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The Beating the BTSX list for 2011 is ready. But first, let’s take a look at the results for 2010. Here are the results for the Beating the BTSX for 2010, updated with prices from May 13th 2011:

Name Price May 14 2010 Price May 13 2011 % Change Total Return (including Dividend)
Rogers Comm. $36.70 $35.82 -2.40% 1.09%
Power Corp. $27.29 $28.36 3.92% 8.17%
BCE Inc. $31.90 $37.87 18.71% 24.17%
Shaw Comm. $19.20 $20.00 4.17% 8.75%
TELUS $40.30 $51.59 28.01% 32.98%
Husky Energy $27.10 $27.78 2.51% 6.94%
Tim Horton’s $35.15 $46.40 32.01% 33.49%
Enbridge $48.36 $60.54 25.19% 28.70%
Sun Life $30.37 $30.18 -0.63% 4.12%
Royal Bank $59.98 $58.45 -2.55% 0.78%

The 1 year return is 14.92%. If we exclude dividends the return is 10.89%. The index outperformed both the TSX 60 (XIU) and David Stanley’s Beating the TSX. The closing price of the XIU on May 14 2010 was $17.74 and the closing price on May 13 2011 was $19.18 for a return including dividends of 10.60% (8.12% excluding dividends). The Beating the TSX returned 13.21% (8.42% excluding dividends) from May 14 2010 to May 13 2011. The outperformance of the Beating the BTSX can primarily be attributed to Tim Horton’s (+33.49%) which made the list because of a large share repurchase ($176 million) that resulted in a Net Payout of 4.34% despite having a relatively low dividend yield of 1.48% (a key differentiator between the Beating the BTSX and David Stanley’s Beating the TSX) see here.

This year the Beating the BTSX is faced with a conundrum: the conversion of income trusts to corporations means that the list is concentrated with former income trusts. Here is the Beating the BTSX for 2011:

Name Dividend Common Shares Stock Issuance/Repurchase Price May 13 2011 Div Yield Net Payout
Yellow Media $0.65 4079.84 -461.88 $4.42 14.71% 17.27%
Rogers Comm. $1.42 498 -1309 $35.32 4.02% 11.46%
Enerplus $2.16 5756.98 35.42 $29.47 7.33% 7.31%
BCE $1.97 12691 -461 $36.94 5.33% 5.43%
TransAlta $1.16 2211 295 $21.24 5.46% 4.83%
Can. Oil Sands $1.50 2587 0 $31.59 4.75% 4.75%
ARC Resources $1.20 3194.5 241.8 $24.05 4.99% 4.67%
Bank of Montreal $2.80 7001 -170 $60.81 4.60% 4.64%
Sun Life Financial $1.44 7407 295 $30.42 4.73% 4.60%
Shaw Comm. $0.92 2276.89 45.86 $19.90 4.62% 4.52%

In fact, 4 of the 10 names are former income trusts. In the past, David Stanley has excluded income trusts from the Beating the TSX index, I am not sure how he plans to deal with these companies now that they have converted to corporations. Their high dividend yields will skew both lists but I am inclined to exclude the former income trusts for precisely the same reasons David Stanley has done so in the past: namely because they have not been able to consistently maintain their distributions (now dividends). For example, all of the former income trusts in the list above have cut their distributions in the past 4 years which has the added negative effect of causing the stock price to fall. Given that the Dogs of the Dow strategy is designed to work on an index of stable large cap dividend paying companies I am inclined to continue the practice of excluding the former income trusts at least until their dividend payouts have stabilized. So, I have compiled the Beating the BTSX with the former trusts excluded:

Name Dividend Common Shares Stock Issuance/Repurchase Price May 13 2011 Div Yield Net Payout
Rogers Comm. $1.42 498 -1309 $35.32 4.02% 11.46%
BCE $1.97 12691 -461 $36.94 5.33% 5.43%
TransAlta $1.16 2211 295 $21.24 5.46% 4.83%
Bank of Montreal $2.80 7001 -170 $60.81 4.60% 4.64%
Sun Life Financial $1.44 7407 295 $30.42 4.73% 4.60%
Shaw Comm. $0.92 2276.89 45.86 $19.90 4.62% 4.52%
TELUS $2.20 5456 15 $52.26 4.21% 4.20%
CIBC $3.48 6951 489 $81.90 4.25% 4.16%
Power Corp $1.16 549 19 $28.18 4.12% 3.99%
TransCanada $1.68 11745 705 $41.42 4.06% 3.91%

Only two companies in this list, BCE and Sun Life, have cut their dividends in the last 4 years. This number would increase dramatically to 6 out of 10 if we included the income trusts.

Interestingly, this year’s list only has 3 companies whose net payout is greater than its dividend yield. In the past the number has been much larger. In 2009, 9 companies had a net payout larger than the dividend yield while in 2010 there were 5 companies. Recall that net payout factors in share buybacks as well as dividends (see here for a reminder on how to calculate net payout).Share buybacks can be an indication that management believes the share price in their company is undervalued. Perhaps the decreasing trend in net payout is an indication that the Canadian market is fully valued? My sense is that the Canadian market is overvalued and that the sky high commodity prices that have propelled it will be sensitive to a slowdown in developing markets. I have underweighted Canada in my own portfolio this year.

