair to say it’s within the Gaussian sta- tistical norm as compared to the rather stellar events of the ‘87 and ‘08 sell-offs. What was less normal was the rebound to new highs.

If one was sitting upon the Tokyo Stock Exchange, the Nikkei 225 fell 12.4% from the high of 16,410 in mid-Sep- tember to the mid-October low of 14,369 only to rally new highs at 17,521 by the 13th November.

A rise of 21%. Source: Bloomberg

Astounding! The recent behaviour in global stock markets down and then back up is a sign all is not well. It should be a clear By comparison if one was sitting aboard the good ship signal that government spending and fiscal dominance Euro Stoxx 50 index - the Eurozone’s leading blue chips of central banks sows the seeds for tectonic disruptions, from 12 EU countries - the 15% decline was deeper than as monetary largesse grinds against the plate of falling the UK and US blue chip stock indices and the subse- growth from industries which once experienced exces- quent bounce barely covered half the decline. sive credit infusions.

The recent talk of a slowdown in the worldwide economy In the later section titled ‘Bubble Babble’ I will observe - which is very real - is not because we are witnessing some of the potential reasons for the differing fortunes government spending inspired ‘austerity’, rather that most of these markets. states have spent TOO MUCH! The Eurozone has seen a 3% rise in public spending as a % of GDP to nearly 50%, an increase in spending of some €300 bn yet industrial production in countries like and has been col- lapsing. Italy itself has just posted a new Post Lehman IP low. France itself just released a budgetary plan indicating it does not expect to hit its 3% fiscal deficit target for next year in defiance of the Eurozone fiscal rules.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 54 Investment Idea #1 IG Group: Spread better to stockbroker? by Mark Mahaffey

IG GROUP HOLDINGS PLC

Price (£) 620.0 Mark Mahaffey Turnover (£mm) 413.7 Net Income (£mm) 147.0 Market Cap (£bn) 2,270.0 P/E Ratio 14.9 Dividend Yield (%) 5.1% Payout Ratio (%) 69.9% Total Debt to Total Equity (%) 0.0% FCF to Market Cap (%) 5.9% ROIC (%) 28.0% Financial

IG Group is generally known as one of the main spread betting firms, along with City Index and Cantor Index (now Spreadex) where financial and sports bets are placed by a myriad of ‘day traders’ online over the last few years.

However, most people will be surprised to know that IG Group which is now the group name that incorporates both IG Index and IG markets was founded in 1974 to enable people to trade the price of gold as an index rather than the costly process of trading the commodity itself.

‘Investors Gold Index’ soon became shortened to IG Index and it has continued being the first mover in financial spread betting milestones ever since. (It shut its fixed-odds sports service -Ex trabet in 2011) Over the last 40 years it has continually offered new markets to willing investors to operate in the financial spread betting arena with all the benefits of reduced taxation and easy to use dealing platforms and procedures. The invention of the internet allowed IG Index to become the first to offer online dealing in 1998. Currently 125,000 clients worldwide access IG platforms, over a third using mobile technology to trade products from currencies to CFDs.

MSCI UK & MSCI FINANCIAL VS IG GROUP HOLDINGS SHARE PRICE 108.0

106.0 660.0

104.0 640.0 IG Group Holdings Share Price 102.0

620.0 100.0

98.0 600.0 Indexed Prices 96.0 580.0

94.0

560.0 92.0

90.0 540.0 31/10/2013 14/11/2013 28/11/2013 12/12/2013 26/12/2013 09/01/2014 06/02/2014 06/03/2014 03/04/2014 01/05/2014 07/08/2014 04/09/2014 02/10/2014 23/01/2014 20/02/2014 20/03/2014 17/04/2014 15/05/2014 29/05/2014 12/06/2014 26/06/2014 10/07/2014 24/07/2014 21/08/2014 18/09/2014 16/10/2014 30/10/2014

MSCI UK MSCI UK/FINANCE IG GROUP HOLDINGS PLC Share Price

HINDESIGHT DIVIDEND UK LETTER / NOV 14 5 UK Institutional Absolute Index Relative Dvd Brokerage Providers Perf. (12m) Perf. (12m) Yield (%) Price/BooK ev/EBITDA* HDVM®**

IG GROUP HOLDINGS PLC -2.04% 1.01% 5.10% 3.86 9.93 56.51 ICAP PLC 8.67% 11.72% 5.56% 2.88 6.29 45.01

Note * EV / EBITDA - Enterprise Value divided by Earnings (before interest, tax, depreciation and amortisation) ** HDVM® - Hinde Dividend Value Matrix

Today IGG is listed on the London Stock exchange as a constituent of the FTSE 250 and has a large market capitalisation of £2.2bn, backed up by the latest (2013) revenue numbers of £362 mm and net income of £142 mm. It boasts a current dividend yield of 5.2% which is a significant factor in its high score of 56.51 on the HDVM® for an explanation of this statistic see the back of this report.

We are recommending IGG for the HindeSight Dividend Portfolio this month not just for that ex- cellent yield but also for the nature of the business that is able to provide this flow of cash.

IGG’s profits primarily come from the ‘bid-to-offer spreads’ that are paid by its clients as they trade their desired products.

The more business, the more spread is paid, simple.

That gross income does not have to be subject to much before it becomes net income.

There is no huge capex. factor or cost of sales.

It is a high margin, cash generating machine and can easily afford to pay out 70% of its earnings in dividends year after year even if its business was not growing at all. So it should be a no brainer on that alone at this time of zero interest rates on deposit accounts.

