The Globe and Mail - 16.10.2019

B10 O THEGLOBEANDMAIL| WEDNESDAY,OCTOBER16,2019

GLOBEINVESTOR

| REPORTONBUSINESS

B

ill Gross, the one-time bond-
market king, is back in the
news, advising investors to
spurn bonds at today’s dismally
low yields and load up on “high-
yielding, secure-dividend” stocks
instead.
It’s a tempting theory. But peo-
ple should be cautious about be-
tting too much on Mr. Gross’s ad-
vice.
Many of those high-yielding,
secure-dividend stocks have al-
ready soared in price. Anyone
who buys them now is paying a
hefty amount for whatever secu-
rity they offer.
Investors should also remem-
ber that dividend stocks are not a
surefire refuge. Consider the iSh-
ares S&P/TSX Canadian Dividend
Aristocrats ETF. It performed bet-
ter than the broad market during
the financial crisis, but lagged
slightly behind the market during
the plunge in the final quarter of
2018.
Granted, dividends have their
appeal, especially in a world
where nearly US$14-trillion of
bonds are now paying a negative
yield, ensuring a certain loss to
anyone who holds them to matu-

rity. The strongest part of Mr.

Gross’s investment outlook is his

argument that we are nearing the

end of what central banks can ac-

complish by pulling rates lower.

“In the absence of substantial

fiscal stimulation, the economic

and asset boost from negative in-

terest rate yields may have reac-

hed an end,” Mr. Gross writes in a

post on his new website, wil-

liamhgross.com.

The 75-year-old billionaire co-

founded Pacific Investment Man-

agement Inc. (Pimco) in 1971 and

built the Newport Beach, Calif.,

company into a bond-market

powerhouse before clashing with

colleagues and being pushed out

in 2014. He then managed money

at Janus Henderson Group, with

generally unimpressive results.

He announced his retirement

earlier this year.

Despite his rocky recent past,

Mr. Gross still sounds much the

same as always. He was renowned

during his Pimco career for writ-

ing commentaries that combined

bond market geekery with pop-

culture references. His latest note

refers toSaved by Zero, a 1983 hit

by the British band The Fixx. His

conclusion: Markets were saved

by zero rates in the aftermath of

the financial crisis, but that fix –

as well as The Fixx – are well past

their stale date.

Lots of people would agree. On

Tuesday, the International Mone-

tary Fund slashed its outlook for

global economic growth to a

mere 3 per cent in 2019, the slow-

est rate of expansion since the fi-

nancial crisis.

Many economists are urging a

return to fiscal stimulation – def-

icit spending, in other words – to

goose lacklustre growth. Some

advocate radical alternatives,

such as “helicopter money” pro-

grams, in which central banks

would create money and dis-

pense it directly to consumers.

How should an investor navi-

gate this environment? Mr.

Gross’s advice is to prepare for

lower returns and place your

money accordingly. “High-yield-

ing, secure-dividend stocks are

what an astute investor should

begin to own,” he writes.

This is sensible advice, but

comes rather late in the day.

Many reliable, recession-proof di-

vidend payers – utilities, discount

retailers and the like – have al-

ready surged this year. In the

United States, Walmart Inc. stock

has returned 28 per cent since Ja-

nuary. In Canada, Fortis Inc., the

power producer, has generated

21-per-cent gains. At this point, it

is difficult to see these or similar

stocks as bargains.

Even tiny flickers in interest

rates could have a major impact

on future returns. Mr. Gross says

he estimates that stock prices

have risen 15 per cent this year

simply because of an 80-basis-

point decline in 10-year Treasury

rates. (A basis point is one 100th

of a percentage point.)

The difficulty for investors is

that this math works in both di-

rections. If a small fall in bond

yields can raise the price of stocks

by double-digit amounts, a small

rise in bond yields could wipe out

that gain just as quickly.

If the market does hit a bad

patch, it is difficult to predict how

dividend stocks will perform. A

recent analysis by money manag-

er WisdomTree Investments Inc.

shows its large-cap U.S. dividend

fund held up better than the over-

all market during six of 10 dou-

ble-digit declines in the S&P 500

since 2007. However, it lagged be-

hind the market in the other four

downturns.

Buying dividend stocks can

still make sense. But investors

shouldn’t see them as an infalli-

ble refuge against today’s uncer-

tainties.