 

I read widely about investing and the strategy I am most drawn to is Value Investing. To me, value strategies make the most sense because they encapsulate a fundamental principle of investment: buy bargains. Of course, the label value investing encompasses a wide array of different investing strategies. I find many of these strategies attractive, however I feel that some can be applied by individual Do-It-Yourself (DIY) investors while others are best left to professionals. In this post I describe a Value Investing Hierarchy where I organize value investing techniques into 4 categories, ordered by ease of implementation for a DIY investor.

 

Category 1:  Quantitative Value Strategies

There are numerous quantitative value investment strategies that focus on ordering a predefined index based on a group of financial attributes and then selecting the cheapest subset in that index for investment. Usually the prescription is to rebalance annually by reapplying the strategy to the index each year. For example, the Dogs of the DOW strategy, which I have written about considerably on this blog, fits into this category. Another famous quantitative strategy is the Magic Formula invented by Joel Greenblatt and made famous in his book The Little Book that Beats the Market.  According to Morningstar, the strategy returned 19.9% from the beginning of 1998 to September 30th 2009 which compares very favourably to the S&P 500’s return of 9.4%, see here.  The Magic Formula ranks companies in a given index based on two factors: return on capital (a quality measure) and earnings yield (a value measure), then selects a subset of the highest ranking companies for purchase. For step by step instructions on implementing the strategy see here.

I include these strategies in Category 1 of my hierarchy because they can be implemented by a DIY investor relatively easily. Simple calculations using freely available financial data are all that is required. Importantly, they do not require intensive research or particular insight into the operation of a business or the quality of management. To make it even easier, many of these strategies are freely available on the internet with the annual rebalanced list calculated and published for you each year. The Dogs of the Dow for any given year can be obtained here, and the Magic Formula list can be obtained here.

 

Category 2: Quality at a Fair Price

Buying quality companies at a fair price is a value strategy famously employed by Warren Buffet. His value metric is a high return on invested capital (ROIC) over long operating histories. Buffet describes companies that achieve this level of performance as possessing a wide moat and buys them when he estimates they are trading at a discount. Implementing this strategy is more difficult for a DIY investor to execute because it involves an intimate understanding of the business as well as an assessment of a company’s management. Not impossible, but it does require more work. Buffet suggests staying within a circle of competence and developing an intimate understanding of the companies within that circle. Buffet’s circle contains many well understood businesses for which information is easily obtainable. For example, the Coca-Cola Company is the largest holding in Berkshire Hathaway’s portfolio and the most widely recognized brand name in the world.

The other important facet of this strategy is assessing a company’s management. This is the more difficult part since unlike Buffett, a typical DIYer doesn’t have access to the management of publicly traded companies. However, you could decide to supplant an assessment of management by using as a proxy the quality of the fund managers that invest in these companies. For example, if you believe that Warren Buffet is good at assessing management you could restrict your circle of competence to the companies Warren Buffet invests in. GuruFocus tracks the investments of Buffet and a number of other investment gurus and the data is updated quarterly. Oftentimes you can purchase the securities they’ve purchased at a discount to the price they paid. Of course, you would also have to wait an entire quarter to find out if they’ve sold a company.

An advantage of assessing management by proxy is that gurus such as Buffet are much more accessible than the managers of the companies they invest in.  Indeed, there is a tome of writing about Buffet and his investing style, not to mention that Buffett publishes his thoughts himself in his annual investment letter which is available here and contains invaluable insight. However, if Buffett’s circle of competence is deemed too restrictive, there are other gurus who have built impressive long term track records employing a similar style. Donald Yachtman and Prem Watsa (for Canadians) are two managers who have very similar strategies and have achieved above average returns.

Another option for assessing management is to pay for it.  For example, as part of its paid subscriber service, Morningstar publishes an assessment of management for many of the wide moat companies that the gurus tracked by GuruFocus invest in. The service is relatively inexpensive at $15-$20 per month and the analyses are updated regularly. In my opinion, these analyst reports and specifically the assessment of management can provide a DIY investor with enough information to draw reasonable conclusions.

 

Category 3: Deep Value Investing

This category encapsulates a set of strategies that attempt to buy stocks at deep discounts to intrinsic value. The strategy employed by Ben Graham, the father of value investing, would fall into this category. Similar in some respects to Category 1, the strategies in Category 3 focus on quantitative analysis of a company’s financials. For example, Ben Graham had a very stringent set of requirements that a company had to meet before he would consider investing:

 

Figure 1: Benjamin Graham’s Criteria for the Defensive Investor
 
P/E Ratio less than 15.
P/Book Ratio less than 1.5.
Book Value over 0.
Current Ratio over 2.
Earnings growth of 33% over 10 years.
Uninterrupted dividends over 20 years.
Some earnings in each of the past 10 years.
Annual revenue of more than $100 Million (1950).

