Ryan Bushell

(Editor’s note: This piece was scheduled to run March 17h which marked the first day of the NCAA Basketball Tournament; however fate intervened when my son was born two weeks early.  The investment content remains relevant but the tournament has already begun)

It’s March and it’s my favourite time of the year.  The first bits of warm sun poke through after the cold winter, golf season is right around the corner, my birthday is on the 16th, and as the proud descendant of an Irish grandmother, March 17th marks a very special occasion… THE BEGINNING OF MARCH MADNESS.  You thought I was going to say St. Patrick’s Day didn’t you

For those of you who don’t know, March Madness refers to the single game elimination tournament played over 3 weekends beginning on or around St Patrick’s Day.  Every year the top 68 teams in US college basketball play a frantic single elimination tournament filled with amazing stories, thrilling comebacks, buzzer beaters and so much more.

In fact March Madness has become one of the largest gambling events of the year.  The American Gaming Association estimates that over 40 million Americans will fill out an estimated 70 million NCAA brackets this year and wager a staggering $9 billion dollars on the tournament.  For comparison, that is more than twice what is bet on the Super Bowl.  As a Canadian who fills out at least 5 brackets per year, I can assure you these estimates are conservative.  If you think I’m crazy, enter a pool with your friends, fill out a bracket randomly, cheer for every team you picked and I guarantee you that you will be hooked.  I extended this challenge to my roommate in University; he had a paper due on Monday March 25th 2002.  He handed that paper in late.

This brings me to my point.  If you’ve ever administered a pool like this you know that there are always one or two people who flake out and don’t pay you on time, leaving you to chase them down (awkward) or suffer a loss (downright annoying).  (If sports pools aren’t your thing, think instead of trying to arrange a group gift, it tends to work similarly) Usually the delinquent parties’ reasons for not paying have little to do with their financial ability; it’s more of a discipline and values thing.

In many ways, the stock market mirrors the people in your sports pool.  There are companies of all shapes and sizes with varying opportunities and abilities, but only certain companies concentrated in specific sectors have embraced the discipline to deliver a share of their profit on time every quarter in the form of a dividend.  It is our longstanding belief that once a company is profitable they should distribute a share of those profits back to their owners in the form of a dividend.  Why some profitable companies choose not to pay a significant dividend is anyone’s guess.  Accountants will tell you that retaining earnings is more efficient from a tax perspective and analysts will tell you a share buyback is a more efficient way to boost share price. Both these avenues leave the money in the company’s hands with a singular option to invest in their own business.  Leon Frazer has always believed that we are more efficient allocators of capital than the companies themselves because we can invest in any business we choose with those dividend proceeds, usually in a way that earns us even more dividend income down the road.  This is compounding, it’s an engine, dividends are the fuel, and it’s a reliable strategy in a market filled with broken promises.  It’s a discipline that has to extend from the business, to the investment manager to the ultimate owner – the client.

Don’t believe me?  Consider the following 10 year example capturing at least a full cycle:


Source: Thomson Reuters

As you can see from the above stock A did not pay a dividend through the 10 year period.  It had the best return to the cyclical high (~90% higher than the next best company) but ultimately ended up losing investors over half of their initial investment as at the end of 2014.  Stock D saw its share price decline by 91% for the 10 year period, a terrible result, but because of the consistent dividend paid over the ten years the total loss was only 10%.  Now let’s look at stocks B and C.  Both had terrific share price returns to the top of the cycle but gave back more than half of those gains by the end of 2014.  Current share prices for stocks B and C are roughly half what they were in July of 2008.  Stock B and C’s total returns however, did not suffer as the dividend paid more than offset the share price decline, allowing both companies to outperform the market and most of the other stocks in the table.  Stocks E,F,G and H all steadily moved higher in terms of share price and total return through the period but only Stock E outperformed Stocks B and C.

So what does this example show us?  First, it demonstrates the value of simply paying a dividend as all the dividend paying stocks (B-H) performed relatively well.  With the lone exception of Stock D all of these companies handily outperformed the Canadian market for the period, largely due to the dividends paid (shown by the difference between the price and total return columns in the table).  It shows that looking at your portfolio statement in terms of book value and market value only can be misguided because the greater picture includes earning, re-investment, and compounding of dividends, which represents a significant portion of total return.  The example shows the danger of relying solely on share price appreciation to fund long term total return goals and it shows that even when you have serious issues with a company (Stock D), the dividend cannot be clawed back from the shareholder’s account, mitigating a loss.

Ok time to end the mystery here is the complete list again, this time showing the companies represented above:

Source: Thomson Reuters

As you can see stocks B, C and D are energy stocks that, even when valued at the low point of the current cycle, have performed admirably over 10 years.  In fact both Crescent Point and Baytex outperformed both the market and most of our backbone companies despite the fact that their share prices are sitting on 5 year lows.  (Important to note that these two Canadian energy companies have also outperformed the S&P 500 in both Canadian and US dollars for the same time period despite the huge divergence in performance in the US recently) Penn West, a huge disappointment for us, does not even approach the pain felt by Blackberry investors.

If we go back to August 2014 the total returns for Baytex (453%) and Crescent Point (316%) and Penn West (12%) are significantly higher showing the potential for significantly higher returns at different points in the cycle.  Backbone stocks were steady for the period, as expected, with Enbridge standing out amongst the group as the only backbone company listed to outperform Baytex and Crescent Point.

The bottom line is that while share prices matter tremendously they are not the whole story.  Share prices are easy to quantify, both in terms of original cost and current market value.  Dividends are much more elusive because they are not totaled over the years in most investor’s accounts.  At Leon Frazer we go to great lengths to show our clients the dividend income earned every year for exactly this reason.  A significant portion of an investor’s total return (~50%) comes from dividends and is undoubtedly higher in Leon Frazer Portfolios.  Additionally, the tables above are conservative in that they show the dividends paid out and invested at short term risk free rates, while we typically reinvest dividends in additional equities.  This increases the total return generation potential of the portfolio as equities outperform cash returns on balance over time.  We tend to take additional risk in sectors that pay additional income to offset some of this risk and the example above helps to illustrate our position.  Individual stocks and even entire markets can put up fantastic returns for shorter periods of time that have little to do with dividends, but when you stretch your time horizon out to a minimum of 10 years, enduring a down market or two, our experience dictates that it is most prudent to stay friends with those who pay you on time.


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