We believe though the business is going to grow in coming years. This year, 2014, IG Group have launched their execution only stock broking service making the final leap from a financial spread betting service to a full stock investment portfolio service. You can buy your shares online, out- right or on margin and hedge that portfolio with contracts for differences, index futures and cur- rency futures. That is yet another early mover in the revolution of individual investor trading and investing access. Today you can have at your disposal all the tools of the trade that have only been available to the institutions before. If you are one of the fast growing number of new DIY inves- tors, an IG platform could easily service all your needs including running the HindeSight Dividend portfolio on it. Since the pension announcements in this year’s budget, the number of individuals who are looking to take control of their finances directly is growing daily. This can only benefit the future revenues for IGG in a big way.

The final reason I like IGG as a perfect addition to the portfolio is its potential to be negatively correlated to the general stock market at times. Different factors drive different stocks but when the overall index declines on global crisis concerns all stocks tend to be correlated (ie they all go down together). We will discuss portfolio construction and correlation separately later but in the case of IGG, they make money by their level of transactions; the more transactions, the more money. The level of transactions is driven by the size of the client account base naturally but also by the volatility of the markets. Low volatility is bad for the IGG business, a slowly grinding up equity market or stable currencies will eat into any revenue potential. But high volatility often as- sociated with market crises can be exceptionally good for business and hence profits. Do not be surprised to see last month’s 10% global equity debacle with interest rates dropping fast produce good results for IGG.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 6 We must mention the negative factors that still weigh on IGG’s revenues and may continue to do so including the ill-conceived Financial Transaction Tax (FTT) although it would appear to be less onerous than first anticipated. In fact all increased regulation is continuing to burden businesses with no real visible benefit, especially in the potentially lucrative US market. It should be remem- bered that interest on clients monies held used to be an excellent revenue line item when interest rates were above zero.

Analysts’ corner As a FTSE 250 constituent, IGG is less well covered with currently only 8 analysts reporting. However all 8 have been positive with no sell ratings. With an average 12 month target price (TP) of 678.6p, representing a 13% upside from today’s prices, the consensus of analysts believe that IGG will outperform the mid-cap market over the 12 months. The focus is that after suffering from low trading volumes in early 2014, market volatility has picked up in H2 and revenues are expected to solidify.

Our external analyst scoring system* places IGG at 53.12 (range 30-70) which is a reasona- ble score out of 250 members. *(please see the Portfolio section for a description).

Summary IGG has an excellent HDVM® score of 56.51 with a dividend yield of 5.10%. While the stock has been fairly stable relative to itself and the index over the last year, the potential for growth is compelling as is its ability to be inversely correlated during market sell offs. This is the first stock from the FTSE 250 that has been chosen for the HindeSight Dividend port- folio but we believe it is a great addition at this time.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 7 INVESTMENT InsightS Bubble Babble By Ben Davies

Financial markets provide constant fascination for individuals; each and every one of us derives, often subconsciously, certain needs or outcomes from them. These are usually personal and specific to the individual, but every now and again Ben Davies market participants can observe imitative or herding behaviour which can lead to the phenomena widely known as ‘bubbles’. Bubbles usually reflect a disconnect between fundamentals and human perception. The outcome of such disequilibria can lead to severe corrections, or even a ‘crash’ as the bubble bursts.

It is very clear that the interaction between central bankers and markets has become highly con- nected in an era of financialization. They are in the process of driving the herd into various asset classes, the antecedence to a bubble. I personally believe the risks of debt deflation are palpable but I also acknowledge that governments and central bankers can play this out likely longer than most would think. Other than the US where I believe fiscal continence has helped assist a recovery I firmly believe the world economy is stagnating because of QE and markets are goosed by finan- cial engineering from cheap financing.

Mark Mahaffey believes that 10% corrections/rebounds such as we saw recently are more likely to be the norm for the next decade, as soothing central bank comments and ‘bubble’ money cush- ions markets.

