A dividend hounds approach to value investing.

[Basil]

Ferg suggested I post this in a new thread so it wouldn't get overlooked where it was posted which I agree was in a bit of an obscure place.

Thanks for the suggestion mate as the contents are part of a legacy of some of my knowledge I want to pass on to others.  Just for context I am eligible for super next year so this approach suits my risk profile at my age and I acknowledge there are all sorts of other ways to approach investing and others have done extremely well using complete different investing methods and younger investors by all means may want to take a higher risk approach with technology companies.  Just one correction.  Turners CAGR in dividends for the last decade is actually 14%.

Anyway, herewith is a repeat of the earlier post I made in another section of this forum.  I hope those of you that missed this post earlier find something in here that may be helpful.

Just very briefly, these are some of the key things I take into consideration with my dividend hound and value investor approach.

As I am sure you guys can appreciate with my long career as an accountant I am a numbers man and what matters most to me is earnings per share.  I believe in the long run share prices follow earnings per share, i.e. the market is a weighing machine not a voting machine.  (Ben Graham / Warren Buffet).

I put a heck of a lot of emphasis on recent past performance and the last 5 years with all the challenges over that period of Covid, the flow on effects from that and the almost endless recession here that's followed is a truly brilliant litmus test for how resilient a business is.  We may never get a better litmus test in our lifetimes.

I'm basically retired now, (although I keep my practice going on very much a part time basis and look after clients I have helped over the decades that I like, which keeps my mind active and keeps me in contact with likeable business people...complete retirement and doing no work at all is overrated in my opinion), but that won't last indefinitely and at some stage I'm looking to replace that remaining part time practice income with dividend income.  That's my focus area at present.

Looking at the last 5 years earnings per share for any company during this tumultuous period and their dividends per share gives you the perfect opportunity to test the resilience and reliability of a companies ability to continue to pay dividends.  Any company that has passed this litmus test with flying colours is worthy of further investigation...sadly there are not many on the NZX.

At my core I am a value investor, dividend hound and a show me the money sort of guy.  I want to pay as cheap as possible a price for growth companies (growth at a reasonable price).
My key filter I use is a derivative of Ben Graham's valuation formula.  I pay a no growth PE of 8.5 and then only 1 PE more for every 1% I forecast a company can consistently grow its earnings over the next 5 - 7 years.   I use the forward next years multiple, (FY26).  Ben Graham used historical PE multiple and paid up to 2 times the expected growth rate + 8.5 PE.   This deep value for growth approach sounds quite easy and prescriptive and of course it is prescriptive and rules out a vast number of growth companies on the NZX, but it ensures, as best as I can forecast it, that I am getting growth in EPS on the cheap.  Accountants are mean bastards and don't want to pay much for anything lol  The real skill here is of course determining how you think a company can grow its earnings over the next 5-7 years.  I look for factors around what are their key competitive advantages, what moat if any exists, what's driven the growth in the past and is that likely to continue into the future as well as looking at the stage of the economic cycle we are at and how that will affect earnings going forward.  How long is their runway for growth is also a key consideration.

Couple of worked examples might be useful.  HLG has a 5 year CAGR of 9%.  I believe with the runway of growth in Australia, (they have very low market penetration there with Glassons stores), they have a very long runway of growth at that sort of rate going forward.  I estimate circa 20 years.  To me this stock screens as extremely good value as its well within my valuation screening criteria.  It would be good value up to no growth PE of 8.5 + 9, 9% being the historical growth rate = FY26 PE of 17.5.  Brokers are forecasting eps of circa 76 cps in FY26 so its very good value up to 17.5 times that at $13.30 and therefore very, very deep value at its current share price of $9.  They have a very strong balance sheet with no debt and circa $1 per share in cash.  HLG is N.Z's oldest listed company and Tim Glasson has an 18% stake.  Execution with Glassons Au by James Glasson has been brilliant and he's obviously tied into the business with inheriting some of his father's stake in due course.  I have a large allocation to HLG.

Likewise Turners has grown EPS at a 5 years CAGR of 10%.  I see them doing similar for the next 5-7 years and deserving of a similar metric to HLG noted above.   My valuation screener says they're good buying up to no PE of 8.5 + 10 = 18.5.  They currently trade on a forward PE of 14.5 and are one of the  very. very cheapest GARP stocks on the NZX and have built an extraordinary track record of resilience and dividend growth over the last 5 years.  The board and management have a circa 30% stake in the business and a clear runway ahead for growth. Turners also commands a large foundational sized portfolio allocation and will be one of the key ways I enjoy growth in dividends in the future.