Source: The Intelligent Investor, 4th Revised Edition (pages 184-185).

 

I found this table at the StingyInvestor site, see here. In contrast to the strategy in Category 1, this technique does not sort stocks from within an index, and thus, there may be periods when no stocks pass the stringent requirements. Norm Rothery, the founder of the StingyInvestor publishes a relaxed version of the Ben Graham screen that returned 26% annually from 2000-2008, see here.

Deep value strategies rely heavily on quantitative analysis and unlike the strategies of Category 2, are not typically concerned with the quality of a company or an assessment of management.  Although this should make it easy for a DIYer, I rank deep value strategies on the third rung of my hierarchy because the stocks selected are often unfamiliar small cap companies that could be thinly traded. An investor would have to be sophisticated enough to take on this illiquidity risk. However, although this is the prevailing wisdom regarding illiquid stocks, I have to add that the concern over illiquidity may be unwarranted. Roger Ibbotson has published research showing that small cap, low liquidity stocks do very well over time returning 17.87% from 1972-2009 (see here). Filtering low liquidity stocks on value parameters does even better, returning 20.63% over the same time period.

 

Category 4: Distressed Debt

I categorize strategies that focus on distressed debt on the lowest rung of my hierarchy. I debated whether to include it here; however I am attracted to it as one of the purest forms of value investing. It requires the ability to examine a debt instrument that is selling at an 80% discount to face value and determining that it is actually worth 60%. I believe that this is a particularly inefficient segment of the market because distress situations involve sellers who are motivated to sell at deep discounts, giving well informed buyers an advantage. Seth Klarman, one of my favourite gurus, is famous for investing successfully in distress debt situations. One of his most famous investments was the purchase of Enron bonds when they were selling at 10-15 cents on the dollar.  The bonds are currently believed to be worth more than 50 cents on the dollar. Klarman describes this as his favourite type of investment since the situation was complex, difficult to analyze and no one wanted anything to do with Enron. This resulted in a mispricing of the debt and Klarman employed an analyst to focus on the bonds for 4 years in an attempt to understand Enron’s liabilities. You can read a good summary of his approach here.

 

While the distress debt investment that Klarman is famous for is best left to professionals, there are other distress debt situations that are available to DIY investors. For example, I would classify purchasing real estate under Power of Sale in this category. This kind of investing isn’t as simple as buying and selling equities on an exchange but can be profitable assuming there is an actual mispricing of the asset and the DIYer is clever enough to find it.

Here is a summary of my value investing hierarchy:

 

 

 

This is my attempt to organize the various value strategies I’ve come across and is not meant to be conclusive or comprehensive. Further, while the gurus mentioned in this article are often associated with the strategies I`ve assigned to them, they do not necessarily restrict themselves to that strategy exclusively.  For example, Joel Greenblatt is also a famous distress debt investor and Warren Buffett made his first fortune in investing by using Graham’s deep value strategy. The unifying theme however is that they always buy bargains.

 

 

Last month I looked at the composition of the TSX 60 and noted that large portions of the index cannot be considered quality dividend payers. In this month’s post, I will apply the Dogs of the DOW strategy to an index comprised of high quality dividend payers, namely the Indxis Dividend Achievers list.

Specifically, I will apply the technique to 3 indexes: the Broad Canadian Dividend Achievers Index, the US Broad Dividend Achievers Index and the International Dividend Achievers Index. To make the Canadian list, a company must trade on a major Canadian exchange and have increased their dividends for at least 5 years in a row. The American list is more stringent requiring companies to have increased dividends 10 years in a row in addition to trading on either the NYSE or NASDAQ. The International list is comprised of companies that have increased their dividends for at least 5 years in a row and are incorporated outside of the United States but trade on a major US exchange. To be included in any of the indexes a company must satisfy certain liquidity requirements to ensure the equities are easily traded.

I have named my list the Underachieving Achievers of their respective index. Here they are, calculated for market close on October 15th 2010:

Canadian Underachieving Achievers


Name Symbol Close Price 16/10/2010 Dividend Yield Annual Dividend
A G F MANAGEMENT LTD AGF.B-T 16.48 6.3 1.04
ALTAGAS INCOME TR ALA-T 21.84 6 1.32
INNERGEX PWR INCOME FD INE-T 9.66 6 0.58
GREAT WEST LIFECO INC GWO-T 25.28 4.9 1.23
IGM FINANCIAL INC IGM-T 42.02 4.9 2.05
POWER FINANCIAL CORP PWF-T 29.4 4.8 1.4
AG GROWTH INTL INC AFN-T 42.95 4.7 2.04
POWER CORP CDA POW-T 27.02 4.3 1.16
TELUS CORP T-T 46.25 4.3 2
TRANSCANADA CORP TRP-T 38.22 4.2 1.6

Note in keeping with David Stanley’s precedent established for his BTSX index I have excluded any income trusts that have not converted to corporations as of October 15 2010 as well as any REITs.