The mere fact that we still fear another 2008 is probably why a massive collapse in prices won’t happen anytime soon but a word of caution - I am more in the school of Mandelbrot in this regard.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 8 Markets have a memory effect whereby future price move- In reality the real kicker came when Japan dumped another ments have a higher probability of repeating recent behav- 30 trillion yen on the world. I suspect the Japanese Govern- iour than would be suggested by a purely random process. ment Pension Fund (GPIF) was already buying US shares a At the moment I believe the memory and reverberations of week before the BoJ QQE (Qualitative & Quantitative Easing) market behaviour is driven by past credit cycles propagat- announcement on the 31st October as they have increased ed by central bankers who never fully allow the cycles to foreign equity holdings from 12 to 25% maximum limit. Bril- complete from boom to bust. So the cycle heights either liant - the BoJ prints and the GPIF willingly dispenses it. run higher and/or longer until such time as no amount of credit keeps the well oiled financial markets rising and the All asset prices are becoming engineered by this supply economy ticking over. This is a classic example of the law of credit induced by excessive central bank monetisation, of diminishing returns - each new dollar printed exacts less but what is worse is the seeming tedium of vocal manipu- and less return or output. lation by said central bankers. The incessant ‘Bubble Bab- ble’ accompanied with bazookas of ‘Bubble Money’ clearly I would observe the recent 30% fall in crude oil prices as explains the differing fortunes of these markets. Causation signifying the unwind of excess central bank monetization. is intuitive. Central bankers speak and markets behave I believe we have seen the egregious created by long spec- in accordance. For now it’s the only game investors and ulative positions - financialized front end energy future con- speculators play. What happened to the never seen, never tracts because of the ample liquidity provided by QE. This heard central bank bean counters of national payment bal- positioning has held energy markets ances - manning crises from behind higher and longer than expected in closed doors the face of resounding increases in I would future oil supply. This in turn created So whilst the markets may have been a self-reinforcing feedback mecha- observe the (mis)behaving recently it would seem nism of capital misallocation by both recent 30% much more apposite to refer to the shareholders and abusive corpora- (mis)behaviour of men (and Chair- tions. CEOs and their boards imple- fall in crude woman) employed by central banks. mented reckless amounts of leverage For there has been a highly discon- and equity financing. It doesn’t mat- oil prices as certing but predictable ‘Bubble Bab- ter what the trigger for the fall - geo- ble’ of non-elected central bank offi- political theories abound - the market signifying cials including Madame Chairwoman was ripe for a clearing out of both Yellen trying to stymie market falls in stagnant positions and marginal oil the unwind stocks and bond prices. businesses. of excess of Simply put, every time bond rates I expect to see over time oil trade central bank rise or stock markets fall central at $55 to $65 a barrel as the long bankers opine on their forward guid- non-commercial (ie speculative) WTI monetization ance suggesting rates will be on hold and Brent Crude positions are still longer or even hinting at further in- around 500 million barrels which is in turn twice the median jections of ‘Bubble money’ ie QE. I am actually not sure for the period 2001 to 2008 just before QE was introduced. which is more disconcerting the staged dialogue of Note demand for oil in this period remained stable at 82 to central bank cohorts regularly chancing their hand in 84 mm barrels a day with supply clearly having risen. The the market process or the feckless response of market mathematical equation looks like this - solve for: ‘Oil Fi- participants salivating like Pavlovian canines for their nancialization’....= QE. QED. next meal - which as we know one day will fail to arrive - but the drooling will continue unquenched nonetheless. The only question now is the trade-off between cheaper oil and the initially destructive unwind of energy sector lever- Both are behaving like reckless gamblers. Officials don their age. The extractive industries are a major supplier of em- poker faces to mask their clearly desperate utterances of ployment and growth in the world. The commodity recess ‘there is more ‘money’ where that came from - we have not will drag growth down. But I readily concede that a fall in folded yet’. Likewise the market participants seem ready to oil prices of this magnitude is beneficial to the cost of living chance just one more roll of the die.....one of these days and standards and a boon for corporate margins which in the it is coming, these utterances and responses will not stop medium term will support economic growth. a steeper fall in the markets. First St. Louis Fed President James Bullard stepped in to assuage anxious markets. On The oil sell-off thus may have contributed to the rebound the 16th October, the day that marked a ‘V’-shaped bottom in US stock markets and the Republican success in the US in the stock markets he said in an interview with Bloomberg Mid-Term elections. Markets may well believe that we will News, that “Inflation expectations are declining in the U.S.... get more responsible policy decisions, but I would point that’s an important consideration for a central bank. And for out the Republicans dislike the Fed’s unconventional ways that reason I think that a logical policy response at this junc- so political pressure will come to bear, which will cause ture may be to delay the end of the QE.” The market prompt- some equity volatility. ly rallied hard and QE was in the end completed. Job done for now until the ‘edge of tomorrow’ comes.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 9 Then across the pond back here in the UK, the now Bank “That was an important lesson from the Japanese ex- of England Chief Economist Andrew Haldane uttered his perience that we have tried to learn from,” she said and own reassuring words to the market. Haldane who sits indeed the chart below highlights the significant deteri- on the nine-member Monetary Policy Committee that sets oration in market based inflation expectations in US (as interest rates, said a “gloomier” outlook for global growth with the UK). It shows that as inflation expectations near and the risk of stagnation meant that “interest rates could 2% for 5 year forward breakeven inflation rates, the cen- remain lower for longer, certainly than I had expected three tral banks begin monetary intervention. So despite earlier months ago, without endangering the inflation target.” For protestations of normalising rates next year, QE 4 seems the record Carney, or ‘Carnage’ as a market friend refers more likely on the cards in the US than rate hikes. to him said the complete opposite less than a month earli- er. Carney has since joined the dovish chorus and inferred An Austrian economic scholar and market participant rates will be on hold another year. He really is mischievous quipped to me - “after six years and trillions of dollars that Devil InCARNEYate as we prefer to call him. of intervention, the only truly unconventional policies that remain are those which practice sound money, official in- Then one of Greenspan’s offspring spoke. On the 7th No- scrutability, and an approach which is a good deal less vember Yellen opined at a banking symposium held at Hjalmar Schacht and a good deal more Adam Smith.” the Banque de France. There at that historical bastion of monetary sobriety, she delivered her firmest sermon yet Although humorous, this is a deadly serious point to con- to her central bank disciples and canine friends; central sider. As you will see from the economic charts in our Hin- banks - you should read this as ‘willing followers’ - (you) deSight Investor Letter (see below comment) this enor- “need to be prepared to employ all available tools, includ- mous global experiment is not working. The overhang of ing unconventional policies to support economic growth too much debt and moribund growth continues to threat- and reach their inflation targets”. en national balance of payments and the well-being of populations. Yellen said in response to a question at the Q&A after her speech that before the 2008 financial crisis hit, the Fed Fed Fischer summed it up best about the efficacy of US had spent a great deal of time studying the prolonged pe- 1.7 trillion in QE3 that just ended. “Even if you are living riod of weak economic growth and deflation in Japan in under a rock..you know that this gift of near-cost-free debt an effort to learn how to deal with similar problems. as measured in inflation- and tax adjusted terms has thus far been used primarily to finance stock buyback, increase She said amongst the lessons U.S. policy-makers drew dividends and fatten cash reserves and recently, finance from the Japanese experience was the need to quickly mergers by the most creditworthy companies. For those get banks on a sound footing and to guard against infla- with access to capital, it was a gift of free money to spec- tion persistently falling below the Fed’s 2 percent target. ulate with. One wag—I believe it was me—quipped that there was, indeed, a ‘positive wealth effect’… the wealthy were affected most positively.”