My view is once you start paying PE multiples over 30 for anything, you're leaving yourself wide open to that growth company disappointing you in the future.  Paying that sort of multiple or higher you're basically making the call that company XYZ is going to keep growing really fast for the foreseeable future.  This doesn't sit comfortably with my value and GARP M.O. at all.

If there's no growth its okay to me to buy a share for income if I think the company can reliably pay me a gross dividend of equal to or more than 5% above the official cash rate.  Ideally no growth companies should be on a no growth PE of 8.5, (which is the benchmark Ben Graham used) but cashflow is very much a factor here and if a company can reliably pay high gross dividends its worth owning for income provided you buy it at a good price.  Watch out for agricultural companies with wild cyclical swings in commodity prices, they're very risky, disease, pestilence, wild cyclical changes in commodity prices e.t.c.

Apart from the numbers I'm looking for what makes a business resilient.  What's their special sauce.  Watching the cash flow, are the earnings real or just on paper, how strong is the balance sheet and do senior management and directors have real skin in the game.  Overseas studies have shown where senior management / directors interests are aligned with shareholders and they have a serious stake in the business, those business's consistently outperform.

I put a hell of a lot of stock on past performance, probably 80-90% and 10-20% on what a company says they're going to do in the future..  Have management already built a track record of earnings per share over this treacherous 5 year period in business that impresses me ?  Have they earned my respect ?  I'm not really looking to take meaningful positions in companies where management might or might not earn my respect in the future.  This is a function of my age and lack of desire to invest in speculative positions.  Speculative investment should be kept under 10% of one's portfolio for someone in their semi retirement or full retirement in my opinion.

Dividend per share growth.  Its okay to keep holding companies that are paying less than OCR + 5% if they have a demonstrate-able track record of strong DPS growth, Turners a very good example, arguably the best example on the NZX.  Although the forecast FY26 gross dividend is only about 6.5%, it should keep growing at circa a CAGR of 10% per annum so only takes a couple of years to get back above OCR + 5% and after that all future growth is cream on top.

Of course there are exceptions to the above fundamental principles.  Two good examples are current significant positions in Tower and MCK.  Towner doesn't have a 5 year track record of earnings and dividends that impresses because of the extreme weather events of the summer of 2023.  Sure extreme weather like that could happen again but I believe the very high yield I am forecasting and significant changes in their business model in recent years makes this a great emerging dividend payer.  I see it as somewhat speculative and high risk so my portfolio allocation is less than 10%.  MCK is a takeover play pure and simple and I think there's an excellent chance there's another takeover attempt coming in 2026 at a significant premium to the current share price.  Index inclusion events are another favorite place this hound looks for a feed.

Watch out for certified B Corp companies and any company that runs amuck with ESG.  Any company that puts people and the planet on exactly the same footing as shareholders and spends vast amounts of management time meeting all the requirements for that...just run for the hills.   Such a company has lost sight of the very reason they exist to put shareholders interests first and foremost.  Sure, respect the environment and be fair to employees and other stakeholders but shareholders come first and I always look at a companies culture to make sure they really know what they're there for and who they are serving.

This is just a very, very brief overview of some of the key ways I go about being a value investor.  One day I might write a book but that will be years away if it ever happens.  In closing, there are many ways to skin a cat and others have done well using different approaches to mine and that's fine.  This is what has worked well for me over the years and what I feel comfortable with.  Happy to answer any questions or expand upon any topic that you want me too.

[Acol]

As someone who started investing late in life I have learnt a lot from reading this and the other forum over recent years.
I haven't posted previously as I don't feel I have anything to contribute.
But I can't let this post go by without saying a huge thank you to you Basil for taking the time to share your investing principles, expertise and wisdom in this very informative post.
It is much appreciated and I have learnt so much from you and the many others who regularly share their wisdom, research and thoughts. Thank you all.

[Shareguy]

As someone who started investing late in life I have learnt a lot from reading this and the other forum over recent years.
I haven't posted previously as I don't feel I have anything to contribute.
But I can't let this post go by without saying a huge thank you to you Basil for taking the time to share your investing principles, expertise and wisdom in this very informative post.
It is much appreciated and I have learnt so much from you and the many others who regularly share their wisdom, research and thoughts. Thank you all.

Everyone's post is valued here. There are too many people who don't contribute anything which is evident by the lack of posts and number of guests on the site. So well done on your first post. Look forward to many more.

