Tag Archives: modern

Strongest Market Sectors Since 1933: Smoking Wins, Steel Rusts Away

Summary A new review sorts the performance of 30 sectors over the past 82 years. So-called ‘sin stocks’ such as tobacco and beer run away with the best returns. Cyclical sectors and basic materials tended to fare poorest. The article specifically considers the implications of these data for DG investors. Philosophical Economics, one of my must-read financial blogs, recently put up a fascinating post showing the returns of the US market by industry with dividends reinvested since 1933. If you’re wondering about the methodology used to create the results, check the linked post, it’s too complicated to explain here briefly. The winning sectors showed a truly shocking degree of outperformance. The #2 performing sector, beer turned $1,000 in 1933 into $26 million today! By contrast, the worst sector, steel, turned that same $1,000 into just $57,000 today. $57,000 isn’t bad, but over an 82 year investment period, it certainly isn’t great. $57,000 pales in comparison to $26 million for sure. Here’s some key takeaways for dividend growth investors. The Worst Investment Sin? Socially Responsible Investing For long-term investors, the message is clear, you need to own the so-called sin stocks. Hold your nose and donate profits to charity if you must, but these stocks can’t be passed up if you want market-beating performance. The top 3 sectors over the past 82 years were cigarettes at 8.34% real annualized return, beer at 7.51%, and oil at 6.84%. Investors in “ethical” funds that avoid these sectors are virtually guaranteeing drastic underperformance. I heard recently, and I’d love to attribute it but I can’t remember the source, that socially responsible investing suffers from two primary flaws. That is, by choosing not to invest in these sorts of companies, you’re actually rewarding both the sinful investors and giving the sinful companies an easier ride. Stock prices, on a day to day basis are set by supply and demand. If you convince a large portion of the investing public not to back an alcohol, tobacco, or oil company, for example, you lower that company’s share price. Since the share price is artificially lowered due to lessened demand, shares will return higher than otherwise anticipated returns. Companies that regularly buy-back shares perform particularly well if their shares remain artifically depressed for long periods of time. Thus ‘sinful’ investors, along with the ‘sinful’ managers of these companies see their investments become more profitable thanks to the socially conscious investor. Management in particular earns fat performance bonuses for their superior stock returns. In short, you’re depriving yourself of investing profits so people that aren’t as morally upstanding as you can earn more money. What good does that accomplish? Perhaps more problematically, by not owning companies, you lose the ability to influence them. If you own an oil company and its operations destroy a water supply and poison the local population you and other ethical investors can raise hell and force them to change their ways. If only morally oblivious people own oil companies, there will be no reaction and the company can continue in its unethical behaviors. Mining companies, for example, engage in ethically questionable behavior and only rarely get called on it because their shareholder bases don’t tend to complain about bad practices. By contrast, a Nike (NYSE: NKE ) for example, if it tries to mistreat its employees hears no end of it from upset shareholders. Finally, it should be noted that most of the sin stocks don’t need fresh capital frequently, if ever. How often does Altria (NYSE: MO ) or Diageo (NYSE: DEO ) need to offer new stock to the market? By not buying their shares, you aren’t even depriving the company of capital – you’re only depressing the after-market value of shares already issued. To actually harm these companies, you’d have to be able to block them from getting the capital necessary to expand their operations. Not buying the shares of companies that generate sufficient free cash flow to buy small nations; you aren’t really going to set them back too much. Other Top Performing Sectors Of The Past 82 Years The #4 returning sector, electrical equipment (6.61%) is a bit surprising, at least to me. For people thinking about Emerson Electric (NYSE: EMR ), it’s an encouraging result. I’d guess this segment of the market is probably significantly underweighted in most of our DGI portfolios. Mainstays of many folks DGI portfolios, #5 food and #6 healthcare come in nicely, though they trail the sin stocks dramatically. While necessary for life, these products simply don’t have the addictive function that drives the returns of the very top performing stocks. Still, they’re key sectors we should all own in large quantities. The 7th top performing sector, paper and business supplies is a real head-scratcher. And returns have been very steady over the past 8 decades, it’s not like this one got a fast start and trailed off recently. I’m not sure how to incorporate this into my DGI portfolio. Ideas anyone? Next up, retail at #8 isn’t too surprising. Though for