Bank Strategy – 2017/2018 Review

During the 2007/2008 financial crisis, bank stocks were one place many investors fled from – like herds of lemmings.  I can’t say this was unreasonable as these companies sustained blow after blow – some deserved and some not.  When a company such as Lehman collapses,  mortgage  GSEs are federalized and mortgage lending comes to a grinding halt one has to consider the Chicken Little scenario – is the sky really falling?  From this systemic failure emerged a new dawn on the heels of legislation, notably Dodd-Frank.  Though far from perfect, this bill in 2010 established a floor from which the system could be rebuilt.

To paraphrase Warren Buffett, my view was this fear and dysfunction presented an opportunity.  With the dust beginning to settle, in early 2013 I dipped my toes back into Financials.  With the exception of Prosperity Bank (PB), which I classified as a Core position at that time along with a few others, these holdings – peaking at about 32% of the total portfolio in aggregate – didn’t exceed the 1% threshold individually.  Financials currently hold 29.9% and are trending down.  Truth be told, this group did provide the octane enabling my portfolio to consistently exceed the benchmark.

The Dividend Diplomats employ a similar small bank strategy but our approaches differ.  Whereas their baseline is the dividend screen process, I rely more on size and geography.  This is due primarily to embedded distortions in a TARP (and post-TARP) world as well as historical factors regarding bank failures.  For example, Lanny’s Isabella Bank purchase wouldn’t make it onto my list as I consider Michigan banks inherently risky due to the number of failures within the state during the last crisis.  You could posit a macro versus micro view in our perspectives.

Since I began this strategy I’ve periodically reported my results with my 2015 and 2016 reviews.  I was remiss earlier this year as the pace of significant mergers decreased in the post-Trump world.  This activity is now accelerating due to two factors, I think.  The first being the Dodd-Frank modifications enacted in May making it less onerous for banks of a certain size to combine.  The second being rising interest rates.  This one is less obvious as rising rates should be a boon to banks.  However, the spread between long and short rates is compressing (perhaps inverting soon?) which is where much of the profit is derived.  So the results, please?

Bank Strategy
YEAR TTL FULL PREM REVERSE % NOTES
2014 6 1 2 21.9% 41 positions
2015 16 3 0 38.7% 49 positions
2016 8 2 0 13.8% 58 positions
2017 16 1 0 25.8% 62 positions
2018 15 5 1 19.23% 78 positions

Note: through 7 Oct 2018

Of interest is that the majority of 2017 was mostly a year of consolidation with smaller banks (usually thinly traded or private) being acquired by one of my holdings.  2018 is interesting in that a number of mergers have a cash component which adds to the complexity of determining the ‘real’ valuation resulting in some initial pricing or recommendation assessments by firms on Wall Street.  I bought into two of these before the assessment changed in my favor (resulting in an unanticipated unrealized gain).

Now that this sector is pretty much fairly valued unless some compelling opportunity presents itself I’ll hope for some of the remaining 73 to be acquired and place my cash elsewhere. 🙂

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Half Year Dividend Increases (2018)

Last quarter, I initiated a series on dividend increases experienced within my portfolio.  The data used was based on actual announcements and identified increases that were “Outsized” as well as those that were merely “Tiny”.

In Lanny’s recent piece, The Impact of Dividend Increases through June of 2018, though thoughtful and in a similar vein, was troubling to me in a subtextual way.  Not that the data presented was inaccurate per se, only that the derived message was a little (likely unintentional) deceiving to the majority of his followers.  The two deficiencies I found in his data were:

  1. Visa reported a dividend increase of 7.69% while he reports 7.73%.  This is likely caused by rounding as his data source (dividend increase from the monthly posts) is based on whole dollars.  A dividend change from $.195 to $.21 will likely result in broker rounding distorting derived percentages.  Not major as he probably saw a 7.73% personal increase.
  2. His approach on annualization is wrong.  The statement, “Of course, one can annualize the percentage and equate to 6.78%.” which is a doubling of the six month number, ignores conventions established by the Global Investment Performance Standards (GIPS) which include, “any investment that does not have a track record of at least 365 days cannot “ratchet up” its performance to be annualized.”  The basic flaw in his approach lies in the fact that his data is not normalized to reflect varying declaration (effective) dates throughout the date range used thereby distorting any derived “annualization” process.

