Tag Archives: Dividends

are South Korea and Taiwan emerging markets?: implications for index mutual funds/ETFs

June 12, 2011 By in Current Market Thoughts, emerging markets, ETFs Vs. Mutual Funds, Purchasing power parity (PPP) Tags: , , , , , , Leave a comment

Korea and Taiwan aren’t emerging economies…

Korea has been a member of the Organization for Economic Co-operation and Development, the association of developed nations, since 1996.  Taiwan would presumably be a member, too, if it were not for China’s insistence that Taiwan is not a separate country, but a prodigal province of the mainland.

On a GDP per capita basis, Korea and Taiwan rank #33 and #37 in the world, respectively, just above the Czech Republic, which is also an OECD member.  On a Purchasing Power Parity basis, the two rank #25 and #20 by their per capita GDP–around the same level as the UK, France and Japan.

Looking at their place in world trade, neither is an exporter of raw materials or agricultural products in the way Australia or New Zealand (both classified by index compiler MSCI as developed countries) are.  Instead, both sell advanced technology and machinery products, like computers and smartphones.

…but their stock markets aren’t well-developed.

My experience is that company financial statements aren’t reliable in either country.  Neither governments nor company managements in either country care to have foreigners as shareholders, and treat them poorly.  There’s also a significant amount of intrusion into market workings by politically powerful entities in both.  The fact of this interference isn’t the issue; that happens everywhere.  It’s the extent–and maybe my lack of familiarity with the local rules–that bothers me.  In this regard, both Taiwan and Korea seem to me like Japan, only on steroids.

Every one of these factors is characteristic of emerging markets, not developed ones.

is MSCI about to reclassify both stock markets as developed?

There’s nothing new about what I’ve written above.  It’s been the situation for at least a decade (in stock market terms, it was worse before).

What is new, however, is that both the Wall Street Journal and the Financial Times have published recent feature articles suggesting that the MSCI will reclassify both Korea and Taiwan as developed markets later this month.

that might be an issue for holders of emerging markets index funds/ETFs

I’m most familiar with these entities in the US, but I think what I’m saying holds true for EU funds/ETFs as well:

Mutual funds/ETFs are both instances of a special type of corporation that is exempt from corporate tax.  It gains this exemption by, among other things, distributing all income (net of expenses) and realized capital gains to shareholders–who must pay tax on them.  Typically, distributions are made once annually, shortly after the tax year for the fund/ETF ends.

Together, Taiwan and Korea make up about a quarter of the MSCI Emerging Markets stock index (the largest other index constituents are China and Brazil).  If both countries are reclassified, index funds/ETFs will be required by their charters to sell all their Taiwanese and Korean holdings and reinvest the proceeds back into the revised Emerging Markets index.  That will presumably generate a large capital gain to be distributed to shareholders.

four quirks about a possible distribution

1.  It’s a fact of life about funds/ETFs that the holder who pays tax on a fund’s capital gain is the person who receives the distribution–not necessarily the person who enjoyed the rise in price of the stock that’s been sold.  If you buy a fund/ETF share today and receive a massive capital gains distribution tomorrow, you’re on the hook for any tax due, not the holder of the share while the capital gain was being amassed.

2.  Any distributions are net of any accumulated realized losses.  In the case of the Vanguard emerging markets index fund, which I hold, it had unrealized gains of $7.5 billion on April 30, 2011, the date of the most recent semi-annual report, but accumulated losses of $2.4 billion.

3.  Distributions are usually made at the same time every year.  For US funds, which typically have an October tax year, distributions come most often in late November or early December.  But a distribution can be made earlier–and often is, if the fund manager fears shareholders intend to sell their holdings to avoid receiving a large taxable distribution.  In other words, a Taiwan/Korea-related distribution could come as early as in July.

