Category Archives: Dividends

what makes casino stocks interesting investments

October 25, 2012 By in Casinos, Dividends, Entertainment, Industry Analysis, Recent Market Action, Stock ideas Tags: , , , , , , , , , , Leave a comment

I started covering casino stocks as a securities analyst around 1980.  At that time, Atlantic City was still the hot, fast-growing market that investors focused on, although the bloom there was already coming off the rose.  Las Vegas was a backwater.  Neither Singaporean nor Australian casinos existed (legal ones, anyway).  Macau, then a Portuguese colony, was a Ho-family monopoly.

In those days, casino operators basically gave away food, hotel rooms and entertainment.  Non-gaming operations were cost centers, existing solely to induce customers to visit the gaming floors.  That situation has changed dramatically over the years.  In pre-Great Recession Las Vegas, which is the gold standard for today’s global gaming industry, non-gambling operations had risen to equal importance–and profitability–with the gaming floors.

It’s not so much that I find the gambling activities themselves so interesting.  As a professional portfolio manager, they used to remind me a lot of work–but with substantially diminished chances of making money.

Instead, what attracted me to casino stocks as an investor–and still does– is that:

–casinos are very cash generative once they’re up and running, and

–they’re relatively simple to analyze.

Under most circumstances, growth in gambling revenue is a direct function of two variables.  They are:  the increase in nominal GDP of the area where target customers live; and any increase in casino floor space.  So gains in gambling earnings are highly predictable.   Resort profits aren’t as easy to project, but they’re not much more difficult, either.

One caveat:  like many commercial property-based businesses, expansion of Las Vegas-style casinos only comes in $1 billion-plus increments.  So the gaming industry can be subject to periodic bouts of overcapacity, when, after a run of profitable years, everybody in a certain area decides to make a major expansion at the same time.  Think of the current situation in Las Vegas–although that’s by far the worst overcapacity I’ve ever seen.

Funnily enough, it’s precisely the disastrous last-decade expansion in Las Vegas and the current slowdown of gambling in Macau, where the Big Three of American casinos (Wynn, Sands and MGM) all have operations, that make WYNN and LVS attractive.  (As regular readers will be aware, I’m not a fan of MGM.)

Why?  The companies are generating tons of cash and they have no place to plow it back in to new casinos.

In the case of LVS, this means it’s repaying borrowings much faster than I think the consensus realizes.  As for WYNN, the company has just announced a special dividend of $7 a share.  It’s increasing the regular quarterly payout as well, from $.50 to $1.  This means the shares have a prospective yield of  3.4%.

More on WYNN tomorrow.

 

watch the currencies!–what they’re saying now

September 13, 2012 By in currency effects, Current Market Thoughts, Dividends, economics, Keeping Score, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , , , , Leave a comment

three key pieces of data for investors

Over the last several weeks, two pieces of information have emerged that have potentially great importance for equity investors.  A third may develop from the US Federal Reserve today.

They are:

1.  the Case-Schiller index, which is very influential in the US, despite being a lagging (also called confirming) indicator of the state of the housing market, has finally signalled that overall residential prices have bottomed and are on the mend.  The five-year slump is over.

Although I think the revival of the housing market gives a second wind to the domestic economic expansion, in the counter-intuitive way Wall Street works, it also has a darker side.  Other than Washington suddenly starting to do its fiscal policy job, which would be a huge positive surprise, it’s hard for me to see what new positive market-moving economic development could happen in the US over the coming months.

2.  The European Central Bank has announced a broad support plan for the bond markets of the weaker members of the Eurozone.  Yesterday, the German high court rejected litigants’ assertions that the German government was barred by that country’s constitution from participating in the plan.  Germany is slated to provide over 25% of the financing of the Eurozone rescue plan, so this decision was crucial.

The implication is that EU economies will be stronger over the coming year or so rather than weaker.

3.  The Fed may announce further unconventional measures today to support the US economy.  The Fed has repeatedly said that fiscal policy would be a much more effective engine to spur growth, but apparently sees about the same chance as I do of that happening.

Two measures are possible.  One is additional bond buying, intended to flatten the yield curve.  The second is a commitment to hold short-term interest rates at today’s emergency low levels for the next three years.  Yikes!  Three more years of nearly no income from CDs and money market funds?

