Monday, October 3, 2016

McIntosh, The Snowball Effect

In The Snowball Effect Timothy J. McIntosh, the founder and CIO of SIPCO Investment Management Company, makes the case for investing in dividend paying stocks. His argument is that “time is the best ally of the long-term, buy-and-hold income investor. The initial results are slow to come about and not that impressive, but in due time, compounding dividends and interest end up snowballing into mindboggling returns, even during periods of market stagnation.”

McIntosh points to four long-term secular bear markets in the Dow between 1906 and 2015: 1906-1924, 1929-1954, 1966-1982, and 2000-2011. During these four periods, almost 70% of the 110-year range, stock prices barely budged. They saw annualized price returns of -0.24%, 0.11%, 0.21%, and 0.32%. With dividends reinvested, however, the annualized returns during these four periods were 6.19%, 5.53%, 4.82%, and 2.78%. “The conclusion: The only reliable way to make positive returns during secular bear market periods is to invest in dividend-paying stocks like those in the Dow.”

McIntosh also investigates small cap stocks, bonds, and covered calls as income-producing investments. But the primary focus of the book is large-cap dividend companies. Although the author recommends some corporate bond ETFs and micro-cap dividend stocks, the bulk of the book is taken up with a detailed description of “the top 100” dividend-paying companies. IBM leads the pack. Rounding out the top ten are Wal-Mart, McDonald’s, Nestle, Lockheed Martin, Chevron, Verizon, Cisco, Occidental Petroleum, and Travelers. In each case the author provides values and rankings for dividend yield, dividend growth, trailing P/E, S&P financial rating, and beta and has a table for the past 11 years showing the company’s yearly dividend, dividend growth, and average dividend yield.

Will investments that generate income continue to be the key to earning consistent returns, as they were for the last 110 years? The problem is that the income component from both stocks and bonds is currently near cycle lows. Between 1906 and 1990 Dow stocks provided an average dividend yield of over 4%. No longer. McIntosh expects the dividend contribution to total return over the next decade to be closer to 2%. “This is a direct result of companies giving preference to stock buybacks and reinvesting their profits in capital expenditures.”

Hence the sample portfolio of 100 especially attractive dividend-paying stocks. McIntosh put together a $100,000 portfolio and projected the dividends and interest it would return for each year between 2016 and 2020. In 2016 the total income would be about $3650; in 2020, about $6475. Continuing this projection further into the future, McIntosh anticipates a total income of $14,350 by 2025. The upshot is that “although the prices of all the stocks and the DVY ETF held in the portfolio stagnated from 2016 through 2025, the portfolio’s value continued to grow the original investment, $100,001.20, to $163,498.85 by the end of 2025—a 4.99 percent annual total return.” That’s some decent snowballing.

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