Wednesday, September 7, 2016

Understanding Dividend Yields

The search for high dividend yielding stocks continues as investors seek alternatives to the abysmal yields on fixed income securities. A stock yielding 3% in the context of a US Treasury 10-year yield of 1.55%, definitely looks attractive. Well, maybe.

Dividend yield is the projected annual dividend per share of a particular stock, divided by the price. So if General Motors, for instance, is paying an annual dividend of $1.52 per share and the stock is trading at $32, the dividend yield is 4.75%. Far better than the 10 year Treasury.

But there are three important points to remember for those investors buying high dividend yielding stocks. The first consideration is that dividends are declared each quarter by the board of directors and, therefore, can be cut or suspended at any time. We've all seen this happen to stocks like Conocophillips (COP) that announce a dividend cut earlier this year. After entering 2016 with a dividend rate of $0.95, the company cut its dividend in Q2 to $0.79, and in Q3 to $0.49.  The stock now trades at $41, fully 25% off its recent November 2015 high of $55.  Meanwhile, other large integrated oils, not cutting their dividends, have risen considerably over this period.

Second, the dividend yield is an annual number. In other words, if you purchase the stock, hold it for a year and the dividend rate does not change you earn a dividend yield, in the case of GM, above, of 4.75%. Now, of course, what is important to investors is not the annual dividend yield, but rather the total return in holding the stock. For instance, taking this same example, if you buy GM today at $32 and it closes one year from today at $30.5, just one and one-half point lower, your total return for the year is exactly zero - quite a bit less than the yield on that US Treasury.

These two considerations are fairly obvious, but there is one more point for dividend investors that's often overlooked. The dividend yield when you purchase a stock is only the projected yield you are to receive (assuming no cut to the dividend rate) at the price at which you acquire the stock. In the example above, the dividend yield for GM purchased at a share price of $32 today is projected to be 4.75%. 

But what happens to your yield over time, is of equal importance. Let's say that you find GM an attractive investment at the prices and yields mentioned. Now, let's say that you hold GM for a year and the price rises to $35. Well, you've done quite well on the investment. Your total return for the year would be $14.12% (9.375% in price, plus a 4.75% dividend). But at this point, assuming no increase in dividend rate, your projected dividend yield has fallen to 4.34%. Still a very impressive yield. But for stocks that have risen appreciably, the current estimated dividend yield may be far less than when the investor purchased the stock. As such, investors should periodically reconsider why they are holding the stock and its estimated dividend yield on capital currently deployed.

Wednesday, August 31, 2016

Is a Fed Rate Hike Good for Bank Stocks?

With talk of a Fed rate hike at its September meeting increasing, following comments of Stanley Fischer and other Fed governors at Jackson Hole, bank stocks are enjoying quite a run. Bank of America is currently trading at $16.14, a nearly 45% gain from its February 2016 lows.  Citigroup is up 38% and JP Morgan +28.5% (a nice game for Mr. Dimon who publicly purchased $26 million of its shares on February 12). The financial services ETF, "XLF" is up an impressive 27.5%.

Some of this gain was a bounce off the February lows, but a healthy share of the return has been produced over the past 30 days as focus turned toward the Fed's Jackson Hole Symposium. Rightly or wrongly, the market thoroughly believes that higher rates are good for banks, as long-suffering bank net interest margins profit by a higher interest rate lending environment.

Truth be known, a hike in the Fed funds rate, in and of itself, is negative for bank earnings. Such a rise in short term rates has to be accompanied by a far larger increase in term lending rates to produce net interest income benefit to the banks. Part of this disconnect has to do with the mystery surrounding the Fed. Despite the Fed's noble efforts at transparency, market participants remain convinced that the Fed has secret data insights, not otherwise available to the markets at large. If the Fed is moving on rates, the economy must be heating up and with it the UST 10-year, or so the thinking goes.

Of course, the Fed is not privy to some covert set of data, but rather is looking at the same economic data as everyone else. In fact, their prolonged hesitation over the most minor of (and nearly insignificant) rate increases should be ample evidence that the data on the economy is more confusing than it is compelling. Nonetheless, as the chatter rises, bank stocks head higher while utility stocks, bonds and gold - each of which thrive in a low interest rate environment - drift lower.

