Tag Archives: texas
Choose The Game You Play Wisely
Expert decision making, especially in the stock-picking world, is not reliable. Stock picking by speculators is not a skill that can be mastered. Value investing needs to be thought of in the context of playing the long-term odds. Daniel Kahneman’s remarkable work, ‘ Thinking Fast and Slow ‘, discusses in detail overconfidence in the professional world and when experts can be trusted in their predictions. He had collaborated with psychologist Gary Klein on a project that researched this very question, as Klein was prone to believe that expert intuition was to be trusted when a decision had to be made, while Kahneman had concluded that algorithms are more trustworthy than human intuition. Their work was interesting, to say the least. Kahneman felt that algorithms could drown out the noise that human emotion brought to the decision-making process, but Klein laughed at the very thought of a machine making a critical decision in the heat of the battle. After numerous discussions and long debates, the question was asked what type of “expert” they were analyzing? Klein had in mind nurses and fire fighters and the like; people who had to make split-second decisions because lives depended on it. However, Kahneman had been thinking of political science forecasters and stock pickers. Kahneman had earlier done studies at a financial firm, analyzing the company’s stock advisors. His findings were not encouraging. Kahneman had been given data on the firm’s advisors and their records over the course of an 8-year period. When the rankings of the advisors were compared year by year, Kahneman found a correlation .01 – basically showing that the stock-picking skill was non-existent within the firm. Those who did well one year were likely to do worse the following year and vice versa; regression to the mean prevailed. He notes that the executives at the firm as well as the advisors basically swept the findings under the rug. They were collecting fees from their clients anyway, right? Kahneman and Klein concluded that stock picking occurs in a low-validity environment. There are no set rules to play within, like a grandmaster would encounter in a game of chess. Intuition can be trusted in such a high-validity world, proven by Gary Kasparov’s success against IBM’s (NYSE: IBM ) Deep Blue in a number of man vs. machine chess matches. The stock-picking world is different, with too many variables and moving parts to ever become “skilled” or “expert”. Stock picking is more like the roll of the dice than a game of poker, according to Kahneman. This is why mutual funds, with their fees and transaction costs, constantly underperform the overall markets. Just ask Jack Bogle! However, anyone who has been around the investing world for more than about 10 minutes is familiar with Warren Buffett’s ‘ The Superinvestors of Graham-and-Doddsville ‘. Mr. Buffett eloquently refutes the idea that the stock market is efficient and discredits the belief that success in investing comes down to a coin flip. It is hard to argue with Mr. Buffett’s logic, backed by his exceptional and illustrious decades-long performance. Buffett fits Kahneman’s description of the former in the “hedgehog and the fox” parable. The hedgehog is good at one thing. He believes himself to be an expert and, so, is overconfident in his predictions. The fox is a more global thinker and opened-minded. He is mindful of the black swan and concedes that he will be wrong on occasion. He constantly questions his position and looks for flaws in his logic. While the hedgehog’s ego prevents him from admitting his mishaps, the fox looks at mistakes as learning opportunities. The fox has historically outperformed the hedgehog. So, what can we conclude from all of this? Many have gone into great detail on the differences between speculating and investing. I categorize Kahneman’s group of stock advisors as speculators, as I do many money managers of today. They have little incentive to outperform the indexes, but their careers are on the line if they make a wrong call. Due to the structure and competitiveness of corporate America and the “instant gratification” mindset that characterizes today’s “investors”, money managers don’t have 5 years to wait for an investment to pan out. Status quo keeps them employed. The proven way is the long-term, value investment strategy employed by Buffett and his skulk of foxes. A true poker player knows that he’ll succeed eventually, if he continues to play the odds. Know that you will occasionally be wrong, keep an open mind, learn from your mistakes, and don’t listen to the pundits of mass media. Speculating is a game of roulette; invest like you’re playing Texas Hold ’em for the long term.
