Dividends and payout ratios

Yesterday I posted a straw for SmartGroup titled “Cash cow struggling to grow”. Today on Livewire Markets Roger Montgomery talks about payout ratios for high ROE business in more detail If you are an income investor, it pays to think long-term.

From prior forums I get the feeling Roger doesn’t have too many fans here on Strawman. However, his argument here is valid and it makes a lot of sense to me. By the way, if you read Roger’s Livewire article it pretty much sums up his book “Value-able”.

Cheers,

Rick

I can relate to what Bob Desmond from Claremont Global said about the process he uses to manage the Claremont Global Fund on Livewire - No secret sauce! The simple process with a proven track record

Here are a few bits that gelled with me:

“We endeavour to put together a portfolio of very high-quality businesses with decent organic growth, faster than nominal GDP growth, high margins, high returns on capital and very little debt.”

While there are many successful investment approaches and no single approach is best, I think Bob’s strategy to achieve a good return is similar to my preferred style…buying quality growing businesses at a discount to valuation. There’s definitely no secret sauce in this approach:

“We often get asked are we value or are we growth? 

We say we're both. it sounds cliched, but we are looking to buy growing businesses, and if you actually look at that graph there, if we can buy a business that's growing at 10% per annum and we can buy the 20% discount to value and that value closes, over four years, we'd be looking at a 15% per annum return.

Those are the type of businesses we like to earn. We are not looking to pay big multiples, but by the same token, we are not looking to buy cheap and nasty, and actually, I think that served us well over the last year.”

Sounds to me like a slow and steady approach that won’t shoot the lights out, but hopefully should achieve a good return over on a diverse portfolio over a period of time, if you take the time to research the businesses and get your valuations right. Sometimes you also need a lot of patience to see the growth and value curves ‘close out’ perfectly as they do in Bob’s diagram.

I have a number of examples where this has NOT worked for me…YET! Codan is a good example. It had a good track record of growing earnings every year with a solid return on equity. Then came the Russian Interference (Wagner Coorporation) into artisan gold mining in Africa which has crippled gold detector sales for an indefinite period of time. Codan still makes the best metal detectors in the world, and the communications business is growing strongly. However I think a lot of patience will be required for Codan to get back to FY2023 earnings.

Kina Securities was another example that didn’t work. Good return on equity, earnings growing strongly and earnings are expected to be very strong this year. However the PNG government saw a ‘cash cow’ and has drafted legislation to introduce a ‘super profit tax’ for banks of 45%, up from 30%. Given the additional tax burden and no franking credits, I decided to exit a large position in what is still a great business…at a slight loss!

There are plenty of examples where this strategy has worked well for me, including Mader, Acrow Formwork, Lovisa, DDH1 drilling, BHP, Lynas and Laserbond. Knowing when to sell is the tricky bit. I still hold every share in Acrow Formwork, DDH1 and Lynas. However, I have sold all of Mader, Lovisa and Laserbond. These are still all wonderful businesses. I sold because I thought they had reached their full valuation, and some (according to my valuation method).

 I sold Mader after the share price tripled, but then it went on to double again! Did I sell too early? Obviously! But when I look at the growth and ROE performance metrics for Mader now, they don’t look dissimilar to when I bought my first shares at c. 70cps. The biggest difference is the sentiment. The PE ratio has gone from about 7x to 33x in less than 3 years. 

I also think momentum can not be underestimated. This is something I’m still trying to get my head around. Momentum is real and it can impact the share price for much longer than you expect in either direction, up and down! I need to be more patient when buying when sentiment is low, and more patient selling when sentiment is high. Sentiment can drive the share price well beyond valuations in either direction…but where’s the sweet spot? 

I still hold BHP (my largest holding IRL) but I have been reducing each time it is close to $50 per share. It is difficult to see how BHP will grow its FY22 earnings over coming years. However BHP is a very well managed business and it often surprises to the upside.

The jury is out on a few of my current picks which I am still accumulating, ie. Nick Scali and Best & Less. Once again, and for good reason, the sentiment has turned sour for retail. I am taking a long term view on these businesses with the hope they will continue to pay out nearly 10% fully franked dividends while the economy recovers (see my forum straw ‘Get Paid to Play’). Both of these businesses returned investors over 40% on their equity during  FY23, and Best & Less has cash in the bank . I’m hoping there is enough fat in their financials to pull these businesses through a few tough years. I’m hoping I can add them to the list of ‘investments where the strategy has worked!’

That’s enough reflection and rambling for a Sunday! DYOR, and never underestimate how far a little luck can go to make you look like a pro…or how a ‘Black Swan Event’ can make you look like an absolute fool! 

Good Luck and Cheers,

Hi Strawpeople.

Wondering if people can poke holes in my theorized strategy, which I have been thinking about for a while and would love all your knowledgeable input and scrutiny.

All the evidence points to best performance over the long run is to be fully invested all the time. At the moment I use 60% of my investment capital (which i add to fortnightly with my pay cycle) allocated DCA into my core ETFs. The remainder 40% goes to my investment account to use for stocks. The money I use for stocks generally sits in the account until opportunities present themselves. Do you think it would be better to just use all money to buy core ETFs, so that all money is fully invested, and then just draw down on the ETF when opportunities in a stock is presented? And possibly I can put an arbitrary rule like only allowing draw down a certain amount each month (to keep the ratio of core ETFs and stocks in balance).

I realize this is probably nickel and diming at this point but would love people to poke holes.

Hi Godders, welcome to the forum and it’s great to see the excellent responses to your questions!  I’ve been consistently impressed with the research and knowledge of the likes of Bear77, PMonkey and Awesomeoman.  I agree with much of sentiment already posted here and the book recommendations.

I have also found some of the more traditional books in the investment canon – such as The Intelligent Investor – to be some hard yakka.  They tend to be the type that I take a break from but consistently come back to with renewed perspective.

For my individual stock picks, particularly in the smaller riskier space, I personally like to keep thinking of it as a bit more of a game as you’ve mentioned.  And for that reason I keep them separate from my long-term retirement plans so I can avoid the angst of trying to time the market or having the stakes too high.

One of my strategies is to look to lessons from history – and not just financial history – to forcibly anchor my thoughts to a longer term view, away from the daily noise.

Another is to seek out more off-beat, interesting and fun reading than the likes of the biographies of Warren Buffett and his mates.  Two that I could recommend are: Monopoly, Money and You:  How to Profit from the Game’s Secrets of Success by Philip Orbanes and A Random Walk Down Wall Street:  The Time-Tested Strategy for Successful Investing by Burton Malkiel.  Think of them as the take-away food to your financial reading diet – don’t eat too much of it and when you do take it with a whole load of salt.

Finally, I reckon it pays to stay patient with yourself with individual stock picks and give yourself the freedom to have fun and make mistakes.  Don’t give the art of individual stock picking too much power by assuming it is too hard and not for you.  There are alternative sources to learning basic valuation techniques and you’ll find them on this forum.  Good luck, and to borrow from Denzel Washington in The Equalizer –  it’s “Progress, not perfection.”