Weekend Reading

9 September 2016 | by Paul Perrino, CFA

A summary of this week’s best articles. Follow us on Twitter (@INTRINSICINV) for similar ongoing posts and shares.

The Problem With Dividend Stocks (John Coumarianos, @JCoumarianos, WSJ)

Funds targeting income generating assets, such as REITs and dividend paying stocks have seen dramatic in-flows of capital. Assets in the Vanguard REIT Index Fund (VGSIX) grew over 10 times from 2009 to today ($6 billion to $67 billion). Vanguard’s Dividend Growth Fund (VDIGX) has doubled in size since 2013. This rapid growth has caused Vanguard to close the fund to new investors. As assets have flowed into these types of funds (not just Vanguard), they’ve been forced to deploy the deposits and buy stocks that match their strategy in order to keep the fund fully invested. This bidding up of these stocks has caused valuations to skyrocket. A great example of this is WD-40. Check out our recent blog post (here) to learn more.

High-Quality Risk (Eric Cinnamond, Absolute Return Investing with Eric Cinnamond)

A number of high-quality stocks are also high-dividend paying stocks. These high-quality stocks are typically characterized as slow, stable, reliable growth. This allows them to be consistent dividend payers. These stocks are currently trading at valuations much higher than their historical averages. They’re being priced as if they’re a high growth or an incredibly low-risk company. Analyzing the cash flow of J.M. Smucker Company (SJM), the required return to justify the price is signaling an incredibly low-risk business. “In my opinion, investors are confusing low volatility — in business results and stock prices — with low investment risk. They are not the same.” At Ensemble Capital, we believe that quality businesses can also be found in economically cyclical industries and that today, these areas of the market offer far better value to investors.

Swedroe: Low Vol Benefits Fading (Larry Swedroe, @larryswedroe, ETF.com)

Moving from the bottom-up analysis in the preceding article, Larry takes a statistical approach to analyzing these low volatility stocks. It turns out that there is a “positive exposure to [the] term risk.” The strong long-term bull market in bonds can explain some of the return generated by these low-volatility stocks. The strong demand for this strategy is changing the very nature of the underlying stocks. The valuation metrics of these stocks, such as P/E, P/CF, etc. are higher than they have been in the past. “The lower exposure to the value premium means that they now have lower expected returns. In other words, since there is an ex-ante value premium, what low volatility is predicting at this point in time is not higher returns, just low future volatility. In addition, it doesn’t seem likely that low-volatility strategies will benefit as much in the future as they have in the past from their exposure to term risk.”

The iPhone 7’s powerful camera could take virtual reality mainstream (Anita Balakrishnan, @MsABalakrishnan, CNBC)

Apple’s “best iPhone yet” includes a new powerful camera. It includes features that are typically found in high-end DSLR cameras, such as the new “portrait” feature that keeps the subject in focus and blurs the background. The Plus version of the new iPhone includes an additional 12-mexapixel telephoto lens camera that pairs with the wide angle lens that’s included in the baseline iPhone 7. These improvements in the camera are causing some to speculate that this is a shift Apple is making toward promoting “user-generated virtual reality (VR) content.” Apple expressed interest in VR when they acquired Flyby Media last year. If Apple continues to innovate and create excellent user experiences, the introduction of a VR platform on the iPhone could be a material impact on how consumers use their phones.

Ensemble Capital’s clients own shares of Apple (AAPL).

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