the DG investor be careful, these names tend to come and go. I don’t like Target (NYSE: TGT ) and seems I’m one of the view that likes even Wal-Mart (NYSE: WMT ) anymore. Next up is a classic picks and shovels example. Transportation vehicles (ships, aircraft, railcars) came in at 9th, while transportation (the operation of said vehicles) was 26th, among the worst five industries. It’s frequently better to supply the tools to run a business rather than to be the actual operator, and transportation is one of those categories. Boeing (NYSE: BA ) is a great business. The airlines? Not so much. Rounding out the top 10 would be chemicals, an indispensable though under-the-radar segment of the modern economy. Middle of the Pack Sectors Coming up in the middle third are quite a few of the DGI mainstays. Doing less well than you might expect, for example, would be consumer goods which come in at only #14. Utilities (#15), and Telecom (#17) rank in the middle of the 30 sector pack, showing you’re giving up a good deal of total return for that high yield. If I’d had to guess, I would have thought telecom would beat utilities though, I’m honestly impressed that utilities came in the dead middle of the 30 sector spread despite being very low growth names. Restaurants and hotels came in 12th, but that almost comes with an asterisk, as a great deal of the performance came from 2005 onward. This sector has lagged for long periods of time – between 1992 and 2005 for example, you lost half your money in this sector and that includes reinvested dividends. Compared to the steady gains most of these top sectors made over the decades, this one stands out as a real dud despite the reasonable overall ranking. Financials came in at 16th, but they were in the top 6 until 2008, when the US financial system rudely decided to self-immolate. The lesson I’d take from this is that financials are a must-own sector, but you should avoid the wild west gamblers’ market that is large US banks. The US weighs in poorly, with the world’s 49th soundest banking system. The lesson here seems clear: Buy sound banks in foreign countries that don’t lever their balance sheet to massive degrees and bet heavily on opaque instruments. The Worst Sectors: Tread Carefully The worst sectors tend to either involve basic materials or be highly cyclical. And that makes sense, to compound money effectively over an eight decade span, you need to avoid wiping out your equity too frequently, as these sectors are prone to do. The very worst sectors were steel and textiles, both of which were effectively terminated by foreign competition. Offshoring and globalization essentially destroyed these industries inside the US’ borders. As DG investors, we must be aware of changing global trends that threaten to not just destroy an individual company but potentially a whole industry. #25 Printing and Publishing is another one that has suffered greatly with recent changes to the entire industry’s dynamic. A dividend investor buying a newspaper stock like Gannett (NYSE: GCI ) 15 years ago would likely never have imagined what would happen in the coming years. Mining at #21 and coal at #23 also fair poorly being cyclical industries. Autos and trucks at #22 also came in with weak results. I’m always amazed at the number of DGIs that own stocks like General Motors (NYSE: GM ) that I wouldn’t buy in a million years. But we all have our weaknesses, I own Barrick (NYSE: ABX ) in the equally pitiable mining sector. My personal lowest-ranked holding comes in the 27th ranked sector of the 30, construction. I’m frankly shocked, given just how much stuff the world has built over the last 80 years how badly this segment has done. I know construction is hyper-cyclical, but businesses like Caterpillar (NYSE: CAT ), which I own, seem to be strong and have a decent moat. Takeaways For me, I only have a few companies in the bottom performing sectors, namely Caterpillar and Barrick mentioned above. From the top 5, I lack electrical equipment and smoking. I want to buy a tobacco stock but I haven’t seen any near what I’d judge to be a fair value, unlike in alcohol, where a stock like Diageo screams “buy me” every time I look at its long-term fundamentals. And for electrical equipment, I’d never viewed this to be a must-own sort of asset. Consider me interested now. My top weighted sector is financials which only scored 16th. Though noted above, this was a top 6 segment until 2008, and the financials I own all grew earnings and raised dividends during the 2008-09 stretch. Since I avoid US financials, I think I get a pass here – banking is still a must-own area. For investors heavily overweighted in popular sectors outside the top 10, say, consumer goods, telecoms, and utilities, think about some potential reallocation. Those segments are all very popular with DGIs, and with good reason, they offer nice yields and defensive stock performance. However, moving more of your money into higher performing areas such as tobacco, oil, liquor, and food might boost your returns without taking more risk. Here’s the full 30 in a table and the link again if you want to see the original post where you can see charts of each industry over the decades.