Source: CLSA

HINDESIGHT DIVIDEND UK LETTER / NOV 14 10 Fisher also urged the Fed to not return to bond buying Many are beginning to understand that QE to infinity isn’t if the economy falters again, saying, “Should the FOMC a joke anymore and is if to reinforce the point, Japan just then try to compensate for fiscal authorities’ inability to embarked on QE 11. act by provisioning still more monetary fuel, it may risk an explosion of speculative excess, or worse: an eventual I feel this is so important a topic to address that I continue inflationary conflagration, the debasement of money and this section by looking specifically at the evidence that the ruination of our economy and lifestyle.” Japanese QE is NOT working. This will be published at the Hinde Capital site in our HindeSight Investor Letter Sadly Fisher is to retire in March 2015 to a chorus of hate November 2014, titled, Bubbleology - ‘The Science of messages on twitter from ‘maddening’ market monetar- Bubble Money.’ This will be emailed to you. ists. If you read our Central Bank Revolution I and II - you will see our disquiet with disciples of this train of econom- ic thought.

investment idea #2 Kingfisher: A ‘Defensive’W orld Superstore by Mark Mahaffey

KINGFISHER PLC

Price (£) 302.5 Mark Mahaffey Turnover (£mm) 11,125.0 Net Income (£mm) 709.0 Market Cap (£bn) 7,130.5 P/E Ratio 13.1 Dividend Yield (%) 3.6% Payout Ratio (%) 33.2% Total Debt to Total Equity (%) 5.1% FCF to Market Cap (%) 6.2% ROIC (%) 8.4% Consumer Cyclical Kingfisher (KGF) employs almost 80,000 people, has 1150 stores in ten countries and boasts six million customers visiting those stores every week, mostly to out- lets such as B&Q. Founded by Richard Block and David Quayle, the first store opened in Southampton in 1969.

Kingfisher itself was founded in 1982 with the buyout of Woolworths by Paternoster Stores Ltd, which became Woolworth Holdings eventually renamed in 1989. Sir led the company from 1984 until retirement in 2002 and during that time pursued an ex- pansion policy through acquisitions. Takeovers include the purchase of B&Q, , Comet and in the UK and , BUT S.A. and Wegert in Europe.

Its headquarters are currently in Paddington in London, UK from where it controls its global em- pire. Home improvement, fuelled by frequent home renewal and population expansion is not limit- ed to the UK’s insanity with houses - housemania - is a worldwide phenomenon. Similar products are accessed and sold across the globe, allowing economies of scale through international net- works. While KGF sits clearly in the sector, DIY has less consumer cyclical characteristics than might be typical for the sector.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 11 MSCI UK & MSCI CONS DISCRETIONARY VS. KINGFISHER SHARE PRICE

120.0

440.0 115.0

420.0 110.0

400.0 Kingfisher Share Price 105.0

380.0 100.0

95.0 360.0 Indexed Prices 90.0 340.0

85.0 320.0

80.0 300.0

75.0 280.0 14/11/2013 14/11/2013 28/11/2013 31/10/2013 12/12/2013 26/12/2013 09/01/2014 23/01/2014 06/02/2014 20/02/2014 06/03/2014 20/03/2014 03/04/2014 17/04/2014 01/05/2014 15/05/2014 29/05/2014 12/06/2014 26/06/2014 10/07/2014 24/07/2014 07/08/2014 21/08/2014 04/09/2014 18/09/2014 02/10/2014 16/10/2014 30/10/2014

MSCI UK MSCI UK/CONS DIS KINGFISHER PLC Share Price

HINDESIGHT DIVIDEND UK LETTER / NOV 14 12 UK Home Products Absolute Index Relative Dvd Providers Perf. (12m) Perf. (12m) Yield (%) Price/BooK ev/EBITDA* HDVM®**

KINGFISHER PLC -19.87% -16.82% 3.65% 1.15 6.58 54.41 WOLSELEY PLC -4.49% -1.44% 2.49% 3.06 9.90 49.32

US Home Products Absolute Index Relative Dvd Providers Perf. (12m) Perf. (12m) Yield (%) Price/Book EV/EBITDA* HDVM®**

KINGFISHER PLC -19.87% -16.82% 3.65% 1.15 6.58 54.41 LOWE’S COS INC 14.91% 0.26% 1.59% 5.04 9.31 - HOME DEPOT INC 25.20% 10.55% 1.92% 11.46 10.37 -

Note: *EV/EBITDA - Enterprise Value divided by Earnings (before interest, tax, depreciation and amortisation) **HDVM® - Hinde Dividend Value Matrix

Today, with a market capitalisation of £7.1bn and £10.6bn revenue, Kingfisher is the largest home improvement retailer in Europe and third biggest in the world behind Home Depot and Lowe’s. The main markets are still the UK and France with B&Q, Castorama and Brico Depot making up the bulk of the revenue although its expansion into , Russia, Turkey and Spain are beginning to pay their way.

KGF has a HDVM® score of 54.41 currently, reflecting an indicated gross dividend yield of 3.65%, a 12 month index underperformance of 16.8% and robust fundamentals.

Despite a history of steadily increasing revenues and strong cash flow generation with low debt levels, KGF’s price performance has been dismal. The main reason is primarily due to the French connection, namely Castorama and Brico - up to 50% of revenue historically coming from France, the woes of the country’s economy are hurting investors’ expectations.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 13 France, a past stalwart of the European engine is still failing miserably to recover from the financial crisis. An over-indebted country, it is still reliant on large state expenditure and has made some disastrous economic policy decisions in recent years, (the 75% wealth tax rate was the most spectacular example). We could argue that with no growth in sight, France currently looks more like a struggling Southern European country now. France has had the lowest GDP growth, the low- est growth in personal consumption, the lowest growth in corporate investment, and the highest growth in public sector consumption spending.

Yet we’d argue that the market has overreacted to the downside. While France might be the basket case of Europe, total sales in France grew at 0.4% and profits were flat. It wouldn’t need much of an economic turnaround to get some better results again here. Also, continued investments in more countries will de-risk the reliance on the core countries in the future. Ratios such as Price/ Earnings

(P/E) and Enterprise Value/Earnings before Interest, Tax, Depreciation and Amortization (EV/ EBITDA) have fallen back to 2011 levels highlighting the cheap valuations currently as well.