Like some of the commenters, I too began the process of calculating my personal results in this manner until my eureka moment arrived.  There is minimal correlation between actual results and the Dividend Growth Rate. The greater correlation resides in the allocation (quantity) within the portfolio.  Yes the power of DGR is real but is not static. It will fluctuate over time across companies, industries and investment allocations. Nor is it predictable. At which point I ceased this replication exercise.

On a similar note, Buy Hold Long issued a challenge to increase total forward dividend income by 4.24% during the month of July.  A noble challenge indeed. However, the unintended consequences are potential reinforcement of bad habits.  For example, how many investors will be researching high yield or investments inappropriate to the degree of personal safety required?  Or putting their strategy aside to engage in this quest? On the other hand, I’m with Mr SLM’s comment when he says, “I think I’m on the part of the curve where increases aren’t linear from contributions”.

I guess my root issue with my disdain with these endeavors is the fact that we know not our audience.  One could assume a baseline knowledge level – but this would be strictly an assumption. This brings to mind another study of mine from a couple of years ago.  At that time I was unable to prove any confirmation bias but still have been unable to shake the sense that there is some within the community – especially with newcomers.  Also, we can’t discount the number of mirror, copycat or coattail strategies that are prolific today. Which is the probable reason I shy from these types of analyses/events.  I like to think that my results can be replicated (if desired) whether a portfolio is robust or just beginning which highlights why I report percentages.

As usual, I digress.  The purpose today is to share the first half increases – by percentage – reported by my dividend payers.  One item to note is the increases enjoyed by financials (banks, in particular) will be tough to replicate going into 2019.

And this, my friends, is the message this week with the upcoming earnings season sure to present some interesting commentary 🙂

Tax Time & Earnings Season

For all the procrastinators out there the deadline is near.  In fact, this year I was one – completing mine yesterday.  This season brings to mind some of the best practices compiled to minimize – or delay – the tax hit, thereby maximizing disposable income published by the Dividend Diplomats.  Though geared towards wage earners, I can be considered a poster child of these practices as one migrates from the accumulation phase of investing.  Over the years the use of many of these strategies have resulted in continued savings well into retirement.  Case in point being a 2017 Federal effective tax rate of  8.04% on a six figure Adjusted Gross Income ($156 of which was earned income).  Take advantage of all of the breaks provided in life as early as possible to reap the rewards (true in investing as well).

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Picking Winners & Identifying Losers

It has been said many times before that attempting to time the market is a fool’s errand. One approach common with Dividend Growth Investors the one taken by DivHut which is to  “…invest in a consistent and systematic manner. Over the long haul, being invested and staying invested in the stock market gives you the best long term odds of success.”  The benefits are consistency, removing emotions and dollar cost averaging while the disadvantages – particularly if fully invested – is the reduced ability to take advantage of “one day sale events” which are becoming more common.

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Dividend Increases & a Buy

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Each week I catch up on blogs, comment on a handful and generally learn a thing or two.  On occasion I take issue with a post (or a portion thereof) – and provide a (hopefully) meaningful comment.  The most recent being Lanny’s post which included, the lines:

I don’t know about you, but the dividend increases keep coming in hot, right off of the Tax Cuts, Jobs Act!  and Let’s just say tax reform has continued to be nice, as it relates to dividend increases.

The rationale for my comment being – assuming all of his US company increases were a result of the tax plan, this would be a 12.45% increase.  Not shabby by any means but a far cry from his reported total of 20.13%.  The difference being his foreign holdings which weren’t beneficiaries of a tax cut but of strength in ore prices and China shipments.  My quibble is not the numbers – only the presentation of the tax bill being a panacea for businesses.  It may well be, however the rules are still being written and the jury is still out.

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My Views on Crypto

There have been many times where my opinion of cryptocurrency and blockchain have been sought.  My thoughts have always been – and continue to be – that blockchain holds promise while Bitcoin and most of the other cryptocurrency contenders have little merit.  Point of fact being I did add to my blockchain centric investments last month while refusing to play in the pure cryptocurrency sandbox.  With the current euphoria I decided this week to at least frame my position a little while noting I could be either wrong, premature or both.

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Sluice Box: My 2018 Strategy

In a recent conversation with a friend of mine, the topic of cryptocurrency arose as he has started accepting Bitcoin in his business.  Though more enamored over the possibilities of wealth through hoarding and/or trading, he began to look under the hood to figure out why I had a greater fondness for Blockchain over any cryptocurrency.  His insight surprised me: “You’re like the sluice box salesman in the California Gold Rush.”