4.  Virtually everyone who buys a fund/ETF signs up for automatic reinvestment of distributions, so that the distribution itself results in almost no outflows. Only anticipatory sales, made to avoid a distribution, do that.

fund groups aren’t talking

I called up Vanguard the other day to ask about this issue.  My own back-of-the-envelope reckoning is that a distribution from the Vanguard emerging markets fund, if any, will be small (25% of the accumulated unrealized gains of $7.5 billion would be $1.9 billion, less than the $2.4 billion in accumulated losses).  And I own my fund shares in an IRA, so a distribution doesn’t affect me, in any event.  But I was curious.

My Vanguard representative was aware of the issue, but said everything depended on what MSCI does later this month.  I asked for the April 30th tax situation for the fund, but she wasn’t able to find it.  I looked it up online after I hung up.

relevant tax data are easy to find

Look for the latest annual/semiannual/quarterly report for your fund/ETF.   It will have a list of holdings and their market value (but not their individual cost basis).  At the end of the list, there’ll be aggregate cost and market value data.  In a section following right after that, the fund will show its accumulated realized losses.

2008 is a key year

The emerging markets index lost over half its value that year.  Although there’s no way of being certain with any individual fund, twenty some years of managing this type of money tell me that all the redemptions that created Vanguard’s accumulated losses came at the bottom or shortly after–probably in large part from people who bought shares in 2007.

Any fund/ETF that’s large now but was just getting started in 2008 probably has little in the way of accumulated losses to offset realized capital gains.  Entities like this are where the risk of a large taxable distribution are highest, in my opinion.  We’ll know more on June 21st, when MSCI does its next revision of the index.

 

“carrying” the dividend

November 25, 2010 By in "carrying" the dividend, Basic Concepts, Dividends, Stock ideas, Trading Tags: , , , , , Leave a comment

Happy Thanksgiving

Today’s post will be short, since I’ve got a pretty full calendar of parade watching, turkey eating and football on TV.

dividend carry, a bit of arcana–but maybe important nonetheless

Back when dividend payments were a more significant part of total return, and of investor desires, than they have been for the past twenty years or so, market watchers occasionally remarked on the fact that some dividend-paying stocks “carried” part or all of their payout.  That is, they did not decline on the day the stock started trading ex-dividend (meaning the seller is entitled to the dividend payment, not the buyer) by the full amount of a soon-to-be-made dividend payment.

This phenomenon may start to become important again, both because aging Baby Boomers are more interested in current income than they have been in the past, and because the dividend yield on the S&P 500 is higher today than it has been (except at the bottom in bear markets) for a quarter century.

A recent example:

On November 2nd, WYNN  declared an $8 per share dividend.  It’s payable on December 7th, to shareholders of record on November 23rd.  The stock started trading ex dividend on November 19th.  (The difference between the last two dates is to allow for the lag between the trade date, when the bargain is struck, and the settlement date, when the money changes hands and the new owner officially takes possession of the stock.)

WYNN closed at $108.99 on November 18th.  That’s the equivalent of $100.99, ex dividend.  On November 19th, the major stock market indices were flat.  But WYNN opened at $101.33, traded in a range between $101.25 and $103.70, and closed at $102.99, up $2, or just a tad under 2%, on the day.  The stock never touched the theoretical ex dividend price.

Why does something like this happen?  I don’t know…but it does.  I haven’t studied the phenomenon closely, but my impression is that this happens mostly with better quality companies.  You might argue that the market is super-efficient, realizes that excess cash is like a dead weight and concludes that the stock is more attractive after making the payout and, so to speak, unloading extra baggage.  On the other hand, you might suspect the unusual support comes from inattentive investors who don’t realize that the stock has gone ex, think the stock has just made a random movement down, and swoop in to pick up a “bargain.”

This is not to say that dividend-paying stocks like this will outperform the averages.  But the returns may be a few percentage points better than what you could reasonably expect, given the risk inherent in owning the issue and its growth prospects.

footnote

You might check my “carry” thesis by looking at the price action of comparable stocks on the same day, last Friday in the case of WYNN, to see if they too had similar better-than-the-market performance, even though they didn’t go ex dividend.  The closest matches for WYNN are MGM and LVS.  Both went up on the 19th, MGM by less than WYNN, LVS by more.