American Underachieving Achievers


Name Symbol Close Price 16/10/2010 Dividend Yield Annual Dividend
VECTOR GROUP LTD VGR-N 18.55 8.6 1.6
CENTURYTEL INC CTL-N 39.88 7.3 2.9
PITNEY BOWES INC PBI-N 21.86 6.7 1.46
BANCORPSOUTH INC BXS-N 14.01 6.3 0.88
SUBURBAN PROPANE PARTNERS L SPH-N 54.13 6.2 3.38
ALTRIA GROUP INC MO-N 24.88 6.1 1.52
AT&T INC T-N 28.33 5.9 1.68
MERCURY GENL CORP NEW MCY-N 42.26 5.6 2.36
CINCINNATI FINL CORP CINF-Q 29.87 5.4 1.6
LILLY ELI & CO LLY-N 37.76 5.2 1.96

Note I have excluded MLPs and REITs from this list.

International Underachieving Achievers


Name Symbol Close Price 16/10/2010 Dividend Yield Annual Dividend
NATIONAL GRID PLC NGG-N 45.87 7.7 3.55
VODAFONE GROUP PLC NEW VOD-Q 26.92 6.5 1.74
TELEFONICA S A TEF-N 81.51 6 4.91
P T TELEKOMUNIKASI INDONESIA TLK-N 40.97 5.7 2.32
TELEFONOS DE MEXICO S A B TMX-N 14.82 5.3 0.79
TOTAL S A TOT-N 54.88 5.1 2.78
TEEKAY CORPORATION TK-N 27.77 4.6 1.26
GLAXOSMITHKLINE PLC GSK-N 41.53 4.4 1.83
SANOFI AVENTIS SNY-N 35.17 4.2 1.47
STATOIL ASA STO-N 22.08 4.2 0.92

Note I have excluded Canadian companies from the international list to avoid overlap.

I plan on republishing this list in May along with the Beat the BTSX list and track the performance of the Underachievers against their index as well as against the Beat the BTSX. It will be interesting to see how the Underachievers perform against their respective indexes. It could be that selecting the highest dividend payers from a list that already constitutes a list of high quality dividend payers will result in a concentration of lower quality companies.

Finally, I will track a combined list of underachievers comprised of the top 4 underachievers from each of the above lists. This will give me a geographically diversified list of dividend achievers. Here it is as calculated on October 15 2010.

Combined Dividend Achievers List


Name Symbol Close Price 16/10/2010 Dividend Yield Annual Dividend
VECTOR GROUP LTD VGR-N 18.55 8.6 1.6
NATIONAL GRID PLC NGG-N 45.87 7.7 3.55
CENTURYTEL INC CTL-N 39.88 7.3 2.9
PITNEY BOWES INC PBI-N 21.86 6.7 1.46
VODAFONE GROUP PLC NEW VOD-Q 26.92 6.5 1.74
BANCORPSOUTH INC BXS-N 14.01 6.3 0.88
A G F MANAGEMENT LTD AGF.B-T 16.48 6.3 1.04
TELEFONICA S A TEF-N 81.51 6 4.91
ALTAGAS INCOME TR ALA-T 21.84 6 1.32
INNERGEX PWR INCOME FD INE-T 9.66 6 0.58
P T TELEKOMUNIKASI INDONESIA TLK-N 40.97 5.7 2.32
GREAT WEST LIFECO INC GWO-T 25.28 4.9 1.23

In a future post I will calculate the Net Payout for the companies in the various achievers lists and track an underachievers list that factors in share buybacks. It will be interesting to see whether share buybacks plus dividends out perform a simple dividend strategy when tracked against the Dividend Achievers index.



Why the BTSX won’t go to the Dogs

In my last post I noted that there are fundamental differences between the TSX 60 and the DOW 30 which I believe make comparisons of the Dogs of the DOW and the Beating the TSX portfolio difficult. Specifically, I do not believe the performance of the Dogs of the DOW is a proxy for the Beating the TSX index. The reason lies within the components of the indexes: the DOW contains many companies that have a wide moat around their business compared to the TSX 60 where companies with wide economic moats are concentrated in particular sectors. Selecting for the highest dividends results in a BTSX portfolio that is concentrated in wide moat stocks, making it a fundamentally different group of companies than the original TSX 60 whereas this concentrating effect is absent for the Dogs of the DOW.

To illustrate this effect, let’s first take a look at the sector composition of the TSX 60 (data from Morningstar):

Of note, the Industrial Materials sector makes up 25%  of the TSX 60. With the exception of a few companies like SNC Lavalin and Bombardier, the companies in this sector are miners. The profitability of these companies is closely tied to the commodities that they supply and in general they are not stable, free cash flow generators. Additionally, the qualities that create an economic moat such as brand loyalty, networking effect or switching cost are generally not applicable to commodity producers.  Furthermore they tend to be low dividend payers and are rarely selected for by the BTSX approach.