This being said, it's probably worth taking a look at how markets actually reacted in the days and weeks following the Fed's 25 basis point rate hike last December.  As discussed in a previous post, in the several weeks following the Fed's December 15, 2015 rate hike, the 10-year UST actually fell in yield (bad for bank earnings, by the way) while utility stocks and gold posted some of their best gains in recent memory. 

The XLF shows a similar phenomena, rising to a close of $24.44 on the day following the Fed decision, up nearly 32% from its August 2015 lows. But in the days that followed, the XLF quickly began to fade, falling nearly 5% the very next day. By the time of the February 2016 lows, the XLF had fallen nearly 20%. Eerily, the XLF today, as we approach the September Fed meeting stands at precisely the same level, $24.56, as it did on the day prior to the December Fed meeting. 

Wednesday, August 24, 2016

The Fed, Bonds, REITs and Utility Stocks

The Fed is hosting its 2016 annual academic conference in Jackson Hole, Wyoming this weekend.  Fed Chair, Janet Yellen is scheduled to speak. While no interest rate decision will be announced, markets nonetheless are fixated on developments. With little real economic data or interest to move stock and bond prices, traders eagerly await some insight into future rate policy, in hopes of gaining some direction for markets.

We see the impact of Jackson Hole on bond and utility stock prices, and prices for REITs.  Each of these instruments trade as fixed income securities and are, therefore, rightly influenced by trends in interest rates. But, it's actually long term interest rates that impact these instruments over time, not the short end of the curve that the Fed sets.

Utility stocks have performed extraordinarily well over the past six months, as we first pointed out in this blog in April 2016, Investing in Utility Stocks.  Utility stocks as measured by the return on the ETF, XLU, were up 18.8% through August 10 of this year (see Returns on Selected Assets Year to Date).  It's also worth reading our 2016 market predications posted on December 30, 2015 and What's Working in this Market Correction from January 7, 2016.

Over the past few weeks, though, bonds, REITs and utility stocks have given back some of their gains as investors eye a potential rate hike by the Fed.  Let's take a look at how bonds are priced and why I treat utility stocks as the equivalent. Utility stocks generally trade with a high level of dividend yield. Because utility revenues are quite stable, the dividend is therefore predictable and protected, as much as possible, from swings in the economy.  Therefore, as with bonds that pay a fixed level of interest, the value of the utility stock is tied to the discounted future value of the dividend stream. If the dividend is stable, the stock value will rise as the discount rate falls and decline as the discount rate rises.

Markets, of course, are forward looking, which explains why utility stocks are weakening, while no interest hike has actually been scheduled. The Fed also does not directly impact longer term interest rates that are the basis by which utility dividend and bond interest would be discounted. Nonetheless, the markets are fragile and investors anxious.  

If we look at the last Fed hike on December 15, 2015, however, we see a very different picture emerge. The US 10-year rose by 2 basis points to 2.30% in the day following the announcement, eventually rising to a high of 2.32% on December 29.  But the yield began immediate falling thereafter, to 2.00% on January 28, and 1.63% by February 11, 2016. The 10-year yield now sits at 1.55%. The XLU utility ETF, by the way closed on the day of the December Fed hike at 42.33, climbing to 53 on July 6, 2016 (a gain of 25%).

This points to the most interesting aspect of how bonds and utility stocks trade, not on forecasted Federal Funds rates, or perhaps even the US 10-year, but on the forecast of inflation in the economy, as inflation erodes the value of fixed income securities. The point of all this is that if a Fed hike acts to curb growth (and therefore inflation) a rise in the Fed Funds rate could actually act to lower the US-10 year and raise, not lower, the price of bonds and utility stocks. This is precisely what happened following the Fed's December rate hike. There's no reason to believe that this would play out any differently in the months following the next rate increase.

Tuesday, August 23, 2016

Wall of Worry

We've all heard this expression, to refer to stocks clawing gains to new highs amidst a market of doubters. It's contrarian logic. Buy when others are selling, when skies are at their most foreboding.

Recent reports have highlighted significant equity mutual fund and ETF outflows of both domestic and international equities, suggesting at least retail investors may be worried indeed. An article in Barron's indicates that fund outflows from U. S. equities in July deepened to a six-year low. International stocks followed suit. ISI Evercore Research reports that fund flows out of equity mutual fund and ETFs last week alone totalled $6 billion, bringing the year to date fund flows to negative $95 billion, a near record.

Now, to those of the contrarian view, the data argues for bullishness with the market soon to drive ever higher. Well, maybe. While markets have been known to climb a wall of worry, just as often investor uneasiness plays out as expected in future events. The herd isn't always wrong.

