Weekend reading: Keeping your Dividend Edge

by The Investor on April 2, 2016

Good reads from around the Web.

I first encountered Todd Wenning’s writing when he was working as an analyst for The Motley Fool UK on one of its newsletters. He had a real knack of bringing complicated active investing decisions down to earth.

Todd went back to the US, but for years his British fans were still able to follow his writings via a blog (now discontinued), which I featured in Weekend Reading more than a few times.

Now Todd has published a book: Keeping Your Dividend Edge.

I’ve read it and found it a slim but deceptively deep dose of wisdom for anyone who has decided to try to pick stocks in the pursuit of long-term income.

This is not a beginner’s guide to investing – it’s more a collection of interesting notes from a fellow investor who clearly has experience in the field. (It reminded me a bit of Anthony Bolton’s Investing Against the Tide in that respect.)

As such Keeping Your Dividend Edge is probably not for someone looking for their first investing book – and obviously it’s not required reading for Monevator’s legion of passive investors, either.

But if you’ve decided that dividend investing is for you and you already know how to wield a P/E ratio, then you’ll find plenty here to digest and put to work.

Todd agreed to answer a few of my questions, too.

Dividend investing is as old as the stock markets, so what did you hope to bring to the table with Keeping Your Dividend Edge?

The core tenets and advantages of dividend investing remain intact, though the environment in which we operate as dividend investors has changed considerably over the last 10-15 years.

Can you give us some examples?

Sure. Firstly, the increased popularity of share buybacks has required company executives and boards of directors to re-evaluate how they think about returning shareholder cash.

In the past, the dividend was typically the sole means of returning shareholder cash, but now companies can also consider buybacks as an alternative.

Buybacks can be great as long as the company is repurchasing its stock at a material discount to its fair value – thus transferring value from selling shareholders to ongoing shareholders – but relatively few CEOs and CFOs have proven to be particularly skillful at this.

Regrettably, few companies have a well-defined buyback policy like they may have with a dividend policy, leaving it up to shareholders to decipher their strategy.

With many dividend-paying companies also implementing a buyback program, dividend investors can’t wish buybacks away.

As such, you should know how to evaluate a company’s buyback philosophy and track record.

Of course those dividends aren’t guaranteed either…

Yes, the financial crisis and the heaps of dividend cuts that occurred in 2008 and 2009 left a few scars.

A number of U.S. and U.K. companies with long track records of maintaining and increasing their dividends suddenly slashed their payouts.

To many, the idea of an inherently ‘safe’ dividend went out the door when this occurred. It’s therefore important for dividend investors to be more vigilant – yet remain patient – when evaluating prospective and current holdings.

Is it at all realistic to expect dividends for life in today’s rapidly changing world?

Intensifying competition due to technological innovation and global economic participation means that today’s giants could have shorter shelf-lives than they might have had a generation ago.

It’s not enough to invest in a company that’s doing well today and assume competitors aren’t taking notice and finding ways to eat away at their profit margins.

When Amazon CEO Jeff Bezos said, “Your profit margin is my opportunity,” he wasn’t joking around.

In my book, I aim to provide dividend investors with some tools and strategies for addressing these new factors.

I know you’re operating in the US now. Is your book equally relevant to UK stock pickers?

Experience has taught me that good investing principles translate well across borders – and I certainly hope that’s what I’ve done here.

You’ll have to forgive my American grammar and spelling, of course!

How should individual investors invest if they hope to do better than professional income funds?

The biggest advantage that individual investors have over professional money managers is their ability to be patient. It’s a massive edge that shouldn’t be underestimated.

The more you invest in businesses that you understand and the longer you extend your average holding period, the more likely you are, in my opinion, to have an edge over most professional income funds.

As Buffett has written, “The stock market serves as a relocation center at which money is moved from the active to the patient,” so erring on the side of patience tends to be a good strategy.

We welcome all sorts of investors here at Monevator, but as you may know our main focus is on passive funds and ETFs. So do you have an opinion about dividend ETFs, such as the iShares UK Dividend Aristocrat ETF?

The biggest thing to know with dividend ETFs is how they are structured.

Are they yield-weighted, dividend-weighted, market-weighted? When do they rebalance? And so on.

In the book, for example, I highlight a U.S.-based dividend ETF that invested heavily in banks leading up to and during the financial crisis precisely because those shares were among the highest yielders in the S&P 500. As you might have guessed, this had a bad outcome

So while I don’t have anything against dividend ETFs on the whole, they’re not all created equal. You still need to do some homework.

Are the old favourite dividend paying stocks overvalued in today’s low yield world?

There’s some mental comfort that comes along with buying the well-known blue chips, the Dividend Aristocrats, and so on.

At times, investors pile into them when they’re feeling risk adverse and drive up their valuations. Indeed, these can be very good companies to own at the right price, but if you’re looking for differentiated dividend ideas, you need to look elsewhere.

So where else might we be fruitfully looking?

This might be heretical in some dividend investing circles, but sifting through companies that have recently cut their dividends can be a fruitful exercise for more enterprising investors. Following a dividend cut, many income-minded shareholders have already folded and the company could be eager to re-earn their confidence by rebuilding the dividend in the subsequent years.

To illustrate, companies like Dow Chemical and International Paper in the U.S. slashed their payouts during the financial crisis and today pay higher dividends than they did in 2008. This strategy isn’t without its risks, of course, but it is an area where you might be able to find differentiated ideas.

Keeping Your Dividend Edge is out now at Amazon.

Todd Wenning, CFA is an equity analyst and writer based in the U.S. His opinions here are his own and not those of his employer.

From the blogs

Making good use of the things that we find…

Passive investing

Where does the money go when the market is down? – Oblivious Investor
The next Smart Beta revolution revealed […on April 1] – C.C.P
Bloggers debate: Peak index fund – Abnormal Returns
What if Vanguard gets nuked? – The Escape Artist

Active investing

Are European stocks cheap or is the US expensive? – A.W.O.C.S
Why “dead money” stocks can still be valuable – Oddball Stocks
Is Google’s Go-winning AI the future of active management? – E.Q.

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

Vanguard to launch cheap target-date funds in UK – Telegraph
One Vanguard, many DFAs – Morningstar

Active investing

What if Big Oil refuses to hunt for oil? [Podcast] – Motley Fool US
Are the best days over for UK active funds? – Trustnet
Why founder-led companies outperform the rest – HBR
The fall of China’s hedge fund king – New York Times

A word from a broker

Index tracker fund FAQ – Hargreaves Lansdown
April is usually a kind month to investors [FWIW!] – TD Direct