Tuesday, November 15, 2011

Diary: Dividend growth

An article at Dividend Growth Stocks got me to thinking about using dividend growth as a filter for investing. The aim would be to try to pick out low risk, high quality companies obtainable at a reasonable price. An investor could look at the current debt situation, and factor in some light-weight qualitative factors. By "reasonable price", I mean anything below 16X PER. It's not a cigar-butt technique; think Marks & Sparks, not Primark.

I just picked out a few examples off of the top of my head (I own all of them except Tescos), and compiled the following table:

     CDR   SPR
DNO  18% +483% Domino Printing Sciences
SN.   9%  +49% Smith & Nephew
BATS 16% +415% Brit Amer Tobacco
BLT  27% +534% BHP Billiton
VOD  24%  -10% Vodafone

CDR: Annual Compound Dividend Rate over last decade
SPR: Share Price Return over last decade

All of the shares listed have had increasing dividends for the last decade; some of them spectacularly so. BLT increased its dividends a massive 27% pa for the last decade, which is truly staggering. The performance of the share prices was very good, too, averaging +255% over the decade - that's about 14% pa. By contrast, the FTSE returned 4% pa. all of them beat the FTSE, except VOD. They had a 7:8 share split in 2006, for which I'm too lazy to adjust the dividends for. Also, its share price plunged precipitously during 2002, which is what I think at a very high PER at the beginning. So a sensible investor would have been able to avoid VOD shares.

This is, of course, hindsight bias (except the VOD thing - a lot of tech stocks at ridiculous multiples could have easily be avoided by those with just a modicum of investment skill). We of course know what you should have done: buy companies that will increase their dividends steadily over the next decade. They'll likely do fantastically well. Ah, but which ones will they be?

I think this is where the "light-weight qualitative factors" comes in. You're looking at the historical record and asking yourself if it's likely to continue. You might look at BLT, and conclude that seeings as it's a commodity company, the future is too unpredictable, and you should avoid.

But there are other candidates, like BATS, which seems in a pretty stable industry. Analysts expect EPS to grow 12% in 2011, and a further 9% in 2012. It currently yields 4.4%, and is on a PER of 14.9. z-score is over 3, so that's pretty good. I look at it this way: I can probably get a better than 10% total return for this stock over the next year. Considering that the market has been flat for the last decade, that's a pretty good return. And remember, you're getting this with minimal risk.

If you look at VOD, analysts are expecting a whopping 31% increase in dividends in 2012 - although that is exceptional, of course. VOD trades at a PER of 11.4, and a PBV of 1.1. It seems to be doing OK in new markets, too. Probably not a choice that will astound Buffett with the depth of your insight into the company, but it looks like it will spit out the goods. Divvies have been growing at only 7% pa over the last 5 years, so it's probably entering a slower phase than in the early 2000's. Like I say, there's nothing I consider inspired about the pick, other than the fact that investors will probably do OK.

DNO looks pretty good on paper. It makes industrial printers - for stuff like printing expiry dates on food products, printing on eggs (no joke!) and printing despatch labels for packages. It's on a PER of 14.5, has a market cap of nearly £600m, and has net cash of £12m, and negative gearing. Interest cover is 201, z-score is 5.98, so the balance sheet is clearly very solid indeed. Its ROE is 21%, compared with a decade mean of 19%. It wins design awards. I like the fact that it has a very nice cash position, and is small enough that there's plenty of room for expansion.

I reckon that if an investor can put together about a dozen issues like DNO, and is patient, they'll do well. Not "Buffett well", but "market beating" well. Some of them will be duds, of course, as no-one can predict the future. There's a poster I respect who found good results over the last decade by buying good-quality low-risk companies at reasonable prices. It seems that the market tends to overlook them in favour of cheap junk or overpriced high-growth shares (some of which turn out to be junk in the end, anyway). BATS is up 19% YTD, compared with FTSE down 6% - a comparison that you are no doubt tired of. I like making that comparison because it just goes to show how a boring, non-esoteric, reasonably priced good-quality company can slaughter the index. That's a serious out-performance. Admittedly, we may be having market conditions that are conducive to such outperformance; but it still makes me think.

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