The Dividend Cafe - A Dividend Growth Mentality

Episode Date: July 14, 2023

Today's Post - https://bahnsen.co/3JYQSbA I am writing this week’s Dividend Cafe from Reagan International Airport in Washington DC. I recorded the video and podcast from my hotel room last night. I am soon departing for Memphis, TN where I am speaking at a conference Friday and Saturday before returning to New York. I was in DC to speak to a very large group of college students at George Mason University on free market economics. I had taken the train in to DC yesterday from New York after my flight to DC on Wednesday got cancelled just minutes after speaking to a symposium in south Orange County on the ESG investing movement (you can guess what perspective I brought to the subject). I made it to that conference after having a flight from New York Monday sit on the tarmac for four hours waiting for fuel. So from New York to California back to New York to Washington DC to Memphis then back to New York again, all in six days. It’s been a week. In the meantime, I scrapped plans for a Dividend Cafe on plans for the American supply chain and what those changes may mean for the American economy, and instead have elected to do a refresher on dividend growth. I plan to do a “dividend growth” focused Dividend Cafe once a quarter, and this seemed like a pretty good day to do it. Not to brag or anything, but I can write a Dividend Cafe about dividend growth quite intuitively (which I guess bragging about that would be like bragging about one’s speech and debate achievements in high school to the football team, which I will just anecdotally mention is not as cool a thing to do as it may sound). Dividend growth is, after all, the very end to which we work. Links mentioned in this episode: TheDCToday.com DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to this week's Dividend Cafe. I am recording from Washington, D.C., our nation's capital, where it is beautiful but absolutely oppressively hot. I guess it's oppressively a lot of things sometimes, but it but absolutely oppressively hot. I guess it's oppressively a lot of things sometimes, but it's mostly oppressively hot. And I am pivoting a little bit in my plan for Dividend Cafe today. And I don't mind at all. I'm pretty candid with those

of you who watch, read, and listen. I had intended to write a Dividend Cafe this week covering the subject of reshoring, on-shoring, near-shoring, basically various changes in the kind of global effort of manufacturing that there is so an economic impact to some of the winds blowing in a different direction in the way that the United States approaches its manufacturing needs in the years ahead, what that impact may look like, where capital expenditures may go. There's a lot of study I've been doing there, and I had intended to make that the subject of this week's Dividend Cafe. And the reason that I'm not is because through a whole lot of travel back and forth this week and speeches and a lot of market stuff going on and meetings and things, I wasn't able to give that topic the attention I want to do.

So I want to hold it and do it right at a different week. And in the meantime, I've been asked repeatedly, and I mean by people who have been clients for 20 years and people who have been clients for 20 days and everything in between, that I do more work in the Dividend Cafe reaffirming, reiterating, reminding, restating our tenets of dividend growth investing, which of course is what the Dividend Cafe was created for. I think that what happens is I take it for granted over time because I live in it, bathe in it, sleep in it all day, every day, that we are constantly in a mode of analyzing dividend growth, writing about,, thinking about talking to management,

reviewing company results. Our investment committee is meeting and talking and typing and dialoguing so frequently that we never kind of get out of the mindset of dividend growth. And yet when Dividend Cafe becomes so macroeconomic, sometimes the major investment philosophy that people have as clients of Bonson Group, I might accidentally ignore it. use Dividend Cafe to just simply re-fortify our commitments to dividend growth and kind of reassess the rationale that we have applied to the way that we believe in managing client money. And so it may be redundant for some of you. Some of you may know all this already. Some of you may have it memorized. I can assure you I certainly do. But I think that it's very helpful to have it reintroduced from time to time. And so I'm going to do that.

And today is a good week for us to kind of kick that off with. We made this commitment, by the way. Our investment committee had met over a month ago and said, let's start doing this on a quarterly basis, use Dividend Cafe to re-discuss the dividend growth investment mindset several times a year. And I'm just deciding to do it now this week because of the logistical things I brought up earlier. One of the things I want to say that I don't think I have said it this way before is a lot of dividend growth investing is a mindset. From the vantage point of the investor, the person who owns the investment strategy, our vantage point as the one implementing the strategy is to find companies that are paying a dividend yield that is within

our criteria and has the ability to grow that dividend over time in an attractive and sustainable way. The vantage point of the investor is a little different in this sense. Learning to evaluate your portfolio on the basis of the level of income growth that is generated. advantage from it because the reinvestment means compounding and compounding is always a mathematically beneficial thing, of course, unless you're negatively compounding. But when you're compounding, buying more shares of something, over time, this is adding an awful lot of offense to the portfolio. But even investors who are not compounding their dividends, because they were drawing them in the form of income, that's how they're monetizing, living off of the portfolio to some degree. Even then, the kind of standard you're using to look at the portfolio is different. It's a different psychology.