There also been a very important ‘changing of the guard’ announcement at KGF last month. From February 2015, Veronique Laury will replace Sir Ian Cheshire as CEO. Currently the CEO of the French KGF companies, it was an easy insider choice that should have no concern.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 14 Sir Geoffrey’s love of sailing was behind Kingfisher’s sponsorship of British sailor Dame Ellen MacArthur. She broke the world record for the fastest solo circumnavigation of the globe in 2005.

Analysts’ corner In our External Analyst scoring system, KGF lies at 54.03. Out of the 19 analysts that have made a recommendation in the last 3 months only 1 has given a sell recommendation. The average 12 month target price (TP) is 355.5p, a 17.5% upside from current levels. The state of the French and Chinese economies is reflected in the price but the retailer’s valuation metrics look cheap to its industry group peers.

Summary With an above average dividend yield, backed up by strong cashflow and low debt, KGF is a worthy addition to our portfolio. A high HDVM® score of 54.41 takes fully into account low ratios from P/B, P/E and EV/EBITDA and the last 12 month underperformance gives a good margin for safety entry point. While the risks of continued strains in the French economy are self evident, we believe the risk/reward from these valuations is skewed significantly in the buyer’s favour.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 15 WHAT HAPPENED? Market & Sector Analysis

UK Market Valuations Finally the ‘Bad Breadth’ we had flagged as a sign of an impending correction knocked the big cap market down with its festering odour. The FTSE 100 fell 8.31% from the close on September 30th to the low in October at 6,072, only to recover and close down 2.03% on the month at 6,488. The FTSE 250 similarly fell 7.71% but closed up 0.79% at end of the month on October.

The recent move back up again in the UK FTSE 100 drove the dividend to gilt yield out to its widest since 2008. It currently stands at 4.75% offering some potential quality names at good yield values.

The recent move back up again in the UK FTSE 100 drove the dividend to gilt yield out to its widest since 2008

FTSE100 DIVIDEND YIELD MINUS 2Y GILT YIELD 6.0%

4.0%

2.0%

0.0%

-2.0%

-4.0%

-6.0% Oct-96 Oct-00 Oct-02 Oct-06 Oct-10 Oct-12 Oct-94 Oct-98 Oct-04 Oct-08 Oct-14 Jun-93 Jun-95 Jun-99 Jun-01 Jun-03 Jun-05 Jun-09 Jun-11 Jun-13 Jun-97 Jun-07 Feb-96 Feb-00 Feb-02 Feb-06 Feb-10 Feb-12 Feb-94 Feb-98 Feb-04 Feb-08 Feb-14

HINDESIGHT DIVIDEND UK LETTER / NOV 14 16 Sector Returns The Basic Materials sector has replaced the industrials as the star underperformer as extractive industries got hit by the resource sell-off. The 25% falls each in BHP, Glencore and Rio Tinto have largely been responsible for this decline.

12M % RETURN RELATIVE TO FTSE 100 15.00%

10.00% 8.65% 7.03%

5.00% 3.39% 1.56% 0.00%

-5.00% -2.59% -2.43%

-10.00% -10.03% -9.58% -9.52% -11.04% -15.00% Energy Utilities Financial Industrial Diversified Technology Basic Materials Communications Consumer, Cyclical Consumer, Consumer, Non-Cyclical Consumer,

As one can see there are some compelling yields on offer in the Basic Materials and Energy sector. As of yet the rout in the oil price hasn’t cleared out the dead wood and excess leverage we believe exists in oil, so we are not recommending any energy stocks at this moment.

SECTOR WEIGHTED DIVIDEND YIELD (%) 6.00%

5.06% 5.00% 4.42% 3.98% 4.00% 3.53% 3.12% 3.16% 3.06% 2.97% 3.00%

2.00% 1.26% 1.00%

0.00% Energy Utilities Financial Industrial Technology Basic Materials Communications Consumer, Cyclical Consumer, Consumer, Non-cyclical Consumer,

HINDESIGHT DIVIDEND UK LETTER / NOV 14 17 investment idea #3 Rolls-Royce: Defensive? ‘Yes M’lady’ by Mark Mahaffey

ROLLS-ROYCE HOLDINGS PLC

Price (£) 843.0 Mark Mahaffey Turnover (£mm) 15,513.0 Net Income (£mm) 1,367.0 Market Cap (£bn) 15,902.8 P/E Ratio 6.9 Dividend Yield (%) 2.1% Payout Ratio (%) 30.3% Total Debt to Total Equity (%) 32.5% FCF to Market Cap (%) 7.7% ROIC (%) 7.5% Industrial

Rolls-Royce Holdings PLC is the world’s second largest maker of aircraft head- quartered in London but with a large base of operations up in Derby. It describes itself as a Power Systems company, providing ‘better power for a changing world’. Divisions include Civil and Defence Aerospace, Marine and Nuclear with 50% of revenues coming from maintaining the power systems they deliver.

Many people will remember ‘Lady Penelope’ and ‘Parker’ from ‘Thunderbirds’ fame - a long run- ning children’s puppet TV series - depicting the adventures of ‘International Rescue’. Whenever I think of Rolls-Royce, I always think of Lady Penelope’s pink ‘roller’, defining class and style with Parker, her chauffeur’s one liner ‘Yes M’lady’.

Founded in 1906 by Henry Royce and Charles Rolls in Manchester, it did indeed begin as a man- ufacturer of luxury cars before developing aircraft engines by the onset of WW1. Half of all aircraft engines used by the Allies in WW1 were Rolls-Royce made but it was the Battle of Britain in WW2 that will be remembered by most. Rolls-Royce Merlin engines powered the British Hurricane and Spitfire fighters to triumph over the Luftwaffe despite being outnumbered 4-1.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 18 Over its 100 year history, it was nationalised by Edward Heath’s government in 1971 and privatised by Margaret Thatcher’s government in 1987, while continuing to be at the forefront in supplying engines worldwide. The Airbus A380, the largest passenger jet in the world is powered by Rolls- Royce Trent 900 engines although it did have to compensate Quantas US$100m in 2011 after a series of problems early on.

