The melt-up continues in U.S. equities. Nothing seems to go wrong (or rather be interpreted negatively by markets). Trade war negotiations between the U.S. and China broke off without a resolution. But Fed Chair Powell signaled on Friday that the central bank has no intention of accelerating the pace of rate hikes. Perhaps the message from his boss (Trump) encouraged him to rethink the pace of rate hikes. In any case, markets appreciated the central banker’s words (as they always seem to do since the beginning of this bull market). The Nasdaq exploded for another +1.7% this past week, pushing the tech index near another record weekly close, +6.7% above the January 2018 high. With the S&P 500 breaking above the prior January high at 2872 this past week, the benchmark index set both yet another record high and surpassed the 1991-2000 bull market in terms of longevity. We are truly living in historic times, as far as financial markets go.
Macroeconomic data this week was light, but not too rosy. Existing home sales contracted -0.7% in July, leaving a y/y drop in home sales (-1.5%). New home sales did little better, falling -1.7% in July. The housing market is not the brightest spot of the economy since the Fed began raising rates. The Dow Jones Home Build Index is about the only U.S. equity sector trading below the February 2018 correction low. Given the likelihood of a continuation of the rate hike cycle, we would not bite on homebuilders, even at these relatively low prices. Durable goods orders slipped -1.7% in July, although ex-transportation, orders gained +0.2%. Below numbers disappointed consensus estimates. Probably too early to attribute the durable goods orders to the trade war. At nine years into an expansion, it would not be surprising to see demand cool off.
Performance, With Less Risk
It is no secret that the U.S. equity market has been driven to record highs by a handful of high-flying technology stocks, led by Amazon, Apple, Google, Microsoft and Facebook. We have frequently featured our chart of the Big 5 versus the S&P 495 (the S&P 500 ex-Big 5). Year-to-date, the divergence is once again impressive.
For reactive traders, riding these winning horses to the end may be a lucrative option. However most investors don’t have the time, nor the ability, to decipher a buy-the-dip opportunity in the Big 5 from the beginning of the end. Big price moves entail big price volatility, eventually.
We have preferred not to crowd into the Big 5 with just about every U.S. equity fund manager and household. Passive index investors in the S&P 500 are holding about 16% in these five companies. For Nasdaq-100 passive investors, there is a real diversification problem, as these five stocks alone represent 37% of the QQQ portfolio (add similar tech companies like Intel, Cisco, Nvidia, and Netflix and your portfolio is over 50% in “big tech”).
One important feature, aside the outsized price movements and volatility, of these tech stocks is the low dividend yield the investor receives. This is normal, as these companies are innovating and are using their cash (mostly) productively, reinvesting in R&D. Of course, of late, many companies are squandering cash on share repurchases, just as the company shares enter parabolic price rises. The key take-away here is that the average dividend yield of the Big 5 is just 0.58% annually. This compares to 1.74% for the S&P 500 and 6.36% for the WMA Ultra-Yield Strategy. As long as tech stocks rise +5% each month, there are not worries for investors. However, when the price gains level off (or prices begin to fall), investors receive just about nothing for holding these essentially non-yielding assets. We believe that investors, at this stage of the bull market, need to be focused on holding a portfolio containing both solid companies (healthy financial situation, profitability, reasonable valuations) and companies that pay a healthy dividend each quarter, such that, should markets come down, the investor continues to get paid while waiting until the next bull market takes off.
In this Commentary, we share three recent acquisitions for our Ultra Yield Strategy that we believe will out-perform into year-end.
Gaming and Leisure Properties, Inc.
Our first company is a REIT (legal obligation to pay out 90% of earnings in the form of dividends) active in the leasing of casinos and entertainment facilities. Gaming and Leisure Properties (GLPI on the Nasdaq) is a mid-cap company based in Pennsylvania and trading publically since 2013. This company was selected by the WMA Fundamental Allocation Model due to its high ranking score in our key Ultra Yield selection categories:
- Profitability score of 100 (ranked 1 out of 4064)
- Financials score of 67.1 (ranked 976 out of 4064)
- Market Value/EBIT score of 65.3 (ranked 1508 out of 4064)
Recall that our fundamental scores range from 0 (weakest) to 100 (strongest). GLPI offer a 7.08% annual dividend paid quarterly. We like that management is growing the dividend each year (to $0.63/share from $0.52/share in 2014). The dividend growth is directly linked to the enormous profitability of the company, which according to the WMA Fundamental Allocation Model, is in the top 0.1% of all companies listed in the U.S. For the quarter ending June 30, GLPI posted $254.22 million in revenue for a $0.43 earnings per share. The recovery in earnings over the past two years reflects the positive dynamics in the entertainment industry as a whole.