I think the second would  have the more significant effect for Wall Street.  It would give two contrary signals:  it would say that there’s no need to flee the bond market anytime soon; and it would imply that the only liquid investment that will provide significant income for savers any time soon is the stock market.

three places to see their effects 

1.  the performance of general stock markets in their local currencies.

The S&P 500 is up 9% over the past three months.  I think the recovery of house prices, which is the major source of wealth for most Americans, is the main reason.  EU growth should also have a positive rub-off effect on US firms involved in foreign trade, as well as the many S&P firms with substantial operations in Europe.

The Eurostoxx 50 is up 19% over the same span.  Broader indices are up in the mid-teens.  Most of the outperformance of the S&P has come in the past month, when Eurozone rescue plans have been publicized. Dollar-based returns on the EU indices are much larger.

2.  You can also changes in the lists of sectoral winners and losers, as I’ve written about on the Keeping Score page on PSI.   Generally, the US investor has shifted away from defensive sectors toward IT and Consumer Discretionary, two moderately bullish areas, while not to sectors like Materials that would benefit from a strong general economic upsurge.

3.  Most US investors generally ignore the third area–currency movements.  I think it’s certainly true this time.  But from mid-July until now, the € has risen from a value of $1.20 each to $1.29, or 7%.  True, the ¥ has been rising since March, when holder had to pay 84 to get $1.  But it has also recently risen above the 78 level that the Tokyo government had been trying to defend.

To my mind, the Japanese economy still has nothing much going for it.  Seeing that currency rise at all–which normally happens only in a healthy country–really says something.

the message?

If we add a currency gain of 7% to, say, a 14% rise in European stocks, the total return to an American investor in the past month is more than 20%.  If we have indeed made a major turn in the EU, the party is far from over, in my judgment.

Many European stocks still have strikingly high dividend yields–certainly a temptation to income-oriented investors but also a warning of potential risk.

I’ve been advocating having a severe underweight in the EU, with exposure only to companies listed there but with significant operations elsewhere.  I haven’t made any changes yet, but I’ve got to at least reconsider my position.

Conversely, US-listed companies with large businesses in the EU may not be having great local currency sales at the moment, but they’re enjoying a big boost in dollar terms.

The rise in the ¥ tells me that at least a part of what is happening is not foreign currency strength.  It’s dollar weakness.  That may be because of continuing fiscal policy failure here, or just the perception that all the potential good news is already out.

The much greater € strength suggests that real economic improvement is expected in the EU.  I’m still mostly convinced that Greece will be forced out of the Eurozone (and the EU).  But markets may not be willing to wait for this final shoe to drop.

To sum up:  we may be in the early stages of a significant shift in the attitude of global equity portfolio managers about where they want to place their clients’ money.  If so, I think the clearest sign is coming from the currency markets–it’s mildly against the US, strongly for the EU.

Return on equity (III): a tax-efficient split up

August 17, 2012 By in Dividends, double taxation, from growth to value: the life cycle, return on equity Tags: , , , , , , , , Leave a comment

double taxation of dividends
In the US, and most often, elsewhere, dividend payments to shareholders must be made from income on which domestic taxes have already been paid. Recipients pay income tax again on any dividend income they receive.
(In contrast, the IRS regards interest payments on bonds as an expense. So these payments are made from pre-tax income, and serve to lower the firm’s tax bill. No wonder some companies leverage themselves too much.)
For a mature, low growth, business that throws off cash and doesn’t have many good ways to reinvest the money, stock buy backs and dividend payments are the two common methods of returning these funds to shareholders. Personally, I think stock buy backs are almost always a scam. At the very least, they’re not a very dependable source of funds for income oriented investors. And double taxation means that a sizable chunk of the money available for distribution–just over a third, in the US–is lost to the taxman.
There has to be a better way!
For many firms, there is. It’s called a Real Estate Investment Trust ( REIT), and it’s becoming an increasingly popular corporate solution to the mature business problem.
Briefly, a REIT is a special form of corporation, somewhat akin to a mutual fund. It accepts restrictions on the kinds of activity it can take part in, and agrees to distribute virtually all the income it generates to shareholders. In return, it is exempt from corporate income tax.
Details on Monday.

dividend-paying stocks in the US (II)

July 18, 2012 By in Constructing a Portfolio, Current Market Thoughts, Dividends, Portfolio management, Strategy Tags: , , , , , , , , , Leave a comment

the income investor’s decision–maximize current income or maximize total return

Suppose an investor can choose between two stocks:

–stock #1 has a current dividend yield of 5%, but no prospects of either earnings or dividend growth

–stock #2 has a current dividend yield of 3%, and will likely grow both earnings and dividends by 10% per year.