BewareBillGross’sdividendenthusiasm

Thebillionaireisback

inthenewswithsome

temptingadvice,but

investorsshouldtake

itwithcaution

IANMcGUGAN

OPINION

BillionaireBillGross,seeninCaliforniain2017,co-foundedPacificInvestmentManagementin1971andturned

itintoabond-marketpowerhousebeforehewaspushedoutin2014.LUCY NICHOLsON/rEUTErs

A

fter being stuffed with tur-
key, the country is ready for
the most spooktacular
time of year. Yes, Halloween is
nearly upon us when wee ghosts
and goblins roam the streets
searching for sweets.
While chocolates and candy
are treats at any age, investors can
nibble on my homage to theMon-
ster Mash, which brings together
dividend investing and momen-
tum investing.
It starts with Canadian divi-
dend stocks that are loved by in-
come investors and bolts on mo-
mentum electrodes to power the
Dividend Monster portfolio.
Building the portfolio begins
with the largest 300 stocks in the
land, by market capitalization,
that have their primary listing on
the TSX.
The list is similar to the old TSE
300 index, which was trans-
formed into the S&P/TSX Com-
posite index in the early part of
the century.
Taken together, the 300 stocks
form the market portfolio, which
provides a benchmark when
weighted by market capitaliza-
tion like an index. The market
portfolio gained an average of 8.9

per cent annually over the 20

years through to the end of Sep-

tember. (All of the returns herein

include dividend reinvestment,

but do not include commissions,

fees or other trading frictions. The

portfolios are rebalanced month-

ly.)

A dividend portfolio is then

formed by picking stocks in the

market portfolio that pay divi-

dends to investors. It follows

roughly 200 of the 300 stocks and

gained an average of 9.8 per cent

annually over the 20 years, when

it was weighted by market capital-

ization. (That is, when it put more

of its money into larger stocks and

less into smaller stocks.)

If the dividend portfolio

bought an equal dollar amount of

each dividend stock, and reba-

lanced monthly, it would have

gained an average of 10.8 per cent

annually. But income investors

love stocks that pay generous di-

vidend yields. The high-yield

portfolio splits the dividend port-

folio in half by yield, and keeps

the stocks with the highest yields.

It gained an average of 11.7 per

cent over the 20 years to the end of

September, assuming an equal

amount of money was put into

each stock.

It’s worth pointing out that the

dividend portfolios fared quite

well over the period. They likely

benefited from the declining in-

terest rate environment of the

past few decades.

The next step might be fright-

ening to many dividend investors

because I’m about to mash mo-

mentum into the mix. Momen-

tum investors look for stocks on

the upswing with the expectation

they will continue to rise.

It’s an active strategy that has

worked well over the long term.

The Dividend Monster portfo-

lio looks through the high-yield

portfolio and invests an equal

amount of money in the 10 stocks

with the highest returns over the

prior year.

It gained an average of 17.7 per

cent annually over the 20 years

through to the end of September,

according to Bloomberg’s back-

testing facility. That’s a mon-

strously good result.

You can see the return history

in detail in the accompanying

graph, which includes the returns

of the market portfolio for com-

parison.

It is important to know that

momentum strategies can suffer

from nasty reversals. You can see

the impact of one big reversal in

the return graph because the Divi-

dend Monster portfolio gave up 51

per cent in the 2008 crash. Many

investors would have bailed on

the strategy in the face of such a

huge decline.

The approach also requires a

level of activity that would not be

appreciated by many dividend in-

vestors because it assumes the

portfolio is updated monthly.

In addition, trading frictions

would reduce the method’s re-

turns in practice.

That said, you can examine the

10 stocks that currently make up

the monster portfolio in the ac-

companying table.

With a bit of luck, the strategy

will continue to do well and prove

to be a graveyard smash.

