This model was down 0.5% in July versus a 1.3% gain for the benchmark S&P 500. Oddly the model has fluctuated a lot in recent months with large cap stocks in the model moving up or down 10% on earnings reports. While typical of smaller companies this usually doesn’t happen in companies with market caps exceeding $10B.
As mentioned previously, one goal of this model is to slowly trim the amount of positions back closer to 20 after reaching 26 due to mergers and partial positions. Hence, the model sold the remaining holdings in Home Depot (HD) and added to existing small positions in Hartford Financial (HIG) and WellPoint (WLP).
Home Depot was unloaded as the stock finished a long run from October last year where the stock went from just over $30 to the selling price over $51. This considerable gain pushed the Net Payout Yield (NPY) down as the company dropped buybacks. Not to mention that competitor Lowes (LOW) remains a Top 5 holding.
The two purchases were of stocks with small positions in the model that needed to be added to or sold to reach the goal of reduced amount of holdings.
WellPoint consistently ranks in the top of any NPY reports with yields typically exceeding 15% and sometimes approaching 20%. Though the stock was added to in the low $60s after it plunged based on the Obamacare ruling, the timing was still off as it plunged even further to the lower $50s following a weak earnings report.
Hartford has been equally weak as well. The property and life insurance provider trades at roughly 35% of book value providing a unique opportunity as every buyback adds to book value.
These trades further highlight the benefits of a model that sells stocks after big runs and buys stocks after significant declines.
With a decent market in July, this model underperformed for two primary reasons: Lowes and WellPoint. Both companies had disappointing earnings outlooks that sent the stocks down considerably. Odd for large cap stocks with market caps both over $18B, but conversely each company has a buyback and strong balance sheets that will benefit from the stock price drops.
As mentioned above, WellPoint was particularly weak again following a disappointing earnings report for Q2 2012. This occurred after the weak June following the Supreme Court ruling upholding Obamacare. The stock fell over $10 during the month to end at $53.29. On top of that the stock was near $73 in the middle of June. Per the earnings report, the company expects to utilize $1.5B in the 2H of the year on repurchases and dividends. An incredible 8% return of capital to shareholders for a 6 month period.
Lowes dropped more than 10% in August as analysts continue to reduce analyst estimates for 2012 and 2013. The company is the 2nd largest home retailer behind Home Depot. It currently has an 11% NPY focused primarily on buybacks.
Several stocks in the model had a good month with retailers Gap (GPS) and Kohls (KSS) having the best months. In fact, the majority of stocks had positive returns for July, but with no stocks having outsized gains the losses from WellPoint and Lowes swamped the gains.
Dividends versus Buybacks
With a market hungry for yield, it has become increasing popular to own dividend paying stocks. Even to the point where dividend yields for certain sectors have been pushed down to multi year lows. With Treasury yields at all time lows, dividend stocks might not be in bubble territory yet though investors need to be careful.
This is where the concept of the NPY pays dividends (no pun intended). An investor isn’t restricted to either the dividend or buyback discipline like most funds that focus on these concepts. As dividends become more popular, those stocks gain and push yields down automatically forcing this model into more buyback stocks. In essence, the cheap and ignored stocks rise to the top of the list.
So while investors are busy chasing the 4.5% dividend yields on AT&T (T) and Verizon (VZ), this model is chasing the 20% yields on ConocoPhillips (COP), Kohls, and Goldman Sachs (GS). Or grabbing similar dividends on Lorillard (LO) and Lockheed Martin (LMT) while also obtaining 8-10% buybacks. Signs that the latter stocks are much cheaper than the wireless giants loved by the markets. See our article on the subject here.
As speculated in the last couple of reports, as each day passes the market gets more and more comfortable with the ability to avoid a major financial collapse in Europe. As the market tires of the relentless headline risk that never comes to fruition, investors have been slowly moving out of cash into dividend stocks.
The main risk for domestic markets and stocks remains the fiscal cliff and pending election. Any inability to keep the markets calm regarding fiscal and tax issues in the US could lead to healthy losses. The most at risk stocks could be those of high dividend payers that have had an exceptional 19 month run. These stocks might face the headwinds of higher tax rates that pushed them down at the end of 2010.
Regardless of the markets, the average stock in this model yields greater than 10% with the majority of yields coming from buybacks. This provides huge support if the market turns weak again.
Disclosure: Long all positions mentioned. Please review the disclaimer page for more details.