‘Coupon-clipping’ value funds By Colum McKinley | Tuesday, April 26, 2011
Value managers are well known for seeking mispriced assets, but the importance of reinvested, compounding dividends is sometimes overlooked. For the CIBC Canadian Equity Value Fund and the Renaissance Canadian Core Value Fund, we seek out opportunities with the best total return potential. That total return includes both the capital appreciation in the stock price and the accumulated dividends from what has become the new way of clipping coupons. In their own way, embedded in dividend-paying stocks are similar bond-like qualities, which is one of the attributes that makes them so attractive to us as value investors. Quarter after quarter our funds receive regular cash payments – almost certain cash flow. Typically, dividend-paying companies are larger, well-established, stable companies with strong cash flow and no excessive debt. These are also the kind of companies we like to invest in when they reflect value characteristics. Dividend-paying stocks offer a solid foundation for an investment portfolio. You receive a steady stream of income while your investment has the potential to increase in value. The yield of the stock can serve as a safety net beneath your wealth.
Over the long term, history shows us that the benefits of compounding and reinvesting dividends results in outperformance over simple capital appreciation. In fact, as outlined in the chart below, we calculate that two thirds of an investor’s return over the past 50 years has come from reinvested dividends. But while dividends are important, owning the shares of companies that can grow dividends over time holds even more significance. Since 1986, dividend growers have generated a compound annual return of 12.4%, and dividend payers have delivered 10.6%, compared with the 7.1% return from S&P/TSX Composite Index.
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For a business to consistently pay higher and higher dividends, it must be successfully executing a strategy that generates stronger sales, earnings, and free cash flow to generate the excess capital to return to shareholders. While it might be tempting to buy stocks simply on the size of the yield, we focus instead on dividend growth potential and on companies that do not may out too large a percentage of their profits. Companies that have to stretch to deliver dividends can disappoint. Identifying Canadian companies that have a legacy of sustaining and growing dividends is very important. A key role of the analyst team at CIBC Global Asset Management is to use indepth fundamental analysis in order to identify those businesses. The longevity of the dividend and the health of the share price depend on the soundness of the business and its prospects for the future. As such, dividend-paying stocks can be less vulnerable to rising interest rates than other income-generating investments. Dividends can increase as company earnings grow, while the interest payments from most other investments stay static. However, dividend-paying stocks can, of course, also lose their lustre and value. We continue to seek out opportunities to buy strong businesses when their stock prices do not reflect their true long-term value. Both the Renaissance Core Value Fund and the CIBC Canadian Equity Value Fund represent a collection of businesses that in aggregate offer a higher yield than the overall market. Dividends represent the bird-in-hand of investing and contribute meaningfully to performance over an investment cycle. Our funds recently added to their positions in Mullen Group Ltd. (TSX: MTL), a trucking and logistics company that mostly serves the Canadian oilfield sector. Mullen’s revenue split is 63% oilfield services and 37% trucking. The company will benefit from robust drilling activity in Western Canada as well as from improving fundamentals in its trucking and less-than-truckload business. The company has consistently improved its earnings and cash flows, enabling it to return capital to investors through dividends. In fact, it recently doubled its expected dividend. The stock currently pays a dividend of $1.00, implying a yield of 4.7%. The company’s management expects that future growth will enable the dividend to move even higher over time. The importance that CIBC Global Asset Management value funds place on dividends can be witnessed through its holdings. As of March 31, 2011, the weighted average yield of the Renaissance Core Value Fund was 2.5%, approximately 9% higher than the S&P/TSX Composite. In addition, 38 of the 41 holdings pay a dividend. The table below shows the highest yielding stocks in the portfolio and their corresponding dividend yield at the end of the first quarter of 2011. Company BCE Inc.
Yield (as at March 31, 2011) 5.50%
AltaGas Ltd.
5.09%
Mullen Transport Ltd.
4.70%
Sun Life Financial Inc.
4.70%
Power Financial Corp.
4.50%
Telus Corp.
4.50%
Bank of Montreal
4.40%
TransCanada Pipelines Ltd.
4.30%
IGM Financial Inc.
4.20%
TMX Group Inc.
4.20%
Husky Energy Inc.
4.10%
Canadian Imperial Bank of Commerce
4.10%
Corus Entertainment Inc.
3.70%
Bank of Nova Scotia
3.50%
Royal Bank of Canada
3.30%
Toronto-Dominion Bank
3.10%
Manulife Financial Corp.
3.00%
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In addition, many of the holdings have historically delivered consistent dividend growth. With successful implementation of their strategies, we believe BCE Inc., Telus Corp., and the Canadian banks will deliver further dividend growth, benefitting the fund from expected higher dividends in addition to the potential growth in the underlying business. Over the long term, compounding and reinvesting dividends contributes to wealth creation. CIBC’s value funds continue to place a focus on maintaining an above-average dividend yield. The combination of disciplined value investing, buying attractive businesses when they are temporarily unloved, and consistent cash flow from dividends will contribute to consistent investment results over an investment cycle.
Colum McKinley, CFA is vice president of Canadian equities at CIBC Global Asset Management and is the manager of the CIBC Canadian Equity Value Fund and the Renaissance Canadian Core Value Fund.
Notes and Disclaimer The views expressed in this article are the personal views of the author and should not be taken as the views of CIBC Global Asset Management Inc., Canadian Imperial Bank of Commerce (CIBC), or Fund Library. This document is provided for general informational purposes only and does not constitute investment advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisors. The information contained in this document has been obtained from sources believed to be reliable and is believed to be accurate at the time of publishing, but we do not represent that it is accurate or complete and it should not be relied upon as such. All opinions and estimates expressed in this document are as of the date of publication unless otherwise indicated, and are subject to change. Š 2011 CIBC Global Asset Management Inc. operates under the brand name of CIBC Asset Management and is a member of the CIBC Group of Companies.
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