Dividends, Credit, Financials: How to play Value - Weeden Coкод для вставки
Christopher Harvey (203) 861-7636 email@example.com March 14, 2012 Dividends, Credit, & Financials: How to play Value At the beginning of the year, we stated that our enthusiasm for Dividend Yield had waned and expressed our preference for Dividend Increases as opposed to higher Yields (вЂњStock Performance after Dividend Increase AnnouncementвЂќ and вЂњ2012 Outlook: US Quants on the Rise, a Quiet Re-BirthвЂќ Jan вЂ™12). While deflating Dividend Yield strategies, we cited relative performance, idiosyncratic risk, credit spreads as well as the yield curve. Recently, a handful of clients have asked whether we expect the negative YTD performance for Dividend Yield factors to continue. Further, theyвЂ™ve inquired about our view on Bookto-Price factors and if we believed the YTD resurgence would continue. Executive Summary Our analysis suggests that the environment will continue to be hospitable for higher risk Book-to-Price strategies and weвЂ™re anticipating solid factor performance over the coming months / quarters. Alternatively, the environment remains difficult for lower risk Dividend Yield strategies and the factor will likely experience meager returns for the balance of 2012. For those investors wanting a Dividend play, we recommend strategies that try to exploit Dividend Increase Announcements, especially within the Financial sector (Exhibit 5 & 6). Liquefying Credit Markets allows firms to source Risk Funding as well as Risk Seeking: Corporate bond issuance is increasing suggesting investor willingness to provide Risk Funding. Credit spreads are contracting indicating Risk Funding is becoming cheaper and risky firms are being re-priced. Credit spreads are above their longer-term average implying room for compression. Historically, the improving credit environment favors higher risk firms and higher risk factors such as B/P over Dividend Yield. Solid credit fundamentals suggest further spread compression for Corporate Bonds: Leverage ratios are still trending down (Exhibit 1), the EPS cycle is in an uptrend and solid balance sheets are liquid. Improving credit metrics often go hand-in-hand with corporate bond spread compression and corporate bond spread compression usually fosters equity valuation compression. Over the years, weвЂ™ve observed this dynamic with our Book-to-Price factor as valuation spreads between cheap and expensive B/P quintiles wax and wane with credit spreads (Exhibit 2). Overall, the credit fundamental picture suggests Risk Seeking has longevity. Exhibit 1: Credit fundamentals are favourable as leverage ratios, balance sheet liquidity and default rates are constructive. Exhibit 2: Expect further spread compression for Corporate Bonds and consequently, positive returns to Book-to-Price Net Debt to EBITDA for the S&P500 1.50 6 B/P Spread btw Cheap & Rich Quintiles (S&P500) B/P Average Spread ML Corporate Master Index - OAS 700 600 5 4 500 1.00 400 3 300 2 0.50 200 1 100 0 Dec-99 Dec-01 Dec-03 Source: CapIQ and Weeden & Co Dec-05 Dec-07 Dec-09 Dec-11 0.00 Dec-99 0 Oct-02 Source: CapIQ and Weeden & Co Aug-05 Jun-08 Apr-11 Book-to-Price valuation spread has scope for compression: The valuation spread between cheap and expensive Book-to-Price quintiles (S&P500) is still above average and indicates further compression can occur driving positive relative performance (Exhibit 2). Risk Profiles by Factor: When looking at the common characteristics associated with attractive Book-toPrice and Dividend Yield stocks, the metrics paint dissimilar risk profiles. On average, an attractive B/P name has a higher beta, lower market cap, lower interest coverage and higher volatility than an attractive Dividend Yield stock (Exhibit 3). These characteristics are generally consistent over time. Consequently, the risk environment plays an important part in the performance of the factor. High Yield supportive of Risk Seeking : Within credit, weвЂ™ve stated High Yield is an attractive Risk/Reward. The asset class possesses appealing credit spreads, lower than expected default rates and favorable credit metrics. In an environment which is favorable to High Yield (Exhibit 4), we would expect companies sporting higher leverage ratios, lower credit ratings (lower Quality) to outpace higher Quality names. This dynamic is also benefiting B/P over Dividend Yield as cheap B/P stocks, in general, possess lower credit ratings, lower interest rate coverage and higher leverage ratios than the average higher Yielding stock. Dividend Yield and Serial Correlation with Errors: Many Quants believe and try to exploit serial correlation with AnalystsвЂ™ errors. We think this correlation effect will hinder Dividend Yield performance for material parts of the year. In 2012, Sell-Side Strategists have