MSCI UK & MSCI INDUSTRIAL VS. ROLLS ROYCE SHARE PRICE 110.0 1,360.0

105.0 1,260.0 Rolls Royce Share Price 100.0 1,160.0

95.0 1,060.0 Indexed Prices

90.0 960.0

85.0 860.0

80.0 760.0 31/10/2013 14/11/2013 28/11/2013 12/12/2013 26/12/2013 09/01/2014 23/01/2014 06/02/2014 20/02/2014 06/03/2014 20/03/2014 03/04/2014 17/04/2014 01/05/2014 15/05/2014 29/05/2014 12/06/2014 26/06/2014 10/07/2014 24/07/2014 07/08/2014 21/08/2014 04/09/2014 18/09/2014 02/10/2014 16/10/2014 30/10/2014

MSCI UK MSCI UK/INDUSTRL ROLLS-ROYCE HOLDINGS PLC Share Price

UK Defence & Engineering Absolute Index Relative Dvd Providers Perf. (12m) Perf. (12m) Yield (%) Price/BooK ev/EBITDA* HDVM®**

ROLLS-ROYCE HOLDINGS PLC -26.70% -23.65% 2.70% 2.36 9.95 56.22 MEGGITT PLC -21.21% -18.16% 3.02% 1.78 8.98 52.46 COBHAM PLC 0.94% 3.99% 3.79% 2.83 9.16 51.14 BAE SYSTEMS PLC 0.88% 3.93% 4.87% 5.29 4.97 50.07

US Defence & Engineering Absolute Index Relative Dvd Providers Perf. (12m) Perf. (12m) Yield (%) Price/Book EV/EBITDA* HDVM®**

ROLLS-ROYCE HOLDINGS PLC -26.70% -23.65% 2.70% 2.36 9.95 56.22 BOEING CO/THE -4.28% -18.93% 2.34% 6.14 10.14 - UNITED TECHNOLOGIES CORP 0.71% -13.94% 2.17% 2.86 9.86 - LOCKHEED MARTIN CORP 42.92% 28.27% 3.21% 13.16 9.94 -

Note: *EV/EBITDA - Enterprise Value divided by Earnings (before interest, tax, depreciation and amortisation) **HDVM® - Hinde Dividend Value Matrix

Today, with a market capitalisation of £16 bn, revenue of £15 bn and 55,000 employees, it is a main- stay of the industrials listed on the London Stock Exchange as a FTSE 100 constituent.

Rolls-Royce has a HDVM® score of 56.22 reflecting the increased forward dividend yield of 2.7% and 30% sell off in the share price since earlier this year despite an healthy forward order book.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 19 Since January 6th 2014 when the stock was flying high at 1294p, two profit warnings have been is- sued, the latest on October 17th citing “a rapid deterioration in economic conditions and the impact of Russian sanctions”. The concern that the Chinese and Eurozone economies are slipping into re- cession with a falling oil price is the main challenge in the short term for the engineering giant.

Our recommendation for inclusion in the HindeSight Dividend portfolio this month focuses on the long term valuation of Rolls-Royce and the industry as a whole. The order book as you can see below is strong over the next several years which will in turn provide an exceptionally healthy free cash flow. However analysts have highlighted their concerns about revenue from 2018 when deliv- eries are expected to slow.

Ascend, Flightglobal consultancy, in an independent report ‘Flightglobal Fleet Forecast 2014-2033’ predicts that 36,820 commercial jets and turboprops worth almost $2.6 trillion will be delivered over the next 20 years.

Although at 2.7%, the dividend yield is lower than a typical HindeSight portfolio selection we be- lieve the margin of safety is high at these valuations.

N.B. Unlike other listed companies, the Company makes payments to its shareholders in the form of C Shares.

C Shares are redeemable preference shares of 0.1p each in the capital of Rolls-Royce Holdings plc (the Company). The Company will generally issue C Shares to its ordinary shareholders twice a year in lieu of a cash dividend.

Shareholders can opt for one of the following:

• redeem all C shares for cash; • redeem the shares for cash and reinvest the proceeds in additional Ordinary Shares; • keep the C Shares.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 20 Analysts’ Corner Rolls-Royce is one of the best known global brands. This firm’s performance has lagged as many believe it has run off course following the departure of their long established boss Sir John Rose. We think the firm has suffered as a result of its own success. Their engineering has been winning multiple orders; however it is important to deliver product on time, something Rolls-Royce have found difficult at times. Analyst sentiment has been turning positive having listened to John Risht- on’s (Current CEO) encouraging words in relation to cost cutting and future strategy. Over the last three months only 3 analysts have reported on this stock, all of whom have been neutral to positive on Rolls Royce’s business. With an average 12 month target price (TP) of 1100.9p, this represents a potential upside of 30% from today’s prices.

Summary The external analyst scoring system* places Rolls-Royce at 56.25 (range 30-70) which is strong score for a FTSE100 company. Rolls-Royce has a HDVM® score of 56.22 reflecting the increased forward dividend yield of 2.7% and 30% sell off in the share price since ear- lier this year despite an healthy forward order book.

A Short Note on EXISTENTIAL FEAR by Ben Davies

Many individual investors consider the market a fearful arena but it’s not your enemy. The market does not distinguish enemy or foe. It just is. It is innate - note I do not use the word inanimate, as the market is a living organism with a universal conscious.

When I am at my best with the market, it is when I am in the flow of the market. Again I deliberately use the word ‘with’ the market. I never want to fight the market. We have developed rules-based investing methodologies which are systematically implemented. This may seem at odds with this notion of being in the flow or ‘at one’ with the market. It seems very mechanical, perhaps lacking the subjective and more ‘zen-like’ touch of a master investor. I see it differently.