Afrighteninglygoodstrategyforincomeinvestors:Usemomentum

NORMANROTHERY THEDIVIDENDMONSTERPORTFOLIO

NaHe Price Yield 1-YearTotalReturI

AlgonquinPoweR(AQN) $18.00 4. 16 %46.12%

ATCO (ACO.X) 49 .32 3. 28 40. 11

Canadian UtilitieS(CU) 39 .40 4. 29 3 5.5 4

CaRibbean UtilitieS(CUP.U) 22 .33 4. 18 39. 99

EmeRa (EMA) 58 .37 4. 20 55. 32

FiRStNationalFinancial(FN) 39 .14 4. 8 556.5 1

FoRtiS S)(FT 56.78 3. 37 41 .65

GenwoRthMI Canada (MIC) 52 .55 3. 88 38. 89

InneRgex Renewable EneRgy (INE) 16.09 4. 35 37. 15

TRanSAlta RenewableS(RNW) 13. 89 6. 77 3 5. 19

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OPINION

INsIDE THEMArKET

PhD,CFA, and the founder
of stingyInvestor.com

W

hen a company an-
nounces a big new offer-
ing of shares, you can
probably kiss goodbye whatever
rally had been in the works. But
it can also offer a chance to buy
more shares.
Algonquin Power & Utilities
Corp.expects to close an offering
on Wednesday that will see the
Oakville, Ont.-based renewable
energy producer and distributor
sell an additional 23 million
shares priced at US$13.50.
The offering price marks a 4-
per-cent discount to the stock’s
record high of US$14.06 in New
York last week, before the com-
pany announced the offering.
The stockhas beenwavering
since then: The share price fell as

much as 5 per cent by last Friday,

ending a 40-per-cent rally since

the start of the year.

No doubt, the new offering

raises a couple of issues for in-

vestors who have bet on Algon-

quin’s growth-oriented approach

to wind, solar and hydroelectric

generating facilities in Canada

and the United States.

One issue: dilution. Since the

new offering will raise the num-

ber of outstanding shares by 4.7

per cent, existing shareholders

will see their slice of ownership

shrink a little.

The other issue: Algonquin

may be signalling that the valua-

tion on its stock is a bit stretched.

After this year’s strong gains,

the stock’s price-to-earnings ra-

tio has risen to 23.4 (using trail-

ing 12-month profits), up from a

P/E ratio of 16.6 at the end of

2018.

What’s more, the dividend

yield has fallen below 4.2 per

cent, down from 5.1 per cent at

the end of 2018 and near the low

end of a historical range since

2010.

So, yes, the stock is pricey. But

investors should look at the up-

side: Here’s a company with a

good track record of fuelling

growth for long-term investors,

and minimizing concerns over

dilution by tapping the market

when its shares are richly valued.

“The market is awarding Al-

gonquin a very low cost of cap-

ital, helping to make its acquisi-

tion-based model work,” Greg

Payne, a portfolio manager at

Greenchip Financial, a Toronto-

based investment firm that fo-

cuses on environmental themes,

said in an e-mail. (Greenchip

does not own Algonquin shares.)

The current offering marks Al-

gonquin’s fourth since 2015, and

the share price in Canadian dol-

lars on the TSX has done rela-

tively well after each offering.

The company issued 37.5 mil-

lion shares at $11.85 in April, 2018.

Six months later, the shares had

delivered a return of 10.3 per cent

after including dividends. That

beat the 2.2-per-cent decline in

the S&P/TSX Composite Index

and the flat performance by the

utilities sector (also after includ-

ing dividends).

Algonquin issued 43.5 million

shares in November, 2017, at

$13.25 a share. Although the total

return was negative 3.1 per cent

after six months, the return beat

utilities by nearly five percentage

points. The return was a decent

7.3 per cent within a year, beating

the TSX by more than nine per-

centage points.

Algonquin issued 14.34 million

shares in December, 2015, at

$10.45 a share. Six months later,

the shares had returned 15.4 per

cent, also beating the TSX and

utilities.

Coincidence? No way.

In addition to organic growth,

Algonquin is expanding success-

fully through acquisitions. Its to-

tal assets are now valued at

about US$10-billion, up from

US$3.5-billion in 2015. Annual

revenue over this period has

doubled to about US$1.6-billion.

Most recently, the company com-

pleted a deal for New Brunswick

Gas earlier this month and struck

a deal in June for Bermuda Elec-

tric Light Company.

“With equity in place to fund

near-term growth objectives, we

believe the shares can continue

to appreciate as the company

continues with solid execution,”

Mark Jarvi, an analyst at CIBC

World Markets, said in a note.

The short-term sell-off could

be a long-term buying opportu-

nity.

ALGONQUIN POWER &

UTILITIES (AQN)

CLOsE: $17.88,DOWN 18¢

AlgonquinPower’snewshareofferingraisesacoupleofissuesforitsinvestors

DAVID
BERMAN

OPINION