However, the TSX 60 also contains 10 companies from the financial services sector of which 6 are banks. Unlike  miners, Canadian banks have wide economic moats due to the oligopolistic nature of the industry in Canada.  Similarly, the pipeline companies TransCanada and Enbridge have wide economic moats. Once a pipeline has been built, competition is very difficult because the existing pipeline becomes the most economical means of transporting oil and gas and the regulatory approval to build a competing pipeline for the same route is hard to obtain. Both TransCanada and Enbridge operate the kind of expansive network of pipelines that will provide the long term stable cash flows associated with wide moat companies.

Now let’s consider the companies that constitute the Beating the TSX. Here is a chart of the companies in the BTSX from 2006-2009:

2006 2007 2008 2009
BCE Great-West Lifeco Shaw Comm. Manulife  Financial
Great-West Lifeco Enbridge Power Corp. BCE
TransCanada BCE BCE Power Corp.
Enbridge TransCanada TELUS Sun Life Financial
Bank of Nova Scotia Bank of Nova Scotia Bank of Nova Soctia TransCanada
Royal Bank Royal Bank TransCanada Bank of Nova Scotia
National Bank National Bank Bank of Montreal Bank of Montreal
Bank of Montreal Bank of Montreal Royal Bank National Bank
Teck Resources TD Bank National Bank TD Bank
CIBC CIBC TD Bank CIBC
CIBC
Number of Bank or Pipeline Companies in BTSX
2006 2007 2008 2009
7 of 10 (70%) 8 of 10 (80%) 7 of 11 (64%) 6 of 10 (60%)

Notably, banking and pipeline companies consistently make up a large proportion of the companies on the BTSX, despite making up only 13% (6 banks and 2 pipeline companies) of the TSX 60.

Now let’s consider the DOW 30. Here is a breakdown of the stocks by sector:

There are a couple of things to note: the industrial materials sector makes up the largest sector in both indexes, but in the TSX 60 most of the companies are miners and 8 of the 15 are gold miners. The industrial materials sector on the DOW is comprised of diversified manufacturers; household names such as GE, Boeing, Caterpillar and 3M. Energy is a much smaller component of the DOW making up only 6.67%  (2 companies: Exxon and Chevron) as opposed to the TSX 60 where energy makes up 21.67% (13 companies). On the other hand, healthcare makes up 10% of the DOW (3 companies: Johnson and Johnson, Pfizer and Merck) while it makes up less than 2% on the TSX 60 (1 company: Biovail). Furthermore, if we look at the consumer goods and consumer services sector, the companies on the DOW are well known global brands (Procter & Gamble, Coke-Cola, Pepsi) which are very different businesses than the consumer sector on the TSX which is mostly made up of retailers that service the Canadian market (Loblaws, George Weston, Canadian Tire, Tim Horton’s). In short, the DOW Jones industrial average is comprised of a number of companies from a range of sectors that have built distinctive competitive advantages and wide economic moats. Companies on the TSX in general have far fewer of these advantages.

In The Five Rules for Successful Stock Investing Pat Dorsey lists the companies that Morningstar considers to have a wide moat and 14 of these are members of the DOW. So, according to Dorsey 47% (14 of 30) of companies on the DOW have wide moats. However, turning our attention to the 2010 Dogs of the DOW we find only 3 wide moat companies from that list: Home Depot, Merck and Pfizer. Repeating the exercise for the 2009 Dogs yields only 2 wide moat companies: Merck and Pfizer. This suggests that investing in the DOW in general would result in a higher percentage of wide moat companies than the Dogs of the DOW since sorting on dividend yield does not correlate with selecting wide moats in the case of the DOW.   This could explain why the Dogs of the Dow has underperformed relative to the DOW over the last 15 years.

In direct contrast, if we accept the argument that the wide moat companies on the TSX are the pipelines and the banks, then the BTSX does in fact single out the wide moat companies and essentially concentrates them into one index.  In my opinion this is a key differentiator and the underlying reason why the BTSX should continue to outperform the TSX 60 over the long term unlike the Dogs.

In an interesting post, Larry MacDonald introduces David Stanley’s Beating the TSX list (BTSX) and then questions whether the list can continue to outperform the TSX. Larry suggests that if many more people adopt the BTSX it cannot continue to outperform the TSX. For evidence he points to the fact that the Dogs of the DOW strategy has underperformed the DOW by 2% annually for the last 15 years. He goes on to suggest that this underperformance is due to the popularity of the Dogs of the DOW, noting that in 2000 an estimated $20 billion (U.S.) was invested using the strategy.

In this post I question the proposition that the reason the Dogs of the DOW has underperformed the DOW is because of the popularity of the strategy.  Intuitively, if the amount of money deployed to the Dogs of the DOW was so large that it was affecting returns then, necessarily it would mean that so many people were buying the 10 highest yielding stocks each year that the prices of those stocks were being pushed higher.  Put another way, the dogs would be getting more expensive. Conversely, the dividend yield of these stocks would decline.  Therefore, as more and more money over the last 15 years was committed to the Dogs strategy, you would expect the average dividend yield of the Dog stocks to approach the average dividend yield of the DOW.