Man is fallible and to ‘err is human. We want to implement a strategy that doesn’t drift in style when markets are fractious, when stress exhibitors may cause the best of us to act rashly. We want to remain at one with the market and pick up the gifts it brings....in our case those of dividends accompanying lower stock prices. I like nothing more than to see a market correct as I know I will reinvest more and more dividends for greater amounts of stock. The same dividend distributed at lower prices enables one to buy more of that stock than if it had been invested at higher prices. We have created concepts that keep us from fighting the flow. We are selecting long only dividend stock positions but use risk management methodologies to protect us when we are momentarily out of the flow.

In many ways dividend investing can be likened to a cork bobbing on the surface of the sea, mostly rising gently up and down with the ocean swell. Then at times when the ocean becomes more tumultu- ous , the sheer mass of the sea can pull the cork and hold it down on the sea-bed for quite some time. Similarly dividend stocks rise and fall with the market gently going nowhere and then suddenly the mar- ket drags them lower in price and holds them down. However good quality dividend stocks with sound fundamentals accrue income for their investor. This provides the opportunity to reinvest this income in greater amounts of stock than if the dividends had been reinvested at a higher price. So when the sea calms and the mass of overhead water parts the cork rushes higher to the surface of the ocean and so it is with dividend investments. The market calms and the weight of ‘irrational and rational’ behaviour lifts allowing one’s position to rise in value quickly, as stock positions with reinvested income boast more shares than they first owned. This is the total return accelerator. To read more on this go to the home page at the site and read Dividends - Back to the Future.

A number of subscribers wrote in to say what of the ‘macro and geopolitical’ back-drop - markets could be serially overpriced because of all the ‘money-printing’. I don’t disagree but our greatest fear is fear itself. We have to play the probability of outcomes and prepare for the Mandelbrot fractal sets when clusters of ‘crashes’ can arrive.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 21 So our strategy is three-fold.

Our aim is to be stock-specific and portfolio specific in our creation of a dividend portfolio. We then use momentum and trend indicators to inform us the market is about to trend one way or another. Recently we were vigilant to a potential 10% correction in the market across developed stock markets - a number of signals were flagging amber to red warnings. Poor internal price structure (more new lows than highs on a cumulative basis), correlations to other markets rose to nearer one for one and the market broke down on in a self-similar way over many time horizons.

So we will warn you of a potential correction and subsequent cessation in the correction.

We had just begun this service but in future one will receive notification. dividends go a long way to nulli- fying such risks, especially if we are occasionally dynamic in re- ducing risks on rallies

For now we chose to write about three companies every month to build into a 20 to 30 stock port- folio which will rotate periodically based on poor and good performance.

We will accelerate purchases if we see value.

If one is concerned about investing too much into these equity markets because one fears the downside then allocate less capital or know that we will give you warnings of extreme valuations and bear market risks. Bear markets are horrible they just grind lower with occasional short cover- ing rallies which can be very powerful.

Just look at Japan since the 1990s with local stock prices still well below the levels seen 20 years ago! However this creates opportunity over the long run and dividends go a long way to nullifying such risks, especially if we are occasionally dynamic in reducing risks on rallies.

Our base case is that although bad deflationary risks from the global debt overhang could lead to falling asset prices over prolonged periods, it is more likely that serial debasement of currencies will create a relative scarcity of currency in some markets which will underpin them as much as those countries which rise on nominal price changes due to inflation. We will monitor global liquidi- ty indicators and will warn you of downside risks. In terms of specific stock risk we do see obsoles- cence risks from time to time due to maturing industries as technological innovation proves rapid and exponential, but we will use stops.

We are a firm that likes to use stops. They protect your capital and keep you from fighting the flow of the market. If a company’s stability worsens we have to legislate for bankruptcy or equity shareholder value being destroyed by dilution and excessive external financing. You cannot afford to own a stock such as Royal Bank of Scotland which fell 90% in 2008, ever, it will destroy your hard-earned capital.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 22 HINDESIGHT DIVIDEND UK Portfolio #1 (nov 2014)

Portfolio Update and Construction Our current 3 stocks, CNA, GSK and SL/ are broadly unchanged from entry points relative to the index at time of writing, although they all suffered reasonable mark to market losses in the October sell off when the main indices were down 10% from a month earlier.

GSK passed an Ex-Div day on 6th November so although not actually payable until January 8th we record that as additive to our total return as it is already in the price.

With the addition of the 3 new stocks, RR/, KGF and IGG it seems an ideal time to discuss the ongoing portfolio construction.

Using the HDVM® score system, we are selecting stocks which have the same basic characteris- tics, an above average and growing dividend, whose performance has suffered in the short term but remain in the long term strong, viable companies. We expect the total return to come from the dividend stream and the mean reversion from cheap to fair value over the coming months.

Unlike other dividend programmes, where stocks are bought for income and not sold, we will in- vest into cheap, relatively high paying dividend stocks and hold them until they get too expensive. Where the margin of safety is no longer available to us, we will take our money and re-invest in new cheap stocks again. While conscious of the costs of trading we believe that the merits of this strategy far outweigh the costs.

One of the important parts of building the portfolio is to add stocks that are diverse. Each stock is defined by what they do, by Sector, Industry Group right down to Sub-Group level. The sectors as seen in the market section last month are split as follow;

• Industrial • Communications • Technology • Basic Materials • Financial • Energy • Utilities • Consumer, Cyclical • Consumer, Non-cyclical

While Industry Group will break in down further for instance, Financial might be;

• Insurance • Bank • Diversified Financial Services

And Sub-Group will break in down further into a category of Diversified is;

• Investment Manager/ Advisory services

At different times in the business cycle, certain industries tend to do better than others but by maintaining a diverse selection of cheap stocks from the sectors and groups we will hopefully avoid any clustering effect.