My view is that although all three have operations in both Las Vegas and Macau they’re not very similar companies at all.  LVS and MGM have much higher financial leverage than WYNN.  And LVS has its spectacular success in Singapore.  But I think the best way to see the differences is to look at the stocks’ performances from their peak levels in 2007 and from the market bottom in 2009.

From the bottom, LVS is up about 35x, WYNN only about 6x and MGM less than that.  But WYNN is now around 75% of its 2007 peak, while LVS is less than a third of the way back and MGM is about a tenth.  I don;t think comparing the price action of WYNN, MGM and LVS on the 19th, although the obvious first thing to do, tells you much at all.

 

WYNN, and indirectly Wynn Macau, report strong 3Q2010 results

November 5, 2010 By in Casinos, China, earnings conference calls, emerging markets, Entertainment, Hong Kong, Industry Analysis, Stock ideas Tags: , , , , , , , , Leave a comment

After the close on Tuesday, WYNN reported its 3Q2010 earnings results.  Since it breaks out the performance of its US and its (72.3%-owned) Macau operations separately, it also in effect renders an accounting of 1128’s performance, even though Hong Kong securities regulations only call for semi-annual reports.

the numbers

WYNN’s revenues for the quarter reached $1 billion, up from $773.1 million in the comparable period of 2009.  Of the increase of $226.9 million, $222.9 million comes from Macau (remember, accounting conventions in the US–and just about everyplace else–dictate that WYNN show 100% of the revenues and costs of 1128 in the income statement and then subtract the share of profits that belongs to third-party owners in a “minority interest” line at the bottom).

Macau had operating income of $124.7 million for the quarter, up 50% from $83.2 million in the September period of 2009.  Las Vegas had an operating loss of $16.2 million, an improvement from the deficit of $20.9 million it  posted last year.

Net income was $48.7 million, or $.39 per share, after adjusting for a loss of $64.2 million on redeeming a bond issue early.  This compares with net of $39.9 million, or $.33, in the third quarter of 2009.  Given that Macau operations earned about $113.7 million, after tax, in the quarter, this implies the rest of the company lost $65 million.

the details

Quarter on quarter, Macau’s operating results were down by about 11% as the house winning percentage from high rollers returned to a more normal 2.88% of the amounts bet, as compared with the very favorable 3.22% it enjoyed during the three months ending in June.

In Las Vegas, casino income was down, hotel results were flattish, but the popularity of WYNN’s nightclubs more than offset this.

the (near-term) future

October was a huge month for Macau–both the market, where revenues were up 50% year on year (up 20% over the average month of the third quarter), and for 1128, which earned $90 million for the month.  WYNN was unclear whether this figure was EBITDA, which it presumably is, or some even more favorable measure.  Assuming WYNN means EBITDA, that would be a 25% jump over what 1128 earned in the average month of the third quarter.

Steve Wynn thinks the Las Vegas market bottomed in the third quarter and that a slow recovery is now underway.

Planning is just about complete and preliminary construction work for 1128’s expansion in the Cotai area of Macau is starting.  Opening of the new casino complex is slated for 2014-2015.

what about the stocks?

WYNN has a market capitalization of about $13.7 billion.  1128 has a market cap of around $11.7 billion, meaning WYNN’s ownership share of the subsidiary is being valued in the Hong Kong market at $8.5 billion.

The most straightforward conclusion would be that Wall Street is assigning a value to WYNN’s Las Vegas assets of around $5 billion.  Yes, the company is perhaps the only healthy body in a sea of walking wounded.  Yes, there’s the iconic name, the well-maintained facilities, the promise of economic recovery in the US that will likely bring WYNN a larger share of a more profitable Las Vegas.  Still, that seems like a lot to pay–and implies one should hold 1128, the “pure” Macau play, that can easily be bought through any discount broker.