By definition the average dividend yield of the 10 Dog stocks will be greater than the average dividend yield of the DOW index. However, as more money is committed to the Dogs Strategy, the price of the 10 Dogs will be pushed higher driving the dividend yield lower. So the difference between the average dividend yield of the Dogs and the average dividend yield of the DOW stocks should get smaller over time.  To test this hypothesis I have compared the average dividend yield of the Dogs to the average Dividend yield of the DOW for the last 15 years.

Year Yield of DOW on date of purchase Yield of Dogs of DOW on date of purchase Difference 5 yr average of difference
1996 2.28% 3.35% 1.07%
1997 1.91% 3.06% 1.15%
1998 1.80% 2.79% 0.99%
1999 1.79% 2.82% 1.03%
2000 1.57% 3.00% 1.43% 1.13%
2001 1.64% 3.03% 1.39% 1.20%
2002 1.95% 3.48% 1.53% 1.27%
2003 2.47% 4.20% 1.73% 1.42%
2004 2.12% 3.61% 1.49% 1.51%
2005 2.26% 3.82% 1.56% 1.54%
2006 4.77% 6.00% 1.23% 1.51%
2007 2.34% 3.59% 1.25% 1.45%
2008 2.60% 4.27% 1.67% 1.44%
2009 3.81% 6.18% 2.37% 1.62%
2010 2.63% 4.17% 1.54% 1.61%

Here is the same data presented as a graph

Examining the data reveals that the difference between the average yield of the DOW versus the Dogs of the DOW is not getting smaller, but appears to be getting larger. Through 1996-1999 the difference between the 2 strategies was approximately 1% and through 2000-2010 the difference was about 1.5%. This argues against the hypothesis that the popularity of the Dogs strategy is affecting returns and I suspect there are other causes for the underperformance.

Having said this, I believe a more definitive conclusion as to whether the popularity of the Dogs strategy is having an effect on its performance could be made by analyzing P/E ratios as P/E is a better measure of how expensive a stock is. I would have preferred to analyze whether the average P/E of the Dog stocks increased over time and whether it increased with respect to the other stocks on the DOW. However, in the absence of easy access to P/E data I decided to extrapolate based on the dividend yield. Perhaps in a future post I will attempt to see if this argument holds based on P/E data.

Finally, I am not sure the performance of the Dogs of the DOW is a good predictor of the future performance of the BTSX strategy. I believe there are fundamental differences between the TSX 60 and the DOW that make comparing the Dogs with the BTSX difficult. I will explore this in my next post.

As promised, I’ve taken a retrospective look to see how the Beat the BTSX and David Stanley’s Beating the TSX would have done in 2009-2010. Here are the results for both indexes, assuming a purchase date of May 23rd 2009 and a sale date of May 14th 2010:

Beat the BTSX

Symbol Price May 14 2010 Price May 23 2009 % Change Dividend Dividend Yield Net Payout
Biovail $16.84 $14.56 15.66% $0.36 2.47% 11.57%
Telus $40.30 $30.96 30.17% $1.90 6.14% 8.98%
TransAlta $20.80 $20.15 3.23% $1.16 5.76% 8.65%
Royal Bank $59.98 $42.25 41.96% $2.00 4.73% 7.89%
TransCanada $35.79 $31.59 13.30% $1.54 4.87% 6.77%
Sun Life Financial $30.37 $27.12 11.98% $1.44 5.31% 6.69%
BCE $31.90 $23.91 33.42% $1.63 6.82% 6.66%
Magna Intl. $76.47 $36.24 111.01% $0.18 0.50% 6.55%
Husky Energy $27.10 $32.02 -15.37% $1.20 3.75% 6.23%
Shaw Comm. $19.20 $19.00 1.05% $0.85 4.47% 5.25%

This yields a capital gain of 24.64% and a dividend yield of 4.48% for a total return of 29.12%.

David Stanley’s Beating the TSX

Symbol Price May 14 2010 Price May 23 2009 % Change Dividend Dividend Yield Net Payout
Biovail $16.84 $14.56 15.66% $0.36 2.47% 11.57%
Bank of Montreal $60.58 $40.87 48.23% $2.80 6.85% 3.89%
CIBC $73.12 $53.70 36.16% $3.48 6.48% -9.30%
BCE $31.90 $23.91 33.42% $1.63 6.82% 6.66%
Husky Energy $27.10 $32.02 -15.37% $1.20 3.75% 6.23%
Telus $40.30 $30.96 30.17% $1.90 6.14% 8.98%
TransAlta $20.80 $20.15 3.23% $1.16 5.76% 8.65%
Bank of Nova Scotia $52.33 $35.97 45.48% $1.96 5.45% 1.47%
Sun Life Financial $30.37 $27.12 11.98% $1.44 5.31% 6.69%
National Bank $60.47 $47.52 27.25% $2.48 5.22% -11.78%

This method results in a capital gain of 23.62% and a dividend yield of 5.42% for a total return of 29.05%.