been very pessimist regarding Equity Targets. According to Bloomberg, the average Sell-Side StrategistвЂ™s Year-End Target is currently 1357 or 3% below last nightвЂ™s close вЂ“ see TNI Strategy Table <go> on Bloomberg. The positive revisions are already occurring as the Target has moved up 9 point from 1348 on Dec 28, 2012. As we wrote about in our Quant Strategy Note, вЂњOur Dividend Yield factor is very sensitive to market directionвЂ¦вЂќ This belief combined with AnalystвЂ™s error theory provides another argument against a nearterm revival of the Dividend Yield factor. Financials, Stress Tests & Dividend Increases: Highlighted in our note вЂњStock Performance after Dividend Increase AnnouncementвЂќ was a belief that Dividend Announcements in the Financial sector pose an interesting opportunity. The average Financial stock displays strong returns relative to the sector (78bps) post a Dividend Increase Announcement. In addition, we stated that in the coming quarters and years, the sector may see several waves of Dividend Increase Announcements as the companies meet Fed requirements and work to restore payout ratios to more traditional levels (Exhibit 5 & 6). With the Exhibit 3: Attractive B/P stocks generally possess a higher beta than attractive Dividend Yield stocks Exhibit 4: High Yield still in an upward trend vs. Investment Grade Credit, which is supportive of the Risk Seeking Beta for Median Stock within our attractive Dividend Yield quintile (S&P500) Return Spread HYG overbought vs. LQD Beta for Median Stock within our attractive B/P quintile (S&P500) 1.75 HYG oversold vs. LQD 10% 1.50 5% 1.25 1.00 0% 0.75 -5% 0.50 0.25 0.00 Dec-99 -10% Dec-09 Dec-01 Dec-03 Source: CapIQ and Weeden & Co Dec-05 Dec-07 Dec-09 Jun-10 Dec-11 Source: CapIQ and Weeden & Co Dec-10 Jun-11 Dec-11 Fed stress test results published, we think the number of Dividend Increase Announcements will increase and provide reasonable opportunity to play Dividend Increase Announcements. Listed below are the Financial stocks in the S&P500 that have the lowest Payout Ratios. We believe this is a good place to start when searching for opportunity regarding dividend increase announcements. Exhibit 5: Financials, Consumer Discretionary and Industrials accounted for 59% of all the Announcements across the last 10 years (R1000). Sector Percent Financials Industrials Con Discretionary Utilities Consumer Staples Materials Technology Energy Healthcare Telco Exhibit 6: Stocks within the Energy and Financial displayed solid performance relative to their sector return but Telcos poor. (Cumulative excess return to their sector over the 21 trading days) # of Occurrences 32% 14% 13% 9% 8% 7% 6% 5% 4% 1% 1364 602 562 383 361 313 255 194 190 49 100% 4273 Source: CapIQ and Weeden & Co Excess Return vs. Sector (10Yr) Sector Energy Financials Materials Technology Consumer Staples Industrials Con Discretionary Utilities Healthcare Telco 1.07% 0.78% 0.59% 0.52% 0.46% 0.31% 0.17% 0.14% 0.03% -0.11% Source: CapIQ and Weeden & Co Financial Stocks with a Payout Ratio less than 25% (S&P500) Ticker BRK/B ICE CBG GNW LUK ETFC AIG NDAQ C COF MA ZION DFS FHN L TMK KEY STI MET BEN V LM Name BERKSHIRE HATHAWAY INC-CL B INTERCONTINENTALEXCHANGE INC CBRE GROUP INC - A GENWORTH FINANCIAL INC-CL A LEUCADIA NATIONAL CORP E*TRADE FINANCIAL CORP AMERICAN INTERNATIONAL GROUP NASDAQ OMX GROUP/THE CITIGROUP INC CAPITAL ONE FINANCIAL CORP MASTERCARD INC-CLASS A ZIONS BANCORPORATION DISCOVER FINANCIAL SERVICES FIRST HORIZON NATIONAL CORP LOEWS CORP TORCHMARK CORP KEYCORP SUNTRUST BANKS INC METLIFE INC FRANKLIN RESOURCES INC VISA INC-CLASS A SHARES LEGG MASON INC Price Payout Ratio $ 80.60 0.0 $ 140.42 0.0 $ 20.30 0.0 $ 8.94 0.0 $ 27.26 0.0 $ 10.22 0.0 $ 28.35 0.0 $ 26.62 0.0 $ 35.20 0.7 $ 52.47 2.8 $ 422.03 4.0 $ 20.92 4.8 $ 32.03 4.9 $ 10.39 8.4 $ 39.04 9.5 $ 49.51 9.6 $ 8.35 10.2 $ 23.21 11.1 $ 37.75 11.5 $ 122.86 11.5 $ 116.92 11.6 $ 28.69 12.2 Ticker AIZ MS WU WFC HBAN AXP AMP STT PRU CMA PNC USB AON CME JPM ACE FITB LNC BK MCO PGR Name ASSURANT INC MORGAN STANLEY WESTERN UNION CO WELLS FARGO & CO HUNTINGTON BANCSHARES INC AMERICAN EXPRESS CO AMERIPRISE FINANCIAL INC STATE STREET CORP PRUDENTIAL FINANCIAL INC COMERICA INC PNC FINANCIAL SERVICES GROUP US BANCORP AON CORP CME GROUP INC JPMORGAN CHASE & CO ACE LTD FIFTH THIRD BANCORP LINCOLN NATIONAL CORP BANK OF NEW YORK MELLON CORP MOODY'S CORP PROGRESSIVE CORP Price Payout Ratio $ 42.82 12.4 $ 18.75 15.6 $ 18.16 16.7 $ 32.94 16.9 $ 6.15 16.9 $ 55.90 17.5 $ 57.12 18.7 $ 44.44 18.8 $ 61.97 19.0 $ 31.65 19.1 $ 61.18 20.1 $ 31.18 20.3 $ 48.95 20.5 $ 273.37 20.6 $ 43.46 22.0 $ 72.85 22.3 $ 13.99 23.5 $ 25.97 23.5 $ 23.18 23.8 $ 41.57 23.9 $ 22.65 24.4 Disclaimer: This publication is prepared by a Weeden & Co., LP Market Strategist. 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