When Everyone Knows it, it Ain’t Worth Knowing

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When Everyone Knows it, it Ain’t Worth Knowing

I just read one of the narrowest views of the investment world in an industry publication yesterday and it bothered me all night. It was about helping a prospective client get out of closet indexing mutual funds and into active share funds. I completely agree with this.  It carried the idea of getting more funds out of Canada, but unfortunately only went so far as to move about 50% internationally. Canada only has 2% of the world’s equity markets.

As you can imagine, we all have different opinions and I will not expand on the advice given in this area, but what really ticked me off was the advice to only invest in value/dividend paying funds for the equity portion. This advisor has narrowed the portfolio’s focus incredibly. This advisor could not have done proper due diligence. I have been hearing this war cry from the public, prospects, some clients and many mutual fund companies that you must chase only solid dividend stock investments.

When Everyone Knows it, it Ain’t Worth Knowing

There is an old saying in the industry that when everyone knows it, it ain’t worth knowing.  When everyone is investing in one direction only and that trend stops, it is almost always very ugly. I wrote about this October in my blog I Dare You to Try This.

I decided to go online to find the percentage of stocks in Canada and the U.S. that pay dividends. All I could initially find was “expert after supposed expert” pushing everyone into dividend paying stock.  They are simply pushing what the public wants so they can make money. What I call the easy sell. We have had a great run on Dividend Paying stocks, but this will not last forever. Once I found the numbers online I decided to call the TSX to make sure these numbers were right. After all these years in the industry I was very surprised. Here are the results;

TSX – 193 Dividend Paying stocks out of a total of 1577 stocks – 12.23%

U.S. – 3,122 Dividend Paying stocks out of a total of 6,667 stocks – 46.8%

 

In Canada, you are missing almost 88% of stocks listed with the TMX exchange (this does not include the venture exchange). What a narrow focus for 50% of the equity in this investor's portfolio. In the U.S. you are missing out on over 50% of the listed stocks on the NYSE, NASDAQ and Amex exchanges. Yes, I do realize that some of these non-dividend paying stock are small and not desirable for many investors, but too many great stocks are being missed with this incredibly narrow view of portfolio management. This investor would have actually had more market breadth with their current index style funds, but obviously overpaying for these almost unmanaged closet indexers.

Value Stocks and Growth Stocks take turns leading the market

The attached chart shows how value and growth stocks take turns outperforming and underperforming the index. An adept active share portfolio management team can increase their exposure to value or growth as needed. Please see my blog on Active Share investing. As you can see from the example below, growth stocks have added more to the return of the S&P 500 for 16 of the last 20 years than value (these assume the re-investment of dividends). This will reverse itself and you will see that value stocks in the U.S. will lead for a time. All markets have this phenomena playing out at all times. At first glance, they all appear to be mirror images of each other, but clearly do not.

Most would state that Canada has had a heavily leaning value market since the bottom of the market in 2009, but since the lows of May 2012 growth has actually outpace value by almost 8%. Good managers have used this for their client’s advantage. Leaning more heavily towards value from 2009 to 2012 and then to growth until now was how to outperform.

The misunderstanding of where the money 

I don’t want you to think I am putting down dividend paying stock, but I am very upset at the way articles have been written over the last few years that take a single statistic and continue to pound on the investing public their view, because they don’t understand how stocks work. This statistic is that most of the return of a dividend paying blue chip stock is from the dividends. If it didn’t pay the dividend it would go up in price instead as the company becomes worth more. It is the company’s ability to earn that drives the stock up.

When a stock has a lot of free cash flow, they can do one of three things:

  1. Keep the cash – either for future expansion or for a war chest

  2. Pay dividends out to the shareholders

  3. Buy back shares – reducing the number of outstanding shares and increasing the value of those you hold

Shareholders for some reason strongly believe that when a company pays them a $1,000 dividend that it is not reducing the capital of the corporation. It is a myth created by the so called experts. This dividend does reduce the capital of the corporation but investors happily take this and spend it. If the corporation doesn’t pay it out, the corporation would be worth more. If you sold $1,000 worth of stock, you would accomplish the same thing. Many see this as depleting their capital. They don’t realize that when paying a dividend, the corporation is depleting your capital by depleting its own capital. I am not going to go through the tax difference between Dividend taxation and Capital Gains tax today.

Even more frightening

During good times for dividend stocks investors forget that not all dividend paying stocks are created equally. They don’t realize that dividends can be cut, or that a great big blue chip stock can go down in value and stay down for an extended period of time, even if it doesn’t reduce its dividend.  People seem to forget the lessons of the past and get in to the moment too often. Some stocks have already started to cut their dividends, lowering the cash flow to investors, on top of the shares dropping in price. A double insult.

Don’t narrow your horizons

You have the choice of chasing what is currently the popular way to make money and not expand your investing horizons and severely limiting your future by not investing wisely. By including both Value and Growth in the equity portion of your portfolio as well as intelligently going more international, you will actually reduce the risk and volatility of your portfolio.

This only covers off one aspect of correct investing but must be part of a properly crafted portfolio.

If you want to see what a truly independent advisor can do for you, call me at 905-846-9060, ext.3838, email me at Terry.McIntyre@manulifesecurities.ca or visit my website at www.terrymcintyre.ca.