How Can I Pick The Best Dividend ETF?

Summary Dividend ETFs are tools for building a better retirement. Finding the right exchange traded fund for an individual investor requires knowing how the investor wants to use the tool. Investors that want to dollar-cost average into the ETF will need to consider the impact of trading costs. When an investor is looking at the dividend yield, they need to calculate the yield across the entire portfolio. Investors should aim to have a healthy margin of safety to facilitate a buy-and-hold strategy. Many investors have recognized that they need to create a dividend portfolio with strong yields and low risks to protect their lifestyle in retirement. ETFs with strong dividend yields are the quickest way that investors can get access to a diversified group of high dividend companies that will provide a growing stream of income for them to live on without having to use up the principle. Drawing down the portfolio eventually leads to a death clock as investors are forced to wonder if they will outlive their money. Building a portfolio around a high-quality ETF is one way to prepare for a long and happy retirement. It Starts With You When you want to find the right dividend ETF, you need to recognize that you are looking for a financial tool. Remembering that the ETF is simply one tool will make it easier to find the best one for you. There are certain factors that will always be important, but the importance of each factor depends on the investor. Buying Strategy Are you making one lump purchase, or are you planning to dollar-cost average into the position over time? The answer is very important, because it determines which aspects of the investment will be most important in analyzing your long-term costs of owning the tool. If you intend to buy all of your shares this month with a large pile of cash, then trading commissions (generally under $10) will be largely irrelevant. On the other hand, if you are planning for a retirement in 20 years and intend to dollar-cost average into the ETF by buying once every week, every two weeks, or each month, trading commissions will be an important consideration. If you fall into the category of frequently making small purchases, then you will want to either prioritize ETFs you can trade for free from your current brokerage, or consider changing brokerages if necessary. Personally, I fall into this category. On average I make about three acquisitions a month through various accounts. I hardly ever sell a high-quality ETF, but I like to be able to make small purchases on a consistent basis. Expense Ratios The expense ratio is a very important factor for the long-term investor. If you follow the simple “buy and hold” strategy, which I endorse, the expense ratio can become a big deal when your holding period stretches from a few years to decades. If you are holding these funds in a taxable account, selling one ETF to buy a different one could incur capital gains taxes. Therefore, I prefer larger funds with a solid history of operating at low costs. In general, expense ratios less than 0.25% are reasonable, and ratios less than 0.13% are excellent. Net or Gross The net expense ratio is what investors actually give up from the fund each year. Some advisors will say that the net expense ratio is the only one that matters, but the gross expense ratio gives investors an idea of where expense ratios might go in the future. If you’re buying an ETF with a low net expense ratio and a high gross expense ratio, it would be better to have the fund in a tax advantaged account so you can change ETFs if the ratio changes significantly. Liquidity and Spreads If you’re going to buy shares in exchange traded fund, you should look into the liquidity and the spread. In general higher levels of liquidity and lower spreads will occur together. A large spread is like an increase in the trading commissions because it will increase your effective costs for each share you buy or sell. So long as the spread is regularly very small, weaker liquidity might not seem like a problem. If the investor is certain they will not need access to the principle at any point, then the weaker liquidity shouldn’t be too much of an issue. On the other hand, if you are not fully insured and might suddenly need access to a large amount of cash, it would be unwise to choose an ETF with poor liquidity. Dividend Yields and the Margin of Safety When you’re buying a dividend ETF, one of the first things you need to ask is whether the dividend yield is going to be sufficient for your needs. When an investor buys into the fund, they should be looking at the dividend yield on their entire portfolio. If the investor is wisely including treasury securities as part of their portfolio, they may have a weaker portfolio yield. Since the ETF will be a major source of income, investors may want to use it as a core piece of their portfolio and allocate between 25% and 60% of their wealth to the ETF. Therefore, they should look at the dividend yield on the ETF. However, simply looking at the number listed for “dividend yield” is insufficient. Investors should pull up the “dividend history”. When investors look at the dividend