Dividend Strategy – Video Transcript

ROSS ANDERSON:

Hi, Fools. Ross Anderson, here. I am one of the financial planners at Motley Fool Wealth Management and we are excited to be bringing you two new SMA strategies. I'm joined by two of the portfolio managers - these are the guys that are actually leading these strategies - Charly Travers and Bryan Hinmon. Thank you guys for joining me today.

So we've got a new dividend, and a small and mid-cap dividend, and we're going to run through those just a little bit, telling our investors what they're about and why they might want to consider those. But before we get into the specifics of the portfolios, themselves, I'd like to hear just a little bit about your backgrounds and your history with Foolish investing. Charly, we'll start with you.

CHARLY TRAVERS:

Sure, Ross. I started with The Motley Fool in 2004 working on a variety of the different newsletter services, most recently with Million Dollar Portfolio, and a year and a half ago, I joined Motley Fool Asset Management working with Bryan and the rest of the team helping to manage the funds and the various SMA strategies. One of the particular industries I spend most of my time on is healthcare.

ROSS ANDERSON:

Great.

BRYAN HINMON:

I've been with The Motley Fool for six years now, Ross. Prior to that I was running a small hedge fund and left that side of the business to come here and work with individual investors on Motley Fool PRO and Motley Fool Options. I did that for about five years, and about a year or year and a half ago I joined Motley Fool Asset Management to team up with Wealth Management to manage the SMAs and mutual funds.

ROSS ANDERSON:

Fantastic. We're talking about dividend-based portfolios, today. That's such a common word in investing. It's thrown around a lot. But at its most basic level, what is a dividend and why would somebody be interested in the strategy that invests this way?

BRYAN HINMON:

It's a return of our cash, is what it is. It's very easy to forget that buying stocks is not just throwing around paper, ticker symbols, and bits and bytes. Owning stock is owning a part of a business, and companies are in business, partially at least, to make money. But that money belongs to its rightful owners, the shareholders, and that's us. So it's important to remember that the money that corporations are making is, in fact, the money of the shareholders, and they can only do a couple of things with it.

They can sit on it and earn nothing in a bank account right now. They can acquire other businesses, and history tells us that managers are not very good at that. They can reinvest it in the business, which we love to see if the opportunities are there. They can buy back stock or pay off debt. Or they can return it to shareholders in the form of dividends.

ROSS ANDERSON:

Charly, if we look, we find a lot of companies that are paying what looks like really high and really attractive dividends (some as high 5-7+%) on some of these stocks that we consider very high-yielding. When you're looking at a company, is that tempting to you? How are you evaluating whether or not a dividend is sustainable that a company is paying?

CHARLY TRAVERS:

With the case of dividend yields, you have to think that bigger is not always necessarily better. Sometimes companies are just paying out too much cash and it's not sustainable. What we're looking for, first and foremost, is high business quality because, as Bryan mentioned, when we buy a share of a company we are business owners and for us the quality of the company, in our opinion, comes first.

What does that mean? It means the company has a good balance sheet, it means they control their own destiny because they're not beholden to their creditors, and it means they have nice, attractive profit margins and return on capital. This, to us, means that the reinvestment they're making is going to make the business more and more valuable over time and should mean higher and higher dividend payouts over time, assuming they keep their dividend policy roughly the same. So we are interested in sustainable dividends rather than just the biggest deal that we can find.

BRYAN HINMON:

And Ross, the goal of our dividend SMA strategies is to provide a safe, significant, and growing stream of dividend income and we purposefully listed safe, first. It's something that we spend a bulk of our time on.

ROSS ANDERSON:

Excellent. So as you guys are thinking about these, and the S&P 500 typically has a yield somewhere in the neighborhood of 2% (sometimes a little less and sometimes a little higher, depending on what's going on in the markets), how will our dividend-focused strategies compare to that and where do you see us coming in on that?

BRYAN HINMON:

We think one of the biggest mistakes that a lot of dividend investors make is reaching for yield. They put on their dividend goggles and all they do is search for the highest yield that they can get. There's a lot of risk that comes with that and we do not want to succumb to that pressure.