The two methods yielded virtually the same total return. Unsurprisingly, the Beat the BTSX had a slightly higher capital appreciation while the BTSX had a slightly higher dividend yield. Over the same period, the iShares S&P/TSX 60 Index Fund (symbol XIU on the TSX) would have yielded a capital gain of 19.70% with a dividend yield of 3.74% for a total return of 23.44%. So both lists would have significantly outperformed the index. Of course, I wouldn’t extrapolate any long term results based on a single year of data; however it is encouraging to see the degree of outperformance, given the market’s turbulence.

More interesting to me, however, are the differences between the two lists: the Beat the BTSX is far less concentrated in financials with only the Royal Bank (RY) and Sun Life Financial (SLF) making the cut, while the BTSX contains 5 financials. The greater diversity in the Beat the BTSX is expected because high dividend payers on the TSX 60 are concentrated in financials, telecoms and utilities while large volume stock repurchase is a tool used by a wider variety of companies in the index.

Technically, dividend payout and stock repurchase are both executed at the discretion of management, however in practice, dividend payout tends to be a more regular event. In contrast, large stock repurchases can be executed opportunistically by managers who deem their company’s share price too low. For example, none of the banks cut their dividends in 2009 even in the face of a cataclysmic event like the Credit Crunch. Of course, they were forced to raise capital which they did by issuing shares, thus keeping many off the Beat the BTSX list. Interestingly, the top performing stock from either list was Magna International (MG-A), which made the cut despite its low dividend yield because of a large stock repurchase. Magna is neither a larger dividend payer nor does it consistently buy back its shares so I don’t expect to see it make the Beat the BTSX very often. I do, however, expect to have various companies appear on the Beat the BTSX as a result of this kind of opportunistic repurchase – companies that wouldn’t make the BTSX.

A couple of technical notes: the calculation for both the BTSX and the Beat the BTSX used the TSX 60 index for 2009 so the BTSX list differs from the one actually posted by David Stanley in the May 2009 issue of CanadianMoneySaver. Also, rather than calculate trailing twelve month values for stock repurchases and/or buybacks I simply used the previous years’ figures.

The Beating the BTSX (Beating the TSX) index for 2010 is ready (for an introduction to the index see here). I have updated the index to track the TSX 60 as per David Stanley’s BTSX since the Dow Jones no longer makes the constituents of the Dow Jones Canadian Titans 60 index freely available. This update was promised at the end of May, but was delayed because it had to be recalculated with the new index. The good news is that I’ve managed to automate most of the work so future updates will be more timely and less labour intensive.

Here are the companies making up the Beating the BTSX list for 2010 (note the index is calculated with prices for the close of trading on May 14th as per the BTSX):

Name Price Dividend Yield Stock Issue/ Repurchase

(In millions)

Common Stock

(in millions)

Net Payout
Rogers Comm. $36.70 $1.28 3.49% -$1,344.00 592.41 9.67%
Power Corp. $27.29 $1.16 4.25% -$498.00 409.07 8.71%
BCE Inc. $31.90 $1.74 5.45% -$460.00 764.25 7.34%
Shaw Comm. $19.20 $0.88 4.58% -$85.36 431.84 5.61%
TELUS $40.30 $2.00 4.96% $0.00 318.38 4.71%
Husky Energy $27.10 $1.20 4.43% $5.00 849.86 4.41%
Tim Horton’s $35.15 $0.52 1.48% -$176.24 175.13 4.34%
Enbridge $48.36 $1.70 3.52% $45.00 380.11 3.27%
Sun Life $30.37 $1.44 4.74% $262.00 566.8 3.22%
Royal Bank $59.98 $2.00 3.33% $113.00 1421.54 3.20%

I have made one adjustment to the process for determining the Beating the BTSX list:  I’ve decided to use the company’s Annual Dividend per Share as reported on the summary description page of each stock on most financial sites. In contrast, The New Dogs of the Dow method, as described in Jack Hough’s book Your Next Great Stock, uses dividends as calculated in the Total Cash Dividends Paid line item of a company’s Cash Flow statement. The problem I have with this value is that it includes anomalies like one time dividend distributions, which are not likely to be paid the following year. This skews the dividend yield of some companies upward. A much better indication of future dividend yield is a company’s Annual Dividend per Share.

Another reason to use the Annual Dividend per Share is that it rewards companies that increase their dividends and penalizes those that cut their dividends. This is because the Annual Dividend per Share forecasts the annual dividend based on the last dividend paid by a company.  For example, if a company raises its quarterly dividend in any particular quarter, the annual dividend will be the latest quarterly dividend multiplied by 4. Using the Total Cash Dividend Paid value would only use the raised dividend in the period it was paid out. The opposite is true for a company that cuts its dividend: the lower dividend will make up the full dividend forecast.

Here are the steps for calculating the Net Payout of a company,

Step 1: Calculate a company’s trailing 12 month stock repurchase or issuance amount.

Step 2: Multiply the annual dividend per share by the number of common shares outstanding.