Next, looking at the weekly price trend, GLPI is solidly oriented to the upside. Analysts raised their consensus one-year target price for the stock by 3.1 percent in the past three months. The mean price target is $41/share versus a price of $35.55/share as of August 22, 2018.
As the economic expansion and wealth effect plays out in the economy, we expect the gaming industry to continue to be profitable. We foresee the earnings per share stabilizing at the levels shown above, which should be more than sufficient for GLPI to maintain its generous 7.1% dividend yield. With weekly price confirming a pattern of higher lows and higher highs, the recent -5% pull-back from the July highs is likely a good entry point.
Another factor we like is the number of insider purchases of the stock. The last four reported insider transactions since June 2017 were all buys. While insiders may sell for various personal reasons, they only buy for one reason: they like the business outlook.
Investors should look at a couple factors in the coming quarters to maintain the GLPI investment. First, the gaming industry is a discretionary expense for consumers. The industry profitability depends on the positive economic outlook and consumer sentiment. A cooling off of the economy may slow revenue. However the stock price is not overvalued, and we do not expect economic slowing to impact GLPI’s stock more than the broad market, especially given its dividend. Second, GPLI accepts variable rents for its leased properties. Any time a REIT accepts variable rents, some of the risk from the operator is transferred to the REIT. Finally, GLPI has additional tax incidences in the operation of its businesses. GLPI has a portion of their revenues coming from a Taxable REIT Subsidiary (TRS) which operates two Hollywood brand casinos in Perryville and Baton Rouge. Barring a change in the tax code, the current tax structure is already reflected in share prices.
Phillips 66 Partners L.P
Our second company is a petroleum limited partnership. Phillips 66 (PXSP) owns, operates, develops, and acquires crude oil, refined petroleum product and natural gas liquids (“NGL”) pipelines and terminals and other transportation and midstream assets. The Company’s assets consist of crude oil and refined petroleum product pipeline, terminal and storage systems in the Central and Gulf Coast regions of the United States.
This company was selected by our model due to its high ranking score in the following Ultra Yield selection categories:
- Profitability score of 87.5 (ranked 351 out of 4064)
- Financials score of 55.7 (ranked 2564 out of 4064)
- Book Value score of 100 (ranked 1 out of 4064)
- Market Value/EBIT score of 77.8 (ranked 666 out of 4064)
The Financials score is not as high as we like, but is still higher than most other LPs. We like the steadily growing dividend (5.68% annual dividend paid quarterly) in a growth sector that is trading at attractive valuations.
The price chart looks nice for an entry at these levels.
The negative point with PSXP is the volatility (standard deviation of 68% annualized). However we are willing to take the choppy uptrend, which should hopefully target the 2015 highs around $70. Analysts are mostly positive (10 buys, 6 holds, 0 sells) with a mean price target (1-year out) of $57.50 (about 9% above today’s price). There has been no insider selling, which is also a positive sign for a longer-term holding.
AU Optronics Corp.
Our third dividend play for this autumn is AU Optronics (AUO on the NYSE). This is a Taiwan-based mid-cap (by U.S. standards) trading as an ADR on New York. AU Optronics Corp. manufactures and markets thin film transistor-liquid crystal displays (TFT-LCDs) and plasma display panels (PDPs). The Company sells its products in Taiwan and exports worldwide. AU Optronics divides its operations across six product lines: Products for Televisions, about 45% of sales; Mobile PCs, about 15%; Mobile Devices, about 5%; Monitors, about 15%; Commercial and Others, 15%; and Solar, about 5%.
While is seems unusual to have a tech company in our Ultra Yield strategy, AUO meets all our criteria:
- Valuation score of 88.8 (ranked 472 out of 4064)
- Financials score of 70.5 (ranked 1717 out of 4064)
- Profitability score of 35.1 (ranked 2886 out of 4064)
The yield on AUO is impressive: an 11.4% annual dividend. And for a tech company, the volatility of AUO shares (37% standard deviation) comes in below our preferred maximum volatility. Price is looking attractive after putting in a solid, multi-year bottom above $2.00/share.
Investors need to stay invested in this aging, but never-ending bull-market. Rotating into high dividend payers will soften any downside in a general market sell-off and offer regular income should the broad market rally stall out.