Let’s assume that we’re in a world where we can make long-term predictions like this with a very high degree of confidence, and that neither stock has any special risks associated with it.  Yes, these are unrealistic assumptions, but I want to make a point about the expected income stream.

Which do you choose?  In this case, investor preferences are the key.

the income stock

Someone who wants to maximize current income would probably choose the stock with the higher yield.

Why?

Figure out how long it will take for stock #2 to grow its dividend until it matches the current yield of #1.  The answer is seven years.  How long will it take for the holder of #2 to receive the same amount of current income as he would by holding #1?  Eleven years.  Eleven years to breakeven by choosing stock #2 is too long to wait, in my view.

the total return stock

Suppose our investor makes his choice today and that each stock is trading at $100 a share.

Over the next seven years, stock #1 will pay out $35 in dividends and #2 will pay out $28.40.  The difference is $6.60.  However, the earnings for company #1 will be the same as they are today, while those of #2 will have doubled.  By year 11, when the cumulative dividend payments of the two will be equal, the earnings of #2 will be almost 3x the starting level.

For the total return of #2 to exceed that of #1, all that’s necessary is that the huge increase in its earnings generate a rise of 6% in its stock price over that of #1.  In the US stock market, if events play out according to our assumptions, that’s as close to a sure thing as ever happens.

That’s not an iron-clad guarantee, however.  Just as important, it’s also not clear when any relative price gains will happen. That’s not such a good thing if you need the money by a certain date.

the point being…

…if you’re interested solely in income, it takes an awfully long time for a fast grower to overcome the influence of the starting point of its higher-yielding rival.

don’t forget about portfolios!

There’s no law that says that anyone has to make the all-or-nothing choice I’ve outlined above.  You could consider buying some of each and hedging your bets.  Of course, any diversification will mean lower current income for a period of time.

back to the real world: today’s dilemma

Stock #1 is a close as you can get in the equity world to a long-term bond.

At some point, not this week, and maybe not for two years, the Fed will determine that the current economic emergency is over and will begin to raise short-term interest rates from today’s zero.  It will have two targets.  One is to make rates positive in real terms (i.e., higher than the inflation rate, which is currently about 2%).  The second, which it wrote about a couple of months ago, is to get them to around 4.5%.  That’s right, 4.5%! 

The effect on the 30-year Treasury, which is currently yielding 2.60%, will be big–and negative.  As yields rise, bond prices adjust by going down.

During past periods of rising rates in the US, stock prices have generally gone sideways or up.  That’s because the signal for the Fed to begin to raise rates is that domestic economic growth is high–and accelerating, which implies accelerating profit growth for publicly traded companies.

So the growing profits of stock #2 give it a chance to avoid going along with Treasuries.  Stock #1 has no such defense.  The only thing it has going for it is a current yield that’s 2x that of the long bond.

I don’t think this is a worry for right now.  But pure income seekers who hold high-yielding stocks are probably in the same boat as holders of government bonds.  So they face the same portfolio rotation issues that bond investors will, when rates eventually begin to rise–or, more likely, somewhat sooner than that, when markets begin to anticipate rate rises.

I think this makes the practical decision between #1-like stocks and the #2s much more complicated now than it would normally be.

 

 

 

 

 

 

dividend-paying stocks in the US (I)

July 17, 2012 By in Current Market Thoughts, Dividends, Stock ideas Tags: , , , , , , , , Leave a comment

then…

I remember a brokerage house strategist(from Lehman?) making a sales call in 1984 on the money management firm I was working for.  The main point of his presentation was his belief that there was tremendous predictive value in the level of the dividend yield on the S&P 500 index.  According to the strategist, the dividend yield on the S&P rarely fell below 3%.  It never stayed that low.  Therefore, the dividend yield on the index falling below 3% was the strongest possible sell signal that stocks could give.

As it so happened, the yield had just dipped below the fateful 3% line.  So the strategist’s strongly held conviction was that clients should reduce exposure to the stock market, and should rotate any holdings that remained into a very defensive posture.