history, they should consider whether the fund pays monthly or quarterly. If the fund pays quarterly, do you feel comfortable managing your living expenses on a 3 month period rather than monthly? The next factor is looking at the dividends to determine if they have been cut on an annual basis at some point. If the fund has a long track record, investors can see how the fund performed during 2007. Remember that the goal of buying a high quality income ETF is being able to have a steady source of income without listening to the news. If dividends are cut during a recession, investors may be forced to “create dividends” by selling off shares. Under Modern Portfolio Theory selling shares is a perfectly acceptable way to generate extra dividends. Under Behavioral Portfolio Theory, the reality is that human psychology encourages the investor to sell off too many shares at the bottom of the correction. Margin of Safety When an investor is determining the yield they need from their investment to create a strong enough portfolio yield to cover their living expenses, they should ensure that there is a healthy margin of safety. Whether the dividend cut comes from the ETF or from other holdings in the portfolio, the investor needs enough income to know they can cover their expenses without being kept awake at night worrying about their portfolio. The more volatile the dividend history of the ETF, the larger the margin of safety should be. Investors using BDCs (Business Development Companies) or mREITs to strengthen their portfolio yield will need a larger margin of safety because those sectors have dramatically more dividend risk than a high quality dividend ETF.

IBB Shockwave: Temporary Hiccup Or Start Of The Bear Market?

Summary IBB has corrected from its all time high by up to 30%. Hillary Clinton’s snowball was catched right in the eye of the pharma industry. The scare is partially unjustified. We look on pharma future growth figures and M&A activity that will drive the secular bull market higher. We believe that IBB is a good place to invest in the long term. We mention two recent picks where we expect further share price growth. iShares NASDAQ Biotechnology Index ETF (NASDAQ: IBB ) has corrected 30% from its all time high of around $401. Several investors start to ask if we have been in the bubble territory. We discuss in this article the facts why the pharmaceuticals industry will continue in a secular bull market towards 2020. We do have a correction now, but it is not the start of the bear market in our opinion. Let’s discuss this in more details. Chart Analysis The IBB bull market started a quick acceleration in 2012. Looking on the quick rise, it is normal to have a correction. No bull market runs up without any significant corrections. Now as China spends more money on drugs also IBB is more correlated with Shanghai SSE index as compared to 2007-2008. IBB data by YCharts Now that we have touched the famous 30% correction line, could we go lower to touch 50%? Let’s have a closer look on what drives this bull market. Pharma Revenues Total pharmaceutical industry revenues are expected to increase from $1.23 trillion in 2014 to $1.61 trillion in 2018. This corresponds to a growth rate of 6-8% annually. Such a 30% increase in revenues would drive the secular bull market higher. Some leading economies are also liberating their drug prices. In June 2015 the communist party in China decided to remove the price caps on a majority of the drugs. That serves as a step towards a more liberalized drug market. We wonder if they tweeted this news to Hillary Clinton. Hillary Clinton’s initiatives might cut the healthcare spending in the United States and set some drug price caps or limitations. We hope that her initiative would not be too disruptive for the industry – if it would be implemented one day. Increasing amount of regulations, restrictions and taxes is typically pushing the businesses to delocalize. These drug firms might also allocate differently their risk capital and not always in the benefit of the patients. For this reason we think that Hillary Clinton’s initiative would end up to be a good compromise. Speaking of delocalizations, we will surely see a wave of startups in China. Currently most big drug firms have large R&D centers in China and the pool of talent has been growing up rapidly. Belgium is no worse, there the politicians compete in attracting new pharmaceutical businesses in the country with tax breaks and benefits. Should Hillary read the tweet streams from Belgium? We think so because Belgium has the highest concentration of life science employees in the whole world and the highest number of Phase I to Phase III drugs in development per capita. Consequently, that has a huge impact on the nation’s economy. We talk later of one Belgian biotechnology company in particular where we hold a long position. Pharma Expenses A topic that is rarely covered in the press is pharma industry’s expenses, i.e. operational costs. Cutting cost is an excellent and quick way to improve the P&L. Well managed companies might be busy cutting down the purchasing and inventory costs and rationalizing the working processes to be more lean and efficient. Pharma industry is still far behind the traditional industries in this. Recent study shows that in 2014 only 32% of the pharma companies procurement organizations’ executives had a full leadership of their key spend areas. The savings generated were slumping down by 45% from year 2009. The study investigated some 185 pharma sector companies with an average revenue of $15 billion. 