And I think that can be very, very rewarding. It is a focus on something that you could say, why do I care what the dividends are doing as opposed to the prices of the underlying shares? And this is where a significant sleight of hand has been perpetrated on people in the investing public that has done grave damage to a lot of investors. And caused many during bear markets to give back years, sometimes a decade of returns. Also caused many to abandon an investment philosophy because of the violence that they could be subjected to. And what I'm referring to is the belief that all that matters is price movement as opposed to the things that are supposed to create price movement. So why should an investor care what is pushing their prices higher?

Well, the answer, of course, is the difference between a sustainable investment result and one that isn't. If you're not getting free cash flow growth, if you're not getting earnings growth, if you're not getting dividend growth, if you're just simply seeing prices go higher because of multiple expansion. simply seeing prices go higher because of multiple expansion. The problem is that your results that feel good can only benefit you if you sell at the right time. You become a very timing-oriented investor, both at an entry point and an exit point. But when prices are either lagging or staying flat or going higher. But regardless, the underlying dividend growth is still continuing to go in the direction we want. Then it's only a matter of when, not if. An investment that has organic internal growth of its cash flow generation through time, that investment becomes more valuable. And a logical rebut could be, well, how do you know? What would make a stock go higher

just because the dividend is going higher over time? And first of all, I think the answer is somewhat intuitive and obvious, but we can pretend it's not. And I could answer the question with another question. If you owned an apartment building and your rents were going up every year, how long can it be until the value of the apartments themselves go higher? Now, I would argue that it's real time, that they are a function. Literally, we actually use terms like a cap rate, that we look at net operating income, that when we do a valuation appraisal, we're actually looking at discounting the cash flows of what rental real estate generates.

And there is no reason we ought not do that with equities as well. We value bonds off of the cash flow they generate relative to an interest rate environment, and we value real estate off the income it generates relative to an interest rate environment. And I have no reason to believe that we ought not do the same with equities. But the difference, of course, is mark-to-market pricing and real-time pricing and the heavy degree of liquidity that public equity markets provide. It's constantly giving people the distraction of a real-time sale price, a sale price that could be at any point in time not nearly stating the value of the company or overstating the value because of sentiment and momentum and bubbles and panic and all sides of the human equation. Dividend growth investing is essentially a very conscious attempt to be removed from

all of that stuff. It is to say, over time, there's going to be investments out there that are overpriced and underpriced, by the way, including dividend growth stocks. It's just we happen to think it happens much less frequently and less severely in that space for a lot of obvious reasons. But most equities are going to have periods of being overpriced, underpriced. They're going to have noise around them. And we don't have any confidence in our ability to discern that noise by timing entry points, exit points, gauging what public sentiment is, and essentially becoming more speculative in buying and selling of equities for metrics that are totally out of our control.

Because we don't have confidence in our ability to do it, because we don't have confidence our ability to do it because we don't have confidence anyone else's ability to do it we choose to look to something more fundamental and intrinsic to real value assessment which is the actual profits the company is paying you it's not just more tangible it is the tangible item that is what we invest for is to receive cash from investments. And to the extent that some people try to skip a step and get into what, how people are pricing those future cash flows today and, and how people are speculating on, on all of those things, you, you add a whole nother dimension of not only severe fallibility, but generally, you set the table for what will eventually be a really significant destruction of capital. And I think that with dividend growth investing, you accept that you'll be outside of some of the

chasing in different periods of time. and you will align yourself with something that is more fundamentally definable and nevertheless still quite profitable. Now, it is laborious. It takes a lot of work. It's subject to fallibility too in the sense that some companies could change their thesis, certain things could go wrong, but over time, a research-intensive process that truly both quantitatively and qualitatively looks to dividend growth sustainability at both entry point and ongoing can generate wonderful results. Now, the argument that I made when I wrote the book, Case for Dividend Growth Investing, I talked about the benefits of compounding that I spoke to a moment ago, that you're just actually really generating a lot of return because you're receiving real cash'm making up a number, but the S&P was up 9% and you were getting half of it from dividends and half from price appreciation. The half that's in dividends is not ever volatile below 0%. They don't ever charge you to own the stock. The part that is volatile around price appreciation, it goes severely negative and severely positive.