Exploring The Highest-Yielding, Dividend-Raising Utility
In a screen for the highest-yielding, dividend-raising utility I came across a Houston-based company with a 5%+ dividend yield. This company has provided solid investment results over the past decade. This article looks at what you might expect moving forward based on the company’s commentary. For dividend-oriented investors, David Fish’s list of Dividend Champions, Contenders and Challenges is the place to get your bearings. It’s nice because it provides you with a great subset of the types of securities you might be looking for: companies that have not only paid but also increased their dividend payments for at least 5, 10 and 25 years. Still, there are hundreds of names from which you can explore. As such, it can be helpful to whittle down the list to discover pockets of the investing world one by one. As an example, you might organize the list by utilities and then by “current” dividend yield. Naturally screens come with a bevy of limitations, but for exploration sake they work quite well. If you completed this exercise, you would notice that CenterPoint Energy (NYSE: CNP ) happened to be the highest-yielding, dividend-raising utility. Let’s explore. Tracing its roots back to 1866 , CenterPoint Energy began as the Houston Gas Light Company. Today the company has more than 7,400 employees serving more than 5 million customers. The business operates in four basic areas: natural gas distribution, electric transmission, natural gas sales and heating and cooling services. The largest segment is the Texas utility serving the Houston area, hence the utility category. However, the company also has a 55.4% limited partner interest in Enable Midstream Partners (NYSE: ENBL ), a natural gas and crude oil infrastructure pipeline. Incidentally, this also explains why CenterPoint has an above average yield – even when compared to other utilities. The payout ratio is well above average, and the share price has declined materially during the last year. Let’s take a look at the company’s history moving from 2005 through 2014: CNP Revenue Growth -0.6% Start Profit Margin 2.3% End Profit Margin 6.6% Earnings Growth 11.7% Yearly Share Count 3.7% EPS Growth 8.7% Start P/E 19 End P/E 17 Share Price Growth 6.9% % Of Divs Collected 54% Start Payout % 60% End Payout % 67% Dividend Growth 10.1% Total Return 10.0% The above table demonstrates an interesting story. On the top line the company actually had lower revenues in 2014 as compared to 2005. Yet this alone did not prevent the company from generating solid returns. The quality of those sales improved dramatically, resulting in total earnings growth of nearly 12% per year. Ordinarily this number is boosted by a reduction in share count. In the case of utilities, the opposite usually occurs. CenterPoint Energy has been no exception: increasing its common shares outstanding from about 310 million in 2005 to almost 430 million last year. As such, the earnings-per-share growth trailed total company profitability – leading to almost 9% average annual increases. Investors were willing to pay a lower valuation at the end of the period, resulting in 6.9% yearly capital appreciation. Moreover, investors saw a 3% starting dividend yield grow by 10% annually, resulting in total returns of about 10% per annum. In other words, despite the lack of revenue growth and P/E compression, shareholders still would have enjoyed a solid return. This was a direct result of strong underlying earnings growth and a solid and increasing dividend payment. Moving forward, looking at the investment with a similar lens can be helpful. Since the end of 2014, both the share price and expected earnings have declined materially as a result of the broader energy environment. For this fiscal year the company has provided full-year earnings guidance of $1.00 to $1.10 per diluted share – well below the $1.40 earned last year. Still, the company has indicated that it expects to keep the dividend at its current rate, resulting in a 90%+ payout ratio for the time being (this simultaneously equates to 60% to 70% utility operations payout ratio). Moreover, CenterPoint has indicated that it expects to grow its dividend in-line with EPS growth (forecasted at 4% to 6% annually) through 2018. This isn’t speculation on my part or a collection of analyst’s estimates. Instead, its what the company is telling you to expect. Granted they could certainly turn out to be incorrect, but it should be somewhat reassuring given their greater stakes, more to lose, higher company knowledge, etc. Here’s what the next three years of dividend payments could look like with 5% annual growth: 2016 = $1.04 2017 = $1.09 2018 = $1.15 In total an investor might expect to collect $3.28 in aggregate dividend payments, or roughly 18% of the recent share price. Without any capital appreciation whatsoever, this would equate to 5.6% annualized returns. With a future earnings multiple of say 17, this would equate to a total yearly gain of about 8.9% over the three-year period. This is how I’d begin to think about an investment in CenterPoint Energy. You might perform a similar screen and come across the company. Yet this alone does not mean that it’s a worthwhile opportunity. Just because a company has an above average yield doesn’t mean that it’s a great investment. There are other factors at play. However, it does mean that the “investing bar” is relatively lower. A higher starting dividend yield, especially when coupled with reasonable growth, means that a good portion of your return will be generated via cash received. In this case you could see 5% or 6% annual returns without any capital appreciation. From there, if capital appreciation does come along, your investment returns start to approach the double digits. Finally, it’s important to be prudent in these assumptions as the slower growing nature of the business creates an out-sized emphasis on the valuation paid. You could see years of slow or moderate growth outweighed by compression in the earnings multiple. As such, a cautious approach is likely most sensible: expecting to receive a solid and above average dividend yield without the simultaneous anticipation of wide price swings to the upside.