Maybe that’s not 100% right, though.  There are certainly institutional investors whose contracts with clients prevent them from buying foreign stocks.  Hong Kong and Macau are different places with different rules, where it’s sometimes hard for many people to keep up with what’s going on–or even to understand how local investors are likely to react to a given piece of news. In addition, WYNN controls 1128 and receives management fees from it.  For al these reasons, there may be an “intangible” premium attached to owning WYNN.

Having said that, as a growth investor, my preference is for 1128.  My guess is that the parent company premium is as wide as it’s going to get.  This would mean all the upward price momentum will come from developments in Macau, until Las Vegas gives strong signs of profit recovery.  Given the sluggish overall US economy and the large amount of overcapacity in Las Vegas, I don’t think that will be soon.  As it happens, I own a very large (at least, for me) combined position in WYNN and 1128.  I’m going to trim the former.

…oh–the dividends!

WYNN will be paying an $8 per share dividend on December 7th to holders of record on November 23rd.  Given that the company is not paying taxes in the US as present, this makes a lot of sense.

The board of 1128 is considering paying a regular dividend, and has declared an initial payout of HK$.76 on December 3rd to holders of record on November 22nd.  1128 thinks it will easily be able to finance Cotai construction costs of maybe $2.5 billion, and still pay a dividend.

US corporates lobby for a new tax amnesty

October 20, 2010 By in Cash position, Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Securities regulation Tags: , , , , , , , , , , 1 Comment

Yesterday’s Financial Times contains three (count ’em, three) articles, one on the front page and prominently above the fold, talking about recent efforts by US corporations in lobbying Washington to allow them to repatriate foreign cash holdings while paying little or no income tax.

This appears to be the start of a public relations campaign by the US Chamber of Commerce aimed at persuading Congress to pass a tax amnesty bill like the Homeland Investment Act (HIA) of 2004.

US tax law, unlike that of many other countries, makes multinationals incorporated in the US pay domestic income tax (less a credit for foreign income taxes paid) on any foreign earnings repatriated here.  This can be a big deal.  For a US company recognizing Asian profits in Hong Kong, for example, the corporate tax is zero.  This means a firm bringing money like this back home would typically have to pay 35% of it to the IRS.  The funds are probably going to be reinvested in growing Asian businesses.  But even if not, unless the funds are crucially needed in the US it would be financially foolish to repatriate it.

HIA allowed firms to pay a maximum of 5.25% tax on any money brought back to the US during a specified period of time.  Companies were required to use the repatriated funds only to hire new workers or to invest in plant and equipment.  The idea was that this would reduce unemployment and spur new investment.  None could be used for stock buybacks, dividend payments or executive compensation.

According to forthcoming research, the reality of the HIA was quite different.  Corporations repatriated around $300 billion from abroad.  Strictly speaking, all the money was used for the purposes intended.  But aggregate employment and capital investment didn’t increase.  The funds simply freed domestically generated profits to be used for dividends etc..  In fact, some firms actually used the repatriated funds to replace domestic profits that they shipped abroad.

Proponents of  HIA II, which the FT says include Cisco, GE and Microsoft, are not making strong claims this time around.  They label the cash, which is estimated at about $1 trillion, as being “trapped” abroad.  They argue that maybe $400 million would be repatriated under HIA II, giving the government $20 billion or so in tax money it wouldn’t otherwise have.  And the repatriated funds would likely slosh around doing something–presumably economically good–in the US.

So far the Obama administration is saying no, seeing that it’s in enough trouble without advocating a big tax break for cash-rich corporations.

investment implications (there actually are some)

1.  I wrote about this topic a bit last April, specifically regarding the large buildup of cash on the balance sheets of technology companies.

