• Introduction: The Decline in Dividends
  • A Simple Solution to a Complex Problem
  • A Financial Fort Knox
  • Conclusion
  • Exhibits

Introduction: The Decline in Dividends

As economies stumble in a manner not seen since the Great Financial Crisis articles on the collapse of dividend yields have exploded. A particularly informative article by the New York Times documented that historically dividends accounted for over 40% of the S&P’s returns but that dividend cuts would be severe due to the crisis. The paper also drew attention to the fact that investing in “…so-called Dividend Aristocrats”1 or in companies that pay larger dividends has proven to be a poor investment decision over the last 25 years.2

On the latter point Kailash finds this to be anything but surprising. In our pieces The Dividend Deception and its companion piece The Dividend Deception Part II, A Call for Active Management Kailash documented:

1. “Yield chasing” had inflated valuations of high-dividend firms to a level never seen before3
2. The top dividend paying firms in both the Large Cap and Small & Mid Cap spaces were not only at record valuations but also distributing record payments relative to cash-flows despite falling ROEs
3. Explicitly warned that the buying binge on simple high dividend yielding ETFs was a recipe for ruin and that active managers of dividend products had a ripe opportunity to outperform these simple ETFs

Since publication every single ETF product mentioned in the report has underperformed the S&P with some returning less than half the index. Adding insult to injury, these dividend products, often touted for their lowvolatility, underperformed the index in the crash from the peak on February 19, 2020.

With endemic dividend cuts and bond yields being pressed lower by monetary policy Kailash was recently challenged by a long-time partner to help locate firms we felt might prove to have durable dividends. While our past work was littered with detailed analysis around payout ratios, aggregate balance sheet scores and valuations, given the macro uncertainty, Kailash chose to take a straightforward approach to this request. This paper employs a set of historical information and a simple fundamental method of selection that could meaningfully improve the durability of payments compared to high-yield focused ETFs.

In our last paper, The Biggest Losers at the Peak we panned a group of catastrophic money losers while noting that firms with 5%-10% earnings yields, long operating histories and healthy balance sheets were prizes worth having. This paper takes that concept to an extreme. Our criteria to “make the cut” proved so severe that at the end of our intuitive analysis the list comprised only 5 qualifying firms in the S&P500 Universe and a meagre 3 in the Small & Mid Cap Universe.

This is not to say that we believe these are the only companies that can or will maintain their dividends. Rather these are firms that passed some very high historic and current hurdles that points to them being possible gems for income-oriented investors. The last exhibit in the paper uses somewhat relaxed criteria to provide investors searching for durable yield potentially excellent candidates.

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.

Disclaimer

The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

May 24, 2020 |

Categories: White Papers

May 24, 2020

Categories: White Papers

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