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Author: valuemargin Two stars, 250 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 52487  
Subject: Re: An appeal to Valuemargin Date: 03/07/2011 19:05
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'with 145 holdings, do you have time to watch them closely, read reports etc or do you just sit back and ignore them after you buy?'

Glad to read you are still prospering overall vi123. I recall fondly your penetrating questions during your HYP 'pupilage' in the heady days of 2007 pre credit crunch. I hope I influenced you sufficiently for you to steer clear of HMV, Premier Foods and Trinity Mirror given what has happened to these firms subsequently, although on a purely value punt as opposed to HYP basis the last is now a very interesting proposition as long as it finds new strings to its bow in diverting those progressively declining newspaper cashflows. I spend an hour or so per working day skimming the Regulatory News Service for anything that might negatively change the character of my HYP constituents. For example taking on excessive debt, making a large acquisition, rapid change in personnel of the directors or a progressive decline in profitability that is not related to market conditions. I will only examine the accounts in depth if I perceive signs that the business concerned is becoming financially stressed. In my view there is a danger of wasting valuable time by over analysing and coming to the wrong conclusions followed by duff decisions. I have sympathy with PYAD in that regard. If a business is performing satisfactorily at an operational level indolence is usually the most profitable policy.

'it is inevitable that over the course of an HYP held for the very long term, there will be the kind of problem with some shares, but I see little reason to beat yourself up over it' -Pyad

Agreed, as I remarked in my concluding sentence 'expect the unexpected'. I don't think the amateur private investor could be faulted for failing to underestimate the toxic securities issue or the potential implications of the increasing reliance on the wholesale money markets and the systemic meltdown of the banking system. However, with RBS there were already simpler red flags. The price paid in cash for ABN AMRO just didn't pass simple Pyadic price to earnings or price to book metrics and the later deeply discounted rights issue to repair the balance sheet was a very bad sign and offered a tinkering out opportunity with a fair amount of capital salvage. Nevertheless, I did triple my holding in the market at 22p following the government bailout and I agree with you that this later investment should ultimately provide a handsome yield on a ten year view.

'the real lesson of Lloyds is IMHO the safety checks used by most HYPers for banks back then were inadequate...........Gearing may well be pretty useless for deciding on the safety of a bank, but we do need to have some way of looking at a bank's debt position to see when it becomes overstreched even for a bank. I haven't worked out what the best way of doing this is yet' - Gengulphus

Neither have I, but as a start on safety factors I would say we should be looking for loans to be more or less covered by the banks deposits, that pure equity shareholder funds should be at least 10% of the bank's loans, the cost to income ratio should be preferably less than 50% , the dividend payout ratio no more than 60% of profits after writedowns and the Return on Equity to be at least in double figures. It looks like the regulators in the UK are pressing for a minimum 10% tier 1 core capital ratio, so they maybe defaulting this safety factor for us. This level was typical in the 1970s across banks before 'big bang' deregulation, so should be sufficiently adequate.

'If you are investing with a long term investment horizon (several decades),would you be tempted to start building a HYP geared towards those sectors with higher yielders (or more clearly identifiable value at least)whilst waiting for other sectors/shares on your watchlist to hit bargain territory (fully recognising this could mean waiting a period of years). .................why do you distinguish Domino's and Unilever by listing their forward yields? -Time and Patience

A warm welcome to the HYP practical board -I dig your moniker. Looks like your made of the right stuff for this investment strategy and an excellent well thought out debut question, my answer to which is absolutely yes subject to adequate levels of diversification amongst the stocks where the yield and other safety factors are present. You'll be surprised how fashion rotates in the market amongst big caps and there are few stocks that fail to yield at least the market average at some time over a decade, although sometimes you really do need time and patience. As an example I had always coveted a holding in aerospace engineer Cobham (COB) which has delivered an outstanding compound dividend growth rate of 14.6% since 1965.Only twice has it failed to raise the dividend, once due to a government imposed dividend freeze in 1966/7 -incidentally that is why no company in the UK has an unbroken dividend record of more than 43 years -and once more during the 1990-92 recession. Great R&D driven manufacturing company that it is, the payout ratio is relatively low and the market valuation usually reflects the business quality. However, due to an indifferent trading year and gloom over government defence cuts here and in its largest market the USA, COB lost its FTSE100 place and was sold down by index funds and I was able to initiate an investment at 196p last December on a yield a fraction over 3%. I waited over a decade for that chance.

Unilever customarily pay 4 roughly equal quarterly dividends the first of which has already been paid for the current year, so I think it fair to say the forward yield is in the bag, except for the fact that its dividends are denominated in euros, so you have to in reality face sterling fluctuations in the actual payout. As far as Domino's goes, yes guilty as charged, I'm making it look more appetising, though given the growth in the estate at 60 units a year and the sales momentum in the business the projected dividend will almost certainly be paid.

'Doing backtesting, I was struck by how persistently the banksters yield not just more but far more than the market norm'-L'universal

I think it was ever thus. If you go back decades long before financial deregulation banks were persistently on elevated yields, often exceeding 5% for long periods. Investors have always sought a yield premium as compensation for the threat of periodic dividend cuts and possible occasional suspension. As an example in 1984 when the fabled Doris was choosing her retirement HYP, all seven main quoted banks of the time had average dividend yields in that year that exceeded the market average of 3.5% for that year:-

Bank of Scotland 4.0%
Barclays 4.8%
Lloyds 5.0%
Midland 7.2%
Nat West 4.6%
Royal Bank Scot 3.7%
Stan Chartered 5.5%

'between 1900 and 1985 an investment in the UK financial sector would have delivered a profit of 2% per year (ex-dividend)'-TM Marr

And the key point is that the dividends were fat and largely progressive, except for some setbacks during recessions. The dividend growth rate between 1965 and 1985 of major banks was not much inferior to that achieved between 1985 and 2007. So bank shares were eminently HYPable before the radical financial deregulation of the mid 1980s , as part of a properly diversified portfolio and made decent ROE in excess of their cost of capital.

There is a danger to which Gengulphus alludes of assessing the contemporary banking crisis, which is by no means fully worked out, as atypical and permanently ruling the sector out on that basis. Given the serious financial stress heaped on western societies following the government sponsored bailouts there is unlikely to be a return IMHO to over reliance on the wholesale money markets, major investment in very risky packaged loans or capital light balance sheet models as championed to destruction by RBS and HBOS. Otherwise, the regulators, politicians and even institutional shareholders will be on the case pronto.

Valuemargin
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