2.  To be able to pay it out in dividends, a US-incorporated company has to have the cash available in the US.  But most publicly-traded companies don’t disclose enough about where there cash balances are, or the cash generating/cash using characteristics of their US and foreign businesses for an analyst to see how well a given dividend is covered.  This didn’t make any difference when dividend yields were very low and investors were interested in capital gains.  But it does now.

3.  It takes a US$1.50 earned pretax in the US to give the same lift to the reported earnings of a US company as US$1 earned in Hong Kong.  So a corporation concerned with maximizing eps might well choose to recognize profits in Hong Kong rather than the US, assuming it had a choice.  Similarly, a decision to shift the profit stream to the US in order to may dividends–again, assuming this were possible–would mean a structurally lower level of eps.  I suspect that at some point, investors will ask for earnings estimates that are “normalized,” in the sense of adjusted to what they would be under a standard 35% tax rate, in order to get a more apples-to-apples comparison.

4.  Why lobby for HIA II?  The paper I linked to above argues that it makes very little difference to corporations in the aggregate.  But there may be firms–most likely in the tech area–who will be forced to borrow or to repatriate foreign cash balances (and pay tax on them), either to be able to maintain the current dividend or raise it.  The strongest advocates of a new HIA might well be in this position.

Start getting ready for 2011 now

October 15, 2010 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Strategy Tags: , , , , , , Leave a comment

it’s not too early

We’re now in the middle of October.

The second half of December is a completely lost time for professional equity investors. Volumes shrink considerably. Most professionals know their year has long since been either made or broken, so they’re on vacation. Many markets are shut down for part of the period. Accountants are starting to tot up the official score. Yes, there are sometimes very profitable anomalies to watch for (moe on this in another post). But, practically speaking, the party’s over and the lights have been turned out, so it’s much too late to be starting to reorient a portfolio.

In the first half of December, it starts to become much harder to talk to companies or to brokerage house analysts. They’re all involved in their internal pushes to close out the year, so they don;t have a such time as the would in other months. And they’re either out of the office or planning an imminent holiday departure, as well.

This means thinking about next year and acting on new strategic thoughts is starting to happen in world stock markets now, and will take place in the six or seven weeks left before December rolls around.

That’s our main investment job from this point on.

what to do

Two approaches:

1.  Develop/update your strategic plan. This is a high-sounding name for trying to figure out what the world will look like and how stocks (and maybe bonds and cash) will behave as investments after 2011 dawns. Stuff like: will it continue to be better in the US to bet on companies with a lot of foreign earnings or should one switch some money to thus-far underperforming domestic-oriented names? (I’ll be posting my thoughts for next year in a week or two

2.  Mechanical housekeeping. Three aspects to this:

—position sizes.    2010 has been a year of widely varying performance by different world stock markets and by individual stocks within them. If you’ve been very lucky or skillful, you’ll have positions that are up 50% relative to your overall portfolio. Some may violate your personal position guidelines. In my opinion, no one should have a stock, or mutual fund/ETF position (except index positions) that’s more than 10% of his total wealth. Your ideas may differ. But there can easily be positions that, when you sit down to look at them, are too risky because they’re too big. You should fix that.

—losers. Take a hard look at what’s gone wrong. We all play mental tricks with ourselves to rationalize away underperforming areas of the portfolio. But chances are, deep down inside, we know when something is a mistake. Sell and redeploy the money.

—asset allocation. This is the most important item under heading #2. I’ve saved this for last because I find it the most difficult decision to make. If you started with a 50/40/10 model allocation among stocks bonds and cash, you almost certainly are underweight cash and are likely underweight bonds. Neither of these asset categories look even remotely attractive to me. What to do? I’ve decided, as recent market action says many others seem to be doing as well, to substitute high dividend-yielding stocks for part of my stocks/cash allocation. In reality, you should be aware, if you also do so, that this is a change in asset allocation and an increase in the risk level of your holdings. At the very least, this means watching the consequences of the decision very carefully; it should probably also mean dialing down the risk level in your pre-existing equity holdings to compensate for the additional allocation to this category.