Conventional Wisdom
October 6, 2023
Zach’s Facts & Figures | Conventional Wisdom
A generally accepted theory or belief.
"Conventional wisdom has it that a book shouldnever be judged by its cover"
Who has not heard the above repeated belief? There are some great
books that may not have attention grabbing titles or covers, while
plenty of flashy books turn out to be terrible reads.
In the stock market, we also shouldn’t judge a company by ‘its cover’. While some widely held beliefs are well-deserved – both positive and negative – we need to think back to first principles to understand the fundamental reasons for this. For example, a CEO or management team that’s ‘well- known’ as a strong capital allocator will attract a premium multiple. Conversely, a management team that does not have a favorable reputation could result in a company trading at a discount to its peers. There are many other factors that go into valuing a company, but whether a management team creates value or not, does carry some weight with investors.
A conventional thought coming into 2023 was to avoid technology stocks which, as the theory goes, see multiple compression in a rising rate environment. Meanwhile, dividend stocks were considered a relatively safe shelter, especially with companies that had exhibited a pattern of dividend growth.
However, that has not played out in 2023 as tech stocks have had a strong recovery, despite bond yields increasing much further than many expected. This has also provided an opportunity for investors to welcome the return of income in instruments such as Money Market Funds, Guaranteed Investment Certificates (GIC’s) and short-term corporate bonds. These now offer competitive yields compared to dividend stocks, with the added benefit of lower short-term volatility.
This has resulted in dividend stocks that previously traded at a 4-5% yield now trade at 6-7% yields, and in some cases even higher. While this may seem like a positive for investors, that is hardly the case. This increase in yield has come largely as a result of share price depreciation. (Yield is calculated as dividend divided by share price) as funds flow out of dividend names to fixed income instruments like those mentioned above.
Conventional wisdom can also create investment opportunities when those beliefs are offside with where a company is trading. One of those general, widely held investor beliefs being tested this year is having a large allocation to dividend stocks. For dividend stocks, the income plays a big part of a company’s total return (Total Return = Share Appreciation + Income).
Companies generally pay dividends monthly or quarterly as a way of encouraging investors to ‘think long term’. For example, if a company has a 5% dividend yield, an investor needs to hold those shares for a full year to receive the benefit of a full year’s dividends. Some companies will even pay a special dividend as a one-time payment if there is an expected increase in cash flow and management believes it is the best use of capital to pay that out to shareholders. There are no short cuts to being a dividend investor, it takes patience and time in the market.
Additionally, dividend growth is a strong component of an investor’s return. A company should be growing its earnings and then passing along some of those gains to their shareholders. Companies that are growing at a faster rate, will tend to have a lower yield but larger dividend increases than larger companies that are more mature.
Just like how last year’s selloff in technology and growth stocks turned out to be a great time to add or just hold, will we look back in a year’s time and see a recovery among dividend stocks? For patient shareholders often avoiding the emotional investment decisions is the best decision. As many selloffs have showed, investors patience is often rewarded once the storm passes, which it always does.