And so that enhances the volatility. Ergo, the portion of the return you're getting from dividend growth, from dividends versus price appreciation is inherently less volatile. It has no ability to go below 0%. So all things being equal, if one's getting 9%, where half's from dividend and half's from price, and one's getting 9%, the same return, where let's call it 8% or 7% is from dividends, and one or two, excuse me, eight or seven or eight is from price appreciation, and one or two is from dividends, then that result, even if the math is the same as the other, that second result is much more volatile because a much larger portion of the return is subject to the up and down movements that can include negative price. And that's just what it

is. You could say there's nothing wrong with that, but for most investors, they do desire a little bit less volatile of a ride. Now, of course, that equation breaks down if the trade-off was, okay, you're getting less volatile, but you're only going to get five or six where you could get eight or nine and have more volatility. These numbers are illustrative here. I happen to think I'm using numbers that are pretty close to real life, but they're not intended to be literal. They're intended to make the point. I think plenty of people would say, I'd rather have more volatility in nine than less volatility in five. The argument though, the dividend growth investors get to make is guess what? Over time, you don't have to make that trade. In fact, as I pointed out more recently in one of our communiques, the dividend growers of the S&P have substantially outperformed the total S&P since the year 2000. You're talking

about 23 years with huge bear markets, huge bull markets, flat years, all the ups and downs of what market cycles, multiple market cycles entail. And yet the returns have actually been much higher with lower volatility for the reasons I just stated. So there is a whole portfolio, no pun intended, of reasoning behind dividend growth. Focusing on that which can be controlled, focusing on something that's more aligned fundamentals and less emotional, sentimental, popular, and dependent upon the behavior of the crowd. And then I would argue more aligned with management, that management is trying to perform in such a way that they can meet the needs of dividend growth expectations,

doing things that could severely disrupt free cash flow, doing things that could over-lever the company and jeopardize their ability to continue paying the dividend. It's not perfect. There have been dividend growing companies over the years that management made key mistakes or that bad things just happened to the company, litigation or regulatory or cyclical things. But as a general rule of thumb, the probabilities of maintaining a business model that avoids severe risk, tail risk, existential risk to the company, and also that just simply keeps management from doing things that are outside the interest of shareholders. Vanity projects, really wasteful spending, things like that. Excessive leverage is the best example. So you don't get a hall pass from fallibility with dividend growth,

but you do get a better alignment of interest. You quite significantly increase the odds of the alignment that you would want as an investor with the management that you have left the stewardship of some of your capital to. So I think that these main principles right now are front and center in the case for dividend growth. The macroeconomic story is one I make all the time. I think we're in a sustained period of Japanification where I expect low, slow, and no growth in the United States. One of those three. Vacillating between low growth and no growth is not a great environment to believe that you will get easy index returns, easy multiple expansion. Japanification puts downward pressure on interest rates that once you get to downward pressure,

if you go over a 20-year period of a 10-year bond yield coming down to 2%, over a 20-year period of a 10-year bond yield coming down to 2%, you get a lot of multiple expansion over the way, and it's sustainable. But if you get into a violent case where yields have downward pressure because of lower growth expectations, which is my thesis about the American economy, about any overly indebted developed economy, then I think you lose the ability to get sustainable, prolonged, multiple expansion. You just subject yourself to booms and busts. And dividend growth is trying to immunize you from the boom and bust, the violence of a boom

and bust cycle. Not from up and down price movements, but from having the entirety of your investment thesis dependent on catching a boom and then selling before a bust. I don't know anyone that does it. Oh, that's not true. I know plenty of people say they do it. I don't know anyone that really does it that will give me the confirms to prove it of the entire portfolio. I've talked about this before. That's fine. I mean, that's human nature. People lie about things all the time. A lot of times they lie to themselves too. And that's another issue I get to deal with. And it's, it's, is what it is. With dividend growth, you really don't have to worry about this stuff. You, you are looking for things that look, um,

can very much surprise you. Uh, there can be upside surprises. There can be downside surprises too. But I believe fundamentally that the risk reward trade-off, the volatility, the fundamentals, the alignment, the enhanced quality of business, the removal of some of those crazy tail risks by being in a less levered environment, all of these things speak to tremendous fundamental value in the pursuit of dividend growth. And that's what we've dedicated our business to, our investment philosophy. It's what I've dedicated my adult life to in a lot of ways, is working within capital markets that I love, that are themselves part of a free enterprise system that I love. And that within that, I'm trying to find fundamental

cashflow growth from these exciting American enterprises, all something I love, both the process and the actual underlying product. And then to do all this to generate results and create solutions for clients who have real needs. I think this entire thing is very, very exciting. And I hope that gives you a little glimpse into the mentality we bring to the table. So reach out with any questions, any time. questions at thebonsongroup.com. That's our thesis for dividend growth today, and I do appreciate you bearing with me if this is redundant for you, but maybe you picked up a couple of new things here today. So thank you for listening, watching, and reading The Dividend Cafe. Enjoy your weekends.

We'll be back at you next week. Take care. Thank you. be suitable for all investors. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no express or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice. This document was created for informational

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