Thursday, February 16, 2012

Investment Report - February 2012: Net Payout Yields

January was yet another solid month on an absolute basis, with a 3.9% gain for my Net Payout Yields portfolio, but on a relative basis the portfolio underperformed the benchmark S&P 500 that was up 4.4%. Though not unexpected as these large cap stocks will tend to slightly underperform on large up months.

For the last 365 days the model continues to greatly outperform the market by outperforming during weak months.

Dividend Risks
As the market entered 2012, too much focus in the market was being placed on dividend yields with no concept of capital loss potential. As the dividend stocks rose into year end, this created the risk of capital losses in stocks yielding only 3-4%. Investors typically expect and want higher gains for a year. What happens when the stock drops for the year wiping out the benefit of the dividend?

This highlights the benefits of a model that focuses not only on dividends but also stock buybacks. The typical stock owned in this model has 60-70% of its yield focused on stock buybacks with only 30-40% placed on dividends. The trades in January further highlight the benefits of this thesis.

Trades
As typical of this model, only two trades were executed in January. Since the model goal is to remain fully invested (less than 10% cash), this usually means the immediate rotation from a low yielding stock into a higher yielding stock.

Bristol Meyers (BMY) was sold in early January around $35 as the stock jumped to all time highs causing the net payout yield to slump below acceptable levels. Also, the RSI exceeded the 70s suggesting the stock had hit overbought levels. The combination suggested that was an ideal time to sell. The stock currently trades in the $32 range which would've wiped out any benefits of holding a 4% dividend yielding stock.

Goldman Sachs (GS) was bought in early January with the proceeds from the Bristol Meyers sell. At a purchase price of $92.85, Goldman currently trades considerably higher at over $110. While Goldman currently only has a dividend yield slightly over 1%, a significant buyback program at the end of 2011 contributed to a net payout yield soaring to over 19%

Conclusion
Entering 2012, the market focus was clearly on dividend paying stocks such as Bristol Meyers without any fear of downside risk. Investors have so far learned the hard lesson that capital gains and losses can have much bigger impacts on total return. On the flip side, Goldman Sachs was a screaming buy with a much higher percentage of the market cap being returned to investors. Focusing only on the dividend yield would've left investors in Bristol Meyers and watching Goldman Sachs move higher. Focusing on the net payout yield, highlighted that Goldman was clearly the cheaper stock.

Investors continue to overlook quality stock buybacks due to the high profile failures of a few growth companies. This model remains happy to take advantage of those stocks overlooked by the market.



Disclosure: Long GS. Please review the disclaimer page for more details. 







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