Our goal is to provide a dividend yield above our benchmark, the S&P 500, which is about 2% or so now. We don't want to succumb to reaching for yield, because we are going to prioritize great businesses that happen to have wonderful payout policies that are going to return some of that cash to us as shareholders.

ROSS ANDERSON:

So right now do you have a target as to how much above the S&P 500 it's going to be?

BRYAN HINMON:

We don't like to throw out a target, but the model portfolio, as we've built it right now, is about 3.5% as compared to 2% for the S&P 500. Again, what's going to determine that spread over our benchmark is access to really high-quality businesses trading at reasonable prices.

ROSS ANDERSON:

Now when an investor hears 3-3.5% as an income level or a yield that sounds a lot better than what they're getting in their checking account right now, which probably rounds to zero. That may not be an exciting number for a stock investor if you're thinking that's the total return. So Charly, would you put that as the total return, or are you looking for these businesses to grow, as well?

CHARLY TRAVERS:

The dividend, in our mind, is just one component of the return that an investor would expect to get. These are growing businesses, so you take the return on the dividend and then the return on the appreciation of the stock over time to get the total return. Historically, I think the stock market will get you roughly 10%. That is, more directionally speaking, the type of total return we're looking to get. We're not just focused on the dividend and saying, "You're only going to get 3%." There is appreciation baked into this, as well.

ROSS ANDERSON:

So you think that these are companies that could ultimately grow and be worth more on a share-appreciation value as well as that income.

BRYAN HINMON:

Because we're targeting business quality that happens to pay great dividends, one of the factors that goes into business quality for us is growing end markets and companies that we think are going to grow their earnings and cash flow over time. We absolutely expect that the companies that we buy will not only have that attractive yield profile, but it's going to be attractive from a dividend growth profile, as well.

So a simple formula that we think about, as Charly mentioned, is to take the dividend yield and take the growth in the dividend. That together, if you pay a fair price, is going to get you about your total return over time. So if we're sitting here, today, at about 3.5%, we think that a 3.5% payer (a really good business) can probably grow its earnings and cash flow, and therefore its dividend, about 4-7% a year, which gets us in the 8-10% total return range. That's, of course, not a promise, but that's a good framework for the types of businesses and the return profiles we're looking for.

ROSS ANDERSON:

That's great. So from a volatility perspective - because that's the other component to investing in stocks - if people are sitting at home thinking that this all sounds fantastic, they do need to realize they're investing in stocks. These aren't going to be static instruments that just pay you cash flow and don't move around. How would you expect these portfolios to behave in a down market? Can we compare them on a volatility basis to what you might see elsewhere?

CHARLY TRAVERS:

Traditionally, you would expect that dividend-paying companies are slightly less volatile than the market as a whole. One of the reasons is that the only companies that can afford to pay a dividend in the first place are higher-quality businesses that have the profitability to actually pay out to their shareholders, so you're just automatically excluding from consideration lower-quality companies that tend to just jump all over the place on earnings and poor performance. We can't promise lower volatility in this portfolio. That is just historically what we'd expect from owning this caliber of a business.

BRYAN HINMON:

I think there's also a psychological benefit that can come from being a dividend investor. When you see income coming into your account on a quarterly basis from your portfolio holdings, it allows you as an investor to take your focus a little bit off the up and down gyrations of the market and ask yourself if you're earning a significant portion of your total return from stable income or from stable dividends. There's psychological benefits there, too, that can get your attention off, a little bit, any market volatility that might be there.

ROSS ANDERSON:

So you're getting paid to wait a little bit.

BRYAN HINMON:

Yes. We like to think so.

ROSS ANDERSON:

Well, we're so excited to be bringing this to our Motley Fool Wealth Management customers. These are available now, so we can incorporate them into an existing portfolio. Or, if you are thinking about opening a brand new account with Motley Fool Wealth Management, the financial planning team (which is myself and my folks) will be happy to help people get onboarded and work through the process. I want to thank Charly and Bryan for spending some time with us, today. Thank you all, and Fool on!

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