Recently these perils have been highlighted in the Supermarket arena. While Morrisons, Tesco and Sainsburys have all been high dividend payers with poor performance, they all look much of a muchness. While one might justify the addition of one of these to an income portfolio, any more than that would have been foolish in indeed.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 23 INDUSTRY date entRY cURRENT/ Index dvd ex-DIV PAYOUt absolUTE Relative Stop COMPANY name gROUP enteRED PRIce close PRIce entRY PRICE Yield date date RETURN Return Loss Price* (INCL DIV PAID) (INCL DIV PAID)

STANDARD LIFE Insurance 02/10/14 399.20 414.00 6,446.39 3.91% 09/04/15 TBA 3.71% -0.17% 299.40 GLAXOSMITHKLINE Pharma 02/10/14 1,403.50 1,471.00 6,446.39 5.44% 19/02/15 09/04/15 6.16% 2.28% 1,052.63 CENTRICA Gas 02/10/14 301.90 298.60 6,446.39 5.75% 23/04/15 TBA -1.09% -4.97% 226.43 KINGFISHER Retail 18/11/14 302.20 304.50 6,709.13 3.26% 14/05/15 TBA 0.76% 0.95% 226.65 ROLLS-ROYCE AEROSPACE 18/11/14 845.00 844.50 6,709.13 2.65% 23/04/15 06/01/15 -0.06% 0.13% 633.75 IG GROUP FinanCIAL Serv 18/11/14 620.00 625.00 6,709.13 4.50% 22/01/15 TBA 0.80% 0.65% 472.50

Note: Standard Life dividend does not include the 73p per share special dividend that was announced on the 4th of September 2014 *Stop Loss Price is 25% below the entry price

INDUSTRY GROUP

Insurance Pharmaceuticals Gas Retail Aerospace/Defense Diversified Finan Serv

INDUSTRY SECTOR

Financial Consumer, Non-cyclical Utilities Consumer, Cyclical Industrial

HINDESIGHT UK DIVIDEND LETTER / NOV 14 24 In addition to building a portfolio using a diversification process, it is also worth considering a cor- relation process. We will go into this in more depth in coming letters but the point is to understand that stocks not only have a relationship to the index but also to other stocks.

In general market terms, analysts rely on a correlation to the index via a number called the BETA of the stock. If a stock has a beta of 1, it means that over a defined previous period if the index has moved by 1 %, the stock has also moved by 1%. A beta of 0.7 would tell you that the stock is less volatile than index and a stock with a beta of 1.3 is more volatile.

While Beta is the industry standard, it tends to lack the in depth view of a correlation matrix, not just between the stock and the index but between stocks themselves.

In simple terms, this might be a comparison of the movement of say an airline stock with an oil producer. While any move down in the price of oil will hurt the oil producer’s profits, cheap oil will benefit the airline’s bottom line. So in this example, there is a case potentially of inverse correlation relative to the oil price. As discussed in the write up of IGG, one of the attractions is that IGG can make money when the stock market goes down because more volatility means more profits. In this way, IGG might well be inversely correlated to a typical asset manager whose profits will sink as the value of his assets declines.

While these two cases might well show inverse correlation, most relationships are positively cor- related or not correlated at all but analysing any portfolio through a basic correlation matrix is vital to avoid clustering again.

In summary, any portfolio that is going to protect and compound your savings over the long run should adhere to a strict filtering with respect to industry diversification and stock correlation.

External Analyst Score This score has two main inputs. Firstly, we look at the average target price for each stock over the past three months. This is given a score through a normalisation process. Similarly, we amalgam- ate all the ratings that have been given to every stock by various external analysts over the last three months. Our proprietary system then gives each stock a rating between 0 and 5, with 0 being bearish and 5 being bullish. This rating score is then put through a normalisation process. The two parts are then combined to create our External Analyst Score (EAS). The combined score for each stock ranges between 30 and 70. A stock with a score of 30 would represent a company that has a low target price, most likely below its current price and accompanied with analyst bearish sentiment. A stock with a score of 70 would represent the polar opposite.

SG HINDE ETN Update In 2013 we formulated our range of equity products based on the Hinde Dividend Value Strategies and earlier this year we launched the first in a series of innovative dividend based equity strategies in an Exchange Traded Product (ETP). These are innovative by strategy and by design as we run long only, half hedged and fully hedged exposed strategies to the overall market.

Our product launched with Societe Generale is a part of the evolution in ETPs. Societe Gen- erale has provided us the wrapper for one of our dividend strategies in a cost effective, highly accessible and liquid product. We took the Hinde Dividend Value Strategy (50% Hedge) and replicated it in the SG Hinde Dynamic UK Equity ETN (50% Hedge) listed as the HALF.L on the LSE. This is an actively managed ETP which aims to accelerate the total return generated by a dynamic portfolio of relatively high yielding UK stocks, whilst providing partial protection against market falls.

HINDESIGHT DIVIDEND UK LETTER / NOV 14 25 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 busi- ness that we are so fixated by – the propensity for a company to produce and continue to grow div- idends 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 3 to 4 stocks until we create a portfolio of 25 UK divi- dend 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 methodol- ogy which screens these companies using the Hinde Dividend Value Matrix®, (HDVM®), a propri- etary 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 / NOV 14 26 APPENDIX II

The Way 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 con- stituent 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 derived a 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

HINDESIGHT DIVIDEND UK LETTER / NOV 14 27 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 com- pany will be able to maintain and grow its dividend. It helps us 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 mar- ket 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.

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 that entail that normally only 1 stock per sector per index can be invested in. For example, if the top 10 stocks are all mining compa- nies 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 apeared in the final ranking means it is already eligible for investment. In exceptional circumstanc- es, it may be that more than one stock has to be selected from an individual sector.

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 dispro- portionately 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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