Step 3: Subtract the stock repurchase/issuance amount from the total dividends paid.

Step 4: Divide this value by the total number of common shares.

Step 5: Divide this value by the price of the stock. Now you have the company’s Net Payout.

Let’s go through an example. I will calculate the Net Payout for Shaw Communications (SJR.B). Here is the Total Cash Dividend Paid line item from Shaw’s cash flow statement for the last 5 quarters:

2010 Q2 2010 Q1 2009 Q4 2009 Q3 2009 Q2
Period End Date 2/28/2010 11/30/2009 8/31/2009 5/31/2009 2/28/2009
Issuance (Retirement) of Stock, Net -$92.66 -$20 $23.42 $19.28 $16.12

Step 1: I will break up the calculation into the repurchase/issuance amount for Q1 and Q2 of 2010 and Q4 and Q3 of 2009.

Issuance (Retirement) of Stock for Q2 and Q1 2010:

The Issuance (Retirement) of Stock line item is cumulative so this figure is simply the value for Q2 2010 which is $-92.66.

Issuance (Retirement) of Stock for Q4 and Q3 2009:

The 2009 Q4 figure shows that Shaw issued $23.42 million worth of shares for 2009.  Subtracting the $16.12 million worth of shares issued in Q2 and Q1 of 2009 leaves $7.3 million worth of shares issued for Q4 and Q3 of 2009.

Adding these two figures together

$-92.66 + $7.3 = $-85.66

For the trailing 12 months Shaw bought back $85.36 million worth of its stock.

Step 2: Shaw’s annual dividend is $0.88 per share. So we should expect Shaw to pay $0.88 * 431.84 million = $380.02 million over the next 12 months. Note in October of 2009, Shaw increased its annual dividend from $0.84/share to $0.88/share annually. So, it makes sense to expect Shaw to pay $0.88 per share for 2010.

Step 3: $380.02 million (Dividends) – -$85.36 million (Share Repurchases) = $465.38 million.

Step 4: $465.38/431.84 = 1.078

Step 5: 1.078/$19.20 = 5.6%.

Thus, Shaw’s Net Payout is 5.6%.

Now, let’s examine the companies in the BTSX for 2010.  I have listed the Net Payout for these companies as well as the dividend yield:

Name Price Dividend Yield Stock Issue/

Repurchase

(in millions)

Total Shares

(in millions)

Net Payout
Shaw Comm. $19.20 $0.88 4.58% -$85.36 431.84 5.61%
TransAlta $20.80 $1.16 5.58% $399.00 218.6 -3.69%
Husky Energy $27.10 $1.20 4.43% $5.00 849.86 4.41%
Power Corp. $27.29 $1.16 4.25% -$498.00 409.07 8.71%
Sun Life $30.37 $1.44 4.74% $262.00 566.8 3.22%
BCE Inc. $31.90 $1.74 5.45% -$460.00 764.25 7.34%
TransCanada $35.79 $1.60 4.47% $2,696.00 687 -7.87%
TELUS $40.30 $2.00 4.96% $0.00 318.38 4.71%
Bank of Montreal $60.58 $2.80 4.62% $608.00 560.11 1.86%
CIBC $73.12 $3.48 4.76% $823.00 386.46 2.39%

Notice that both TransAlta and TransCanada have negative Net Payouts, while the Net Payout of Sun Life, Bank of Montreal and CIBC are significantly lower than their dividend yield. Six of the 10 companies were net issuers of stock in the last 12 months as opposed to 4 for the Beating the BTSX. TransCanada was the largest diluter of shareholder value by issuing over 68 million shares, netting the company over $2.5 billion.

In my opinion, it makes sense to expect companies with positive Net Payout to outperform companies with negative Net Payout. Issuing shares is dilutive because the earnings of a company now have to be distributed across a greater number of shares. This is especially onerous for dividend paying companies because they will have to pay an even greater amount in dividends without actually increasing the dividend per share. So regardless of the performance of the company, the stock issuance will be a drag on the company’s share performance.

Let’s look at an example: in the last 4 quarters TransCanada increased its common shares from 619 million to 687 million (an increase of 11%). This means that TransCanada’s overall earnings will have to increase by 11% just to maintain its current earnings per share. Similarly, the aggregate amount paid out in dividends will be increased by 11% just to maintain the current dividend. So, even if the company does fairly well over the next 4 quarters, i.e. increase earnings and dividends by 10%, it is unlikely to be reflected in its share price or dividend yield.

We will see how the Beating the BTSX list compares to the BTSX over the next year. Next May I will post the results for the Beating the BTSX index and compare it to the BTSX as well as update the index for 2011. In my next post I will back track and look at how the Beating the BTSX index would have done in 2009 and compare it to the BTSX.

Full Disclosure – Long TRP. I purchased shares in TRP prior to the massive share issuance and despite my comments here; I believe TRP has high quality assets that will allow it to increase earnings and dividends over the long term. In the short term however, the share issuance (shareholder dilution) is likely to be a drag on the share price.

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