Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm here with Josh Peters. He is the editor of Morningstar DividendInvestor newsletter and also our director of equity-income strategy. His portfolios recently crossed the 10-year mark. We're here to take a look back and see how performance has been and what lessons he's learned. Josh, thanks for joining me.
Josh Peters: Good to be here, Jeremy.
Glaser: Let's start with that performance number. Now that you have 10 years under your belt in running these portfolios, what did those numbers look like versus a broad-based index like the S&P 500?
Peters: I don't normally target trying to beat the market over any short-term interval, like a quarter or a year. I figure you're going to own a very different group of stocks than the market average if you're going to target those high yields, so you shouldn't expect to behave like the market. But having reached the 10-year mark, it's very gratifying to see that without even trying, so to speak, we have beaten the S&P 500. Since inception, our annualized total return is 9.4%, and that compares to 7.7% for the S&P 500. It's actually a little better in comparison even to some higher-yielding indexes that over this same 10-year span have returned a little bit less than the S&P 500.
So, I think, looking back over 10 years, total return is the bottom line for any investment strategy, whether it's focused on capital gains or income. At the end of the day, you need both in order to have a good result. It's quite gratifying to see that the strategy we set out with 10 years ago has, in fact, worked so well over a long time period here.
Glaser: Digging into that return a little bit more, how much came from capital gains and how much was due to the higher-yielding nature of these securities?
Peters: It's really about the advantage of yield. I don't think this would surprise a lot of people who understand and know how dividends work that, over very long periods of time, it's been shown in lots of academic studies that higher-yielding stocks outperform low- and no-yielding stocks. They do better than the market averages, and that is a tribute to the extra total return that is furnished by the extra yield.
Now, if you look at the returns of our portfolios just on a price-only basis--like looking at the S&P or the Dow or some other index, the way it's quoted in the papers and on TV, stock price only--then we have actually lagged a little bit on average, a little more than a percent a year. But we've had a tremendous advantage from our extra dividend yields--which is a choice. That is what our strategy is about.
On average, we've had close to three percentage points of additional yield relative to the S&P 500 over the last 10 years. So, not only has that overcome the shortfall that we've had in terms of capital appreciation, it accounts for all of our outperformance--and it was outperformance that was paid in cash that you could actually put in your pocket.
Glaser: Even though this was a successful strategy, probably looking back there are things that you maybe wouldn't do again or mistakes that you've made. What's the biggest one that you saw over the last decade and that you've tried avoid since?
Peters: When I started, I had very much that traditional bottom-up type of focus that you'd expect from a value investor. And it happened that, by 2007, I had found merit from the bottom up in lots and lots of bank stocks and other financial-services companies--many of whom had dividend yields of 3%, 4%, or even 5% and records of raising the dividend every year, dating back 20 or 30 years. These looked like perfect candidates for the types of total returns I was looking for.
However, to have owned them heading into the housing and mortgage crisis--that terrible time from 2008-09--was bad enough. Frankly, I just loaded up too much; I wasn't thinking top down enough in order to control my risk. I still believe that it's very, very difficult, if not impossible, to start your investment process from the top down--[to ask yourself] how fast is the economy going to grow, how fast is inflation going to run, where are interest rate is going to go, and then devolve that down to selections of individual stocks.
I think it's best to start with those fundamentals, looking for those wide- and narrow-moat companies with good dividend policies that can provide you with good total returns. But you look to the macro factors to control your risk. And frankly, housing prices and the state of the mortgage market, those were risk factors that should have helped me at least limit my exposure to banks back in that period.
So, we have a lot fewer banks now--in fact, only one, Wells Fargo (WFC). And even with that, I wouldn't be a buyer at today's valuation. I still think it's a decent hold. But we have concentrations elsewhere--in staples, in energy--and I'm much more aware of how those top-down risk factors could ruin what are, otherwise, good company-specific stories.
Glaser: On the flip side, what positive lessons have you learned over the last decade and how have you benefited from that?
Peters: It's really been about the dividends teaching me, which may sound interesting because I started 10 years ago with the same operating system, the same premise that we have today, which is that I want a large and secure, reliable and growing stream of income from my portfolio holdings. That's what the strategy is all about. But I started out with more of the mindset of a value investor. And it's hard; a value investor is looking for mispriced assets. They are looking to buy the proverbial dollar for 50 cents. And within that, what you hope is that that discounted asset gets marked back up to a more reasonable price. You capture the gain, and then you look to repeat with another situation. It puts a lot of the work back on the investor as opposed to the company to generate the total return. You would expect more turnover in that type of strategy.
After a number of years managing our strategy for Morningstar DividendInvestor, I realize this isn't really a value strategy. Our best results have been from high-quality companies--sometimes where we paid nearly fair prices, not bargain prices--that have created a tremendous amount of value for shareholders just because they have good management and good assets. Let those companies do the work. Let your winners run. It doesn't mean you take your eye off the ball in terms of valuation; but the best dividend investing, the best management of a stream of income for total return turns out to be very much that buy-and-hold strategy that a lot of people look down on and have some concerns or qualms about these days. Let the companies do the work.
So, I start off every year thinking, "OK, I can see some buys, some sells potentially emerging over the course of the year, but I want the dividends and the companies that pay them to do 99% of the work, generating the returns in our portfolios." They're going to a tremendous amount of effort. Why should I add that much more effort on my part when trading back and forth, especially the shorter your time interval is likely to be, can easily become counterproductive?
Glaser: Josh, thanks for this look back over the last 10 years. We're looking forward to the next 10.
Peters: Thank you, too, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
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