Take a look at the chart above. It shows the historical pattern of U.S. domestic equity fund flows paired with the S&P 500. While retail investors were seemingly caught off guard in the 2001 tech wreck, only to pull money from equity funds as the market fell to new lows, the stock market crash of 2008 paints a very different picture. While markets pushed ever higher throughout the fall of 2007, equities began to see negative fund flows as early as April, with money being pulled out of the market in increasing volume throughout the year, before the market began to topple in early 2008.

Today's negative fund flows from US domestic and international equities could be just the contrary signal that bulls are looking for, or this time, the herd could simply be right.

Friday, August 12, 2016

Warning Signs in Consumer Product Company Revenues

President Obama recently spoke about the economy, pushing back against nagging naysayers who point to disappointing growth, arguing that his detractors are attempting to make the US recovery look less robust than it really is. He pointed to job growth, a falling unemployment rate, rising wages and, did I mention job growth? Truth is, President Obama shouldn't take it so personally. An $18 trillion economy is more that the doing of one man.

On closer examination, though, there's no denying that something is downright fishy about the economy. Corporate profits for the S&P 500 have now declined for five straight quarters. More disturbing, and to our point about economic growth, top line revenues of S&P 500 companies have fallen for the past six.

It's not just struggling energy companies, or retailers shouldering these declines, both of whom it could be argued are not representative of the broader economy. In the former case, bulls would point to the nearly unprecedented fall in the price of oil, in the latter the shift to online shopping. But truth be told, the poor sales and earnings of major retailers like Macy's, Nordstrom, Walmart, Kohls, Ralph Lauren and Apple all take into account their online sales. So it's not just a shift to online shopping. There is something wrong with the consumer.

The issue is manifest in top line revenue of major banks like Citibank, JPMorgan and Bank of America. While their customer base is as corporate and institutional as consumer, top line revenues for each of these banks has fallen sequentially for the past five years. The banks are in effect shrinking themselves through expenditure reductions to keep cash flow positive.

But it's the consumer brands, like Colgate that are the most disturbing and highlight the structural weakness in the economy. Net sales for Colgate's products fell 7% last year - now bear in mind this is a company that makes consumer staples like toothpaste, mouthwash, soap, deodorant and household cleaners. Assuming for a moment that inflation is zero (if you buy that argument) the world's population is unquestionably growing. How can a company that markets consumer staples see shrinking sales in a growing world? And it's not that Colgate is somehow falling behind its competitors. After all, the stock trades at 47x trailing earnings and is at the top end of its 52-week trading range. Clearly, investors value the franchise.

As dreary as this picture might be, Colgate is not doing nearly as badly as America's largest consumer products company, Procter & Gamble. P&G has seen declining annual revenues, sequentially, for each of the past five years. Its revenues were fully 20% lower in 2015 than in 2012. P&G saw its sales decline last year alone by $10.9 billion. Pepsico's revenue fell by 5.4% last year, and came in $2.5 billion below its sales level of 2012. General Mills, another leading consumer products company, saw revenue decline last year by 6% vs. 2014. How is this all possible in a healthy economy?

Maybe this is what Bill Gross, Stan Druckenmiller, George Soros, Carl Icahn and other billionaire investors see that scares them so terribly about the economy and the stock market. After all, for revenues of major consumer brands to see continuing sales declines, something has definitely gone off track with the economy.

Thursday, August 11, 2016

Earnings Beats Continue to Drive Markets Higher

When it comes to investing, I guess I'm old fashioned. There, I said it. I still dream of owning shares of companies that are growing, building businesses, expanding production, services, facilities and markets. But if you've been trading stocks for less than ten years, this perspective might appear archaic, outdated, downright foolish.

Gina Martin Adams, Equity Strategist for Wells Fargo was on Bloomberg TV yesterday touting renewed bullishness on US equities. Her enthusiasm was driven by the "75% of companies reporting earnings this quarter that exceeded analyst estimates". You can watch the full interview here. Tom Keene, the venerable host, for whom I have great respect, failed to ask the most compelling question: what percentage of companies reported earnings that actually exceeded prior year's results. After all, as old-fashioned as I may be, I still like the idea of owning shares of companies that are growing their businesses, not companies that are failing, but a little less badly than analysts had predicted.