Welcome to Stocktalk Acol.

[allfromacell]

Great post, Basil. I first started reading your posts when I was a teenager, hard to believe that was over a decade ago now...

Thanks to your sage wisdom I'm certainly a lot better off financially now because of you. At times I went against your advice usually to my own expense but I guess some lessons need to be learned the hard way.

I hope you keep sharing your views on these forums long into your retirement!   

[entrep]

Locked (but not yet loaded)

[HAWKDOG]

Thanks for posting, hope to see more related posts in the thread

[ValueNZ]

Companies are worth sum of discounted cash flows. Not discounted earnings.

Distinction not necessarily that important for most companies, especially stable / no growth companies.

But...

Companies that are declining may have cash flows that exceed profit whilst balance sheet runs off.

Companies that are growing quickly may have cash flows that lag profit for a long time as they have to make investments in fixed assets, working capital etc.

Companies that are float generating have cash flows that exceed profit as they grow, for example negative working capital (supplier funding business), any model where you receive payment upfront then render the service later (customer funding) etc. And vice versa.

[Popeye]

Thats some good insight there Basil.

On the agri comment, you could say the same about insurers, banks or infrastructure businesses really, just different cycles.  I would say rather than watch out for them, pay attention to the place in the cycle, and be sure that your investment horizon is longer than the cycle length.  In other words, ensure that you are exposed to average profitability by planning to hold for at least an entire cycle, rather than a temporary peak or trough, which you know will come, but not when.  (Unless you are a speculator)

So long as you are not totally reliant on a cyclically volatile stock, and have a sufficient mix of either cyclically offsetting (the holy grail) or sufficient less volatile stocks, bonds or deposits, there is no reason to be scared of such investments, provided that they are a well run business that management understands how to manage through the cycle, how to emerge stronger from a trough etc. (Basils track record comment)

For example, I bought some Tower a few years back when they were in the doldrums and very unfashionable.  The thinking was that they were at the bottom of the cycle, they had developed a good consumer front end attractive to the customer who wanted to control their own insurance, and they were very focused on taking on profitable business through risk pricing and avoiding the more risky business (as opposed to being open to all business).  Although they seem to have executed this strategy quite well as well as benefiting from an extended period of relatively few disasters, I have no illusions that it is only a matter of time before something unexpected happens (it is insurance after all) and the bottom line suffers temporarily.

I would restrict my comments to industries with obvious cycles, otherwise you are just trying to 'pick the bottom' which is more like speculation and more risky.  Also, pay attention to businesses facing emerging competition or changing market dynamics which might threaten their ability to ride out an industry cycle (MPG anyone?)

Keep the thoughts coming, there are quite a few of you who have plenty to say worth listening to so dont be shy.

Watch out for agricultural companies with wild cyclical swings in commodity prices, they're very risky, disease, pestilence, wild cyclical changes in commodity prices e.t.c.

[Mousehold]

I think one also has to be quite watchful of insurance companies. They get to choose how they determine the value of outstanding claims - an example is the Canterbury earthquakes where the bucket needing to be filled got bigger and bigger. On the plus side Tower is a short tail insurer.

[Otago K]

Thanks Basil for the insight you offer into your rules.
Certainly I think I might have done a bit better with my investing journey to have been more disciplined, around sticking harder to some of my so say rules. Aside from as you say sometimes hard rules for one stock aren't quite so relevant to the merits of another company investment.

Can I please get some insight around the % amounts you run with in regards to weightings of an individual stock or asset class say to your total portfolio, to garner is it restricting to within that percentage of current SP, or more around the amount of dollars you will actively invest into BUYs?

I personally find my money psychology helps me sleep well by tending to buy the cyclical stocks at low points of the cycle and getting cash out perhaps a year or two later at high points, and think of the dividend yields ( as market sets them because I am free carrying often ) as the average of last 5 years to determine if I will continue to hold.  Hope clear, thanks.

[Left Field]

Good thread and good discussions.

The aim of all good NZX investing is to get a return on your investments that is better than money in the bank and/or (say) NZX50 averages, KiwiSaver funds etc while at the same time minimising your risk.

The annual share picking competition is a useful tool to compare % returns for different NZX investing strategies as chosen by various of NZ's guru investors.

See the latest here; https://docs.google.com/spreadsheets/d/1BMjhgAabOBtpBYvjKytRq1d_b7oEx-HcbZZBQd0X3WU/edit?gid=0#gid=0

[Basil]

Thanks for your kind words folks.  We can all learn from each other and I am grateful to many for their help and their posts and insights shared over the years.

