Mebane Faber is on a tear of late. Many of you know him from frequent links to his blog. In addition he has successfully launched an research-focused e-mail newsletter The Idea Farm. Last week he published an e-book Shareholder Yield: A Better Approach to Dividend Investing.* And his firm Cambria Investment Partners launched an ETF the Cambria Shareholder Yield ETF ($SYLD) based on the research and principles in the book. I recently sent Meb a series of questions after reading the (short and easily read) e-book. Below you can find the questions with Meb’s answers in bold. Thanks to Meb for taking the time.
AR: In Shareholder Yield you talk about the secular decline in dividend payout ratios. However of late there seems to be a rush into dividend-advantaged sectors like REITs and MLPs. It seems like everybody and their brother wants to put assets all of types into these vehicles. In short, if there is a secular change in demand for actual dividend payouts how does this affect the strategy?
MB: If you go back about 10, 12 years, dividend stocks used to trade at a big valuation discount to the overall market. But as money has rushed into these stocks in search from yield, the valuation gap has closed and we are now at parity. So, the tailwind of multiple expansion is now gone.
I would also argue that many high yielding stocks are simply high yielding since they pay out more of their earnings in dividends and have higher leverage than the overall market, but their other underlying characteristics are very market like. I don’t find that portfolio very attractive. Indeed most research shows that high dividend yields are not sustainable.
AR: You make a great point about the two very different jobs of a CEO: operations and capital allocation. You correctly note that most CEOs gain fame for their operational successes. However maybe the most famous CEO in America, Warren Buffett, almost exclusively focuses on capital allocation. Why is so little attention paid to the importance of capital allocation?
MB: Creating the iPhone, or a blockbuster drug is much more exciting than the topic of capital allocation. And as Buffett mentions, most CEOs arrive at the job due to operational success rather than capital allocation, which is really a totally different skill set. And I would argue that most CEOs are not prepared for the job when you look at the track record of acquisitions as well as their terrible timing of buybacks on aggregate.
AR: In Shareholder Yield you note the existence of ‘capital destroyers,’ those companies that have positive dividend yields but negative shareholder yields. It seems like this group of stocks would be natural shorts. Have you done any work in this area?
MB: No but it sounds like an area ripe for examination! Although if you look at the lowest fractile of stocks sorted according to buybacks they certainly underperform the overall market.
AR: The performance of a shareholder yield strategy has been quite consistent over time and has done so with relatively low volatility compared to the S&P 500. How does it compare to a low-vol strategy? What other factor portfolios does it correlate with?
MB: I imagine there are some similarities as you may be getting some overlap, especially with the quality companies. However, the shareholder yield strategy benefits from a big bias which is that the portfolio, across almost any valuation metric, is trading at a discount to the overall market. Adding buybacks to a cheap portfolio creates a form of value arbitrage where you are buying stocks below intrinsic value, something Charlie Munger refers to as “looking for the cannibals”.
AR: Shareholder Yield is focused on domestic equities with a sprinkling of work on foreign markets. Have you done additional work in the developed and emerging markets? If so, how does the performance stack up relative to the domestic results?
MB: We have. Dividends certainly have worked in every market around the globe, and even across markets. One big difference is you don’t have as much of a culture of buybacks abroad as you do here in the US, so for example, countries in Europe buy back much less stock. However, after some structural rule changes in the late 1990s that has been improving quite a bit. We think that once companies get more comfortable with corporate finance, you will see the trend of buying back stock accelerate.
*I received a copy of Shareholder Yield: A Better Approach to Dividend Investing from the author.
**Here is another Q&A Meb recently did with ETFdb on the new ETF.