We've discussed this topic elsewhere in this blog, in respect of US banks like Morgan Stanley and Goldman Sachs, then in a blog post just after Apple reported a stunning 27% decline in year over year quarterly earnings (the stock popped on the news, by the way). We saw yet more of this silliness yesterday as Polo Ralph Lauren reported a same store sales decline of 9%, with its stock up roughly the same percentage on the day. Today's pop is over at Macy's up 17% as of this writing on news of an earnings beat. Nevermind the fact that revenue declined by $230 million on a year over year basis, that the retail giant is shuttering 100 stores or that the company is forecasting a full year decline in comp sales of 3-4%.

But markets are markets and the market is never wrong, so what's going on here? My guess is that computer algorithms run by investment banks, hedge funds and other institutions are now programed to spot earnings beats, irrespective of overall company performance, and buy shares on the news. A beat is not always sufficient to drive a stock higher, but if it works in 90% of the cases, the odds are quite favorable for an institution trading hundreds of thousands of shares per day.

For the retail investor, however, this poses a great challenge. Do you seek out growing companies with rich stock prices, or beaten down companies hoping they'll fail a little less spectacularly? If you choose the latter, and I'm not arguing you shouldn't, bear in mind the risks of a miss on the stock performance of a downtrodden company as can be seen from market action following Macy's 2015 Q3 results.

Thursday, July 28, 2016

Up In Smoke Free Promotion

Up In Smoke: How the Retirement Crisis Shattered the American Dream will be available for free download in its entirety to Kindle users from August 1 through August 5, 2016 by following the link belowUp In Smoke: How the Retirement Crisis Shattered the American Dream, available on

Tuesday, July 26, 2016

Apple Does it Again (and other yarns from the financial press)

Apple just released their much anticipated earnings for calendar Q2 (Apple's fiscal quarter Q3).  While the financial press heralded, "Apple Does it Again" , "Apple Beats" and other yarns, the data tells a very different story. The company reported Q3 revenue of $42.1 billion, a decline of a stunning $7.2 billion from the same quarter one year earlier.  The decline in net income was worse. Far worse.  

Apple's Q3 earning fell from $10.68 billion in the year ago period to just $7.8 billion in the current quarter - a decline of a whopping 27%. So much for analysts claiming the earnings recession is all energy related, by the way.  And so much for meaningful  reporting from the financial press.

Wednesday, July 20, 2016

Morgan Stanley Earnings Beat and Other Tall Tales of Wall Street

"Morgan Stanley Solidly Beats Earnings Expectations". That's the headline posted on the CNBC website this morning. Fox Business posted a similar headline reading "Morgan Stanley's 2Q Profit Tops Expectations". Nearly identical headlines ran yesterday when Goldman Sachs reported its 2Q results. The CNBC headline claimed "Bank Earnings on a Roll as Goldman Tops the Street". But drill down into the actual results and you'll uncover a far less bullish story than what the headlines would indicate.

Morgan Stanley, it turns out did beat analyst expectations on both the top and bottom line.  These were significantly lowered expectations, of course, based upon careful if not clever guidance of the company's CFO. But the numbers "beat" nonetheless. However, by all more traditional measures, Morgan Stanley had a terrible quarter. Top line revenues fell by $840 million from the same quarter a year earlier. A nearly 10% decline in revenue is hardly a reason to celebrate. Goldman's top line fell by $1.14 billion on a year over year basis, for a decline of 12.5%. The bottom line for Morgan Stanley was even worse than its revenue performance. Morgan's net income fell 12%, despite significant cost cutting. 

So how do stories like this get spun as "Morgan Stanley Solidly Beats Earnings Expectations"? Welcome to the new Wall Street. With investors trying to game the system in a through the looking glass economy, traders are solidly focused on earnings "beats" and misses. It's a desperate attempt to gain a trading advantage in markets that seldom make sense to anyone. The trouble is, an earnings beat tells us very little about the company's fundamental earnings performance or the growth trajectory of its business. It simply tells us about the skill of the CFO in managing earnings guidance. But year over year revenue and earnings performance tell us something very different. They tell us about the viability of the company's business plan, how customers are responding to the company's outreach and how the company is executing on its profit plan internally. Data points investors should be keenly aware of if they own the stock.

In the seven years following the Great Recession, CFOs have turned gaming earnings expectations into an art. They know that conservative guidance gives the company a lower bar to hurdle in reporting its results. And to the extent they "beat", well... Morgan Stanley stock is up 2% as of this writing.