Can I please get some insight around the % amounts you run with in regards to weightings of an individual stock or asset class say to your total portfolio, to garner is it restricting to within that percentage of current SP, or more around the amount of dollars you will actively invest into BUYs?

Sure mate. I think the guys at Discovery are pretty smart and their rule is no more than 10% to any one stock at cost price.  How far they let their winners run is something that I think is a closely guarded commercial secret.  Textbook investment theory suggests that with stock selection you need 13 different companies in completely different industries to achieve effective risk lowering diversification, (apart from portfolio allocation to other investment classes like property, bonds, and alternative assets like precious metals). Any financial planner worth his salt will ensure their clients have a proper sized allocation to overseas assets, bonds, property and alternative assets classes according to their investment objectives and risk tolerance....but portfolio allocation is probably best left for another thread sometime and is very much client specific.  For example, someone in their twenties might have very different asset allocations that someone in the eighties.

I stick to Biblical principles when it comes to diversification.  The Bible tells us:-

Ecclesiastes 11:2
Key Verses on Diversification
Ecclesiastes 11:1-2: "Cast your bread upon the waters, for after many days you will find it again. Divide your portion among seven, or even eight, for you do not know what disaster may befall the land."
This verse encourages taking prudent actions with resources and spreading them across multiple ventures to safeguard against potential misfortunes. It highlights the unpredictability of life and the wisdom in diversifying investments to ensure stability

In a perfect world it would be easy to find more than 8 very high conviction investment positions but that's easier said than done and for those with a moderate / high tolerance to risk, 8 high conviction positions may give a better long term return than a broadly diversified investment portfolio provided you are very skilled with your selections and monitor them very closely.

One seventh of my portfolio at cost price is generally my limit for a very high conviction position, i.e. 14.3% but there have been very rare times where I was so sure of the investment case I have gone well beyond that for a short period of time.  For example, pending index inclusion with Turners a while back was one of those occasions but I have subsequently rebalanced my portfolio and its in the mid teens now as a percentage of my portfolio, most of which is free carry.

How far do I let something really successful run ?  Generally if something performs really well and gets to ~ 20% of my portfolio I'll pause for thought and usually rebalance.  Work in progress for me, (probably when I turn 65 next year), is to let go of control of so much of my portfolio.  Investing about one third - 40%, (yeah I know its not a lot because I have control issues...none of us are perfect, certainly not me lol), with some good fund managers overseas which will free up more time.  I might move that up to 50% with ETF's and fund managers at some stage in my late 60's.

[SmallSteps]

Hi,

What are the thoughts on shares such as BRM which have a decent & predictable PIE return. Apart from a big spike & drop they have been relatively consistent in SP (no growth to speak of)?
I understand the gains of a growth AND div stock, but I am currently after income primarily.

I have concerns over the likes of Temu / whatever the other one is called eating in to the future HLG market as more people get comfortable with online, and the much lower prices make it more worthwhile. Doesn't look like that is happening currently though?

[Otago K]

Hi,

What are the thoughts on shares such as BRM which have a decent & predictable PIE return. Apart from a big spike & drop they have been relatively consistent in SP (no growth to speak of)?
I understand the gains of a growth AND div stock, but I am currently after income primarily.

I have concerns over the likes of Temu / whatever the other one is called eating in to the future HLG market as more people get comfortable with online, and the much lower prices make it more worthwhile. Doesn't look like that is happening currently though?

Not really personally going to fully address your questions, suspect there maybe other's more articulate to address say the use / merit of a suitable BRM long term investment strategy that can also see very real personal portfolio gains.

Temu and HLG customer bases shouldn't be confused as overlapping, as would I contend the lifetime use / perception of the quality of product (think Temu one time wear in this matter I suggest.) At the risk of being even more derogatory I would say anything sourced through TEMU might at a distance seem to be of some quality but it will degrade quickly, and having shown how a great value duvet sourced from Temu rather than one from WHS burned I wouldn't want to have much of Temu product in my vicinity if a fire was to occur. The person who once held a contra view to Temu being a bad value proposition couldn't endure the toxicity of fumes arising even if they still denied it was way too flammable.

[FatTed]

Thanks Basil,  I bought HLG at an average price of $5.78 I now find it difficult to buy more shares in the company @ $9, in a similar position with CEN and TRA