Three years later, the index had doubled–and the strategist was out of a job.

Where did he go wrong?

Admittedly, hindsight makes it easier to see, but he missed just about all the important economic influences in play during the period.    Specifically:

–the decade of the 1980s saw great structural economic change in the US, including the emergence of women in the workforce, the widespread move of families to the suburbs, the rise of specialty retailing as competition for department stores, and the change from the mainframe to the PC.  Companies were also expanding rapidly abroad.

The result of all this was that most firms were reinvesting all their cash flow into growing their businesses.  They didn’t want to raise dividends.  In some cases, it would have been a condition of getting new bank loans that they not do so.

–the emergence of discount brokers, along with the move to self-directed 401ks and IRAs, made equity investing accessible to young Baby Boomers who were much more interested in making capital gains than earning income.  We didn’t want income.

–interest rates were in the early days of a quarter-century decline.  This secular movement made capital gains easier to achieve, and current income worth less. (Of course, during the accelerating inflation period of the late 1970s, investors of all stripes actively shunned dividend stocks.)

…and now

Other than for a short period in early 2009, when the dividend yield on the S&P reached 4%–and, by the way, gave a strong “buy” signal in doing so–the yield on the index hasn’t spent any significant time above 3% since 1984.

The dividend yield on the S&P is currently about 2.1%.

Economic conditions also changed substantially since that day in 1984.  In particular,

–the dramatic positive effect on the US of the entrance of women into the labor force has passed, as have the boosts caused by changes in retail and the development of the suburbs.  As a result the trend growth rate of the economy has slowed (from 3%+ to maybe 2.5%); consequently, reinvestment demand for corporate cash has waned.

–many of the iconic firms of the Eighties and Nineties have matured (MSFT is the poster child for this phenomenon) and are generating tons of excess cash.

–the Baby Boom is starting to retire and is less interested in investing for capital gains than to receive steady income.

–at the moment, short-term interest rates are at the emergency low rate of essentially zero vs. what the Fed thinks should normally be around 4.5%.  This is to help the economy heal itself of the wounds caused by twelve years of policy blunders in Washington, widespread regulatory failure and fraud perpetrated by major domestic financial companies.  So income investors can’t achieve their goals by buying government bonds or money market funds.

dividend stocks as underperformers

Stocks whose attraction is solely, or mostly, their ability to pay steady or rising dividends to shareholders have been chronic market underperformers throughout the thirty + years I’ve been involved in the stock market.

But changes in investor preferences, combined with the lack of higher-yielding fixed income alternatives and the increasing propensity of publicly traded companies to pay dividends, have caused a mini-renaissance in dividend stocks over the past couple of years.  Yes, dividend stocks have still been underperformers during the market bounceback that began in March 2009.  But not so much recently.  And, as they usually are, dividend stocks had been substantial outperformers during the market decline of 2007-2008.  So the fact that they lagged in the early part of the current cycle is understandable.

where we are today

According to the most recent Factset Dividend Quarterly:

–400 of the S&P 500 constituents are now paying dividends, the highest percentage since before the Internet bubble burst

–growth in dividend payments is outpacing growth in S&P 500 earnings

–the S&P payout ratio (the percentage of after-tax earnings devoted to dividends) remains at 28.0%, about 10% below what has been typical over the past ten years

–the valuation of dividend-paying stocks vs. their non-dividend counterparts appears to be stretched.

The raw data on this last point are stunning.  According to Factset, the PE of dividend-paying stocks is now 244 basis points lower than the PE of non-dividend stocks.  If we take monthly readings of this statistic over the past twenty years, the median discount is 1304 basis points.  So it would appear on the surface that the multiple on dividend stocks has expanded by over a thousand basis points vs. non-dividend stocks.  …uh oh.   …run?!?

That number is misleading, though.  In rough terms, the 1160 point spread would probably be cut in half if we factor out the crazy valuations applied to so-called TMT (tech, media, telecom–mostly non-dividend) stocks during the Internet bubble.  We might clip off another 100 bp or so if we adjusted for the fact that many companies have changed stripes away from non-dividend to dividend payer over the period we are considering.

Even so, there has been a substantial upward readjustment of the relative valuation of dividend-paying stocks in the US market over the past couple of years.

Is there anything left to go for?  or is the dividend stock phenomenon all played out?

That’s my topic for tomorrow.