I choose to think of myself as a shortstop hitting singles rather than a home run hitter going for the fence, but his analogy was apt.  I prefer to get a slice of many transactions as opposed to getting the big one.  I play the percentages.   He was able to visualize I place a greater value on the tools (mining), transport (exchanges) and utility (ancillary applications) rather than the commodity itself.  Meaning, I’d rather sell the Levi’s than look for (and mine) the gold vein.

It appears the revisions to the tax plan being discussed will be slightly less draconian than previously announced resulting in a little lead time for portfolio adjustments.  My guess (pure speculation) is the first half of 2018 will be relatively good but a little choppy.  The last half I suspect we’ll be seeing a weaker dollar, a little uptick in inflation and minimal tangible results from the administration’s policies.  Anyway, an emphasis on appreciation over dividends in a rising tax environment may result in tax deferral possibilities.  This belief is the basis for next years’ strategy as subsequently outlined.

  1. Continuation of the primary portfolio strategy in regards to moving closer to the defined target allocations.  One example of this was my first December purchase, KMB which is an Anchor holding of mine.
  2. With the tax bill still in an uncertain status, load the maximum allowable contribution to the IRA.  These funds have been allocated and will be moved by month end.  A small Canadian holding in my taxable account has been identified as my new IRA purchase which will probably be made in January (pre ex-div).  A by-product of this will be a temporary overweight status in this issue.  Since I don’t like redundant holdings across accounts, my smaller taxable holding will be sold post ex-div.  This should shield more income from taxation (under current tax).
  3. Implemented (December 14th) my side strategy for 2018 titled Sluice Box which is a reference to the Gold Rush days.  This represents about 1% of the portfolio and was created (and bought) in my Motif account (shameless plug).  The emphasis is on Bitcoin, Blockchain, Growth and my first Swiss stocks with a couple of beaten down issues thrown in.

My 2018 strategy research began in earnest when I encountered Fortune magazines’ November 1st article, In Search Of ‘Vital’ Companies.  Of the fifty companies listed, my selection process drilled into the dividend payers – albeit at low yields.  Then on November 7th, Investor Place published The 10 Best Growth Stocks You Can Buy Now I chose to ignore The Dividend Guy’s August 23rd launch of Dividend Growth Rocks as I tend to shy away from paid sites particularly when operated by one person with multiple pseudonyms.  Besides, only one of his selections (Nordson – NDSN) was either not owned already or replicated in the other analyses.

Once the data was combined, I removed issues already owned and ones I had no inclination to buy.  Basically I had to be convinced of the opportunity and that the price (subjective argument) remained reasonable.

The following table presents my 2018 picks and the primary reason.  All but one are dividend payers and I front-loaded my purchase to 2017 to ensure receipt of CME’s special dividend (ex-div Dec 28).

SLUICE BOX (Motif: 2018 Growth)
Yield
NVIDIA Corporation (1,2) NVDA 7.30% 0.32% Bitcoin chipset
CME Group Inc CME 7.30% 1.76% Bitcoin Futures
Cboe Global Markets Inc CBOE 6.70% 0.86% Bitcoin Futures
Intercontinental Ex. (1) ICE 6.80% 1.14% Coinbase investor
Nasdaq Inc NDAQ 6.70% 1.96% Blockchain
Microsoft Corp. (2) MSFT 6.80% 1.98% Blockchain (Azure, Ethereum)
JPMorgan Chase & Co. (2) JPM 6.80% 2.68% Blockchain (hyper ledger)
Veritex Holdings Inc VBTX 5.90% 0.00% emerging growth co. (JOBS Act)
Ottawa Bancorp, Inc. OTTW 6.10% 1.10% 2-step conversion (growth)
Newell Brands Inc NWL 6.50% 3.02% Brands
Energizer Holdings Inc ENR 6.50% 2.44% Brands
Cognizant Technology (1) CTSH 6.50% 0.84% Future 50
Intuit Inc. (1) INTU 6.70% 1.00% Future 50
Novartis AG (ADR) NVS 6.70% 3.21% possible Alcon spin
ABB Ltd (ADR) ABB 6.70% 2.91% purchased a GE segment

Notes:

  1. Future 50 (also currently own: MA, V)
  2. Investor Place 10 (also currently own: V, SQ)
  3. Other Bitcoin/Blockchain indirect investments include: GS, IBM, WU, AMTD

At the very least it will be interesting to observe the Crypto phenomenon in more of a supporting role.  I also need to acknowledge Dividend Diplomats whose research on NWL was enlightening.