41% of the companies were based in the U.S. So, the investors should better check how the spend dollars are controlled when investing in individual big pharma companies. A good control over the expenses is the key for creating very profitable businesses. This is why we wanted to discuss this largely uncovered reality of non-optimally managed spends in the pharma industry. There is an opportunity of billions of dollars in savings. Such a greater discipline could have a great impact on IBB over the upcoming years through higher net profitabilities. M&A’s Are Booming There have been a triple amount of mergers and acquisitions in H1 2015 as compared to H1 2014. We have already seen $221b worth of pharmaceutical deals in H1 2015. This hasn’t been considered yet in the long term industry forecasts. It is a very recent news. These M&A’s will give a further necessary tailwind for IBB. These deals will increase the industry’s key players’ profitability through operational synergies. Risks & Opportunities There are many risks and opportunities and we want to highlight here just a few: Risks Hillary Clinton’s initiatives to push down the healthcare spending in the U.S. Patents expiry on several blockbuster drugs Changing regulatory requirements Rich industry valuations: IBB is trading at a PE of 25.19 and Price/Sales ratio of 7.72 Opportunities Increased focus on Orphan indications with higher margin opportunities Drug price cap removal in China Emerging digital healthcare applications market (drug administration, patient monitoring, etc.) Faster drug development with more modern technologies available in R&D Increase of aging patient populations We believe that by balancing out the risks and opportunities the overall picture is quite positive for the pharma industry. The digital healthcare applications will become a hot market in our opinion. Speaking of the healthcare industry in the wide sense we have covered prior some surgical robotics companies. This is a good example of how the modern technology can revolutionize the market segments and bring benefits to the patients and payers. The readers may have a look on TransEnterix as one example. How To Invest? Surprisingly, we are not holding IBB in our portfolio. Such index is better suited for a passive investor. We prefer to pick individual names and do lots of due diligence on them, that we partially publish at SA articles. We currently have two promising companies in our radar with an imminent share price catalyst in Q1-16. If you want to learn more you can read our articles on Mast Therapeutics and TiGenix. Wake-Up Calls for Two Hidden Gems TiGenix has run up already over 44% since our exclusive article at SA but its valuation is still at a ridiculous level in our opinion. TiGenix (OTC: TGXSF ) already published on 23rd August 2015 that their Phase III study primary end-point was met with the final and full results coming out in Q1-16 for a treatment of perianal fistulas in Crohn’s disease. Their Cx601 allogeneic expanded stem cells drug seems to be very safe as no difference was observed between the drug and placebo groups. The peak sales potential is estimated at $900m and TiGenix trades currently at a market cap of $182m. We think that is making no sense and the share price might have quite a lot of potential to go up with the final Phase III results coming out in Q1-16. We covered Mast Therapeutics (NYSEMKT: MSTX ) at SA on 28th September 2015. It has went up quite a lot after our article was published. It is again an example of a very misunderstood company with a good pipeline drug MST-188 running in late Phase III to treat sickle cell patients. SCD patients have had no proper drug for the past 17 years and this is the first one we expect to arrive on the markets. Both these micro-cap stocks offer a good example of what we look for when picking individual names across the biotechnology sector. We are having long positions with both. Conclusions We believe that IBB is in a secular bull market. This index could still correct lower than the latest 30% drop from the all time high. Eventually, the increased industry revenues towards 2018, recent tripling in M&A activity and a better control over the spend dollars could send IBB to much higher levels. We believe that active investors might be more successful in hand picking individual companies instead of buying IBB. This would go along with a higher risk. Disclaimer: Please do your own research prior to investing and taking investment decisions. This article is provided for informal purposes only and any information mentioned may change at any time without a notice. Please consult your investment advisor for finding a proper allocation for your portfolio that is adjusted with your risk levels and personal situation. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.