November 2007 Update (Part 3/3)

Posted by Dan Hung

December 10, 2007

Curious Investments Equity Income Strategy

At the end of the summer, I was leaving work for an investment management firm which believes in buying low P/E high dividend stocks. I learned a lot over the summer and realized that a high dividend yield portfolio does have its merits and thought that I theorized put together a concentrated portfolio of dividend paying stocks which could provide solid capital appreciation while also giving an investor the peace of mind provided by solid dividends.

While I don’t have any real capital invested in these stocks, I do find it important to maintain some degree of responsibility for stocks that I suggest on The Curious Investor and, thus, I will continue to follow this dividend strategy and provide my commentary on it.

Here’s a table with a breakdown of performance over the last month and since inception on August 28, 2007. I’ve compared performance to the S&P500 as well as a mutual fund with similar investment objectives to this strategy, the Cullen High Dividend Fund (CHDEX).

	S&P 500	CHDEX	CIEIS
November Return	-4.40%	-5.89%	-0.07%
Return Since Inception	3.41%	1.25%	-1.43%
Dividend Yield at Inception	3.89%	1.87%	4.69%
Current Yield	3.87%	1.78%%	4.33%

As you can see above, the Curious Investments Equity Income Strategy has underperformed since inception a few months ago, though this strategy was designed with an investment time frame in excess of 1 year so it is not necessarily time to judge the efficacy of the strategy just yet.

There are some things to be happy about though. The portfolio was structured at its inception to have a balance of stocks trading at deep value and stocks trading with strong momentum both in operational performance and in stock performance. Further, while the portfolio only has five stocks, they were chosen such that there would be diversification across industries in hopes of smoothing near term volatility.

Over the last four months, the portfolio has traded roughly flat with maximum appreciation of 1.69% in a month and maximum depreciation of 2.91% compared with a range of -5.89% to 5.08% in CHDEX and -4.40% and 4.74% in the S&P 500. It would seem that the construction of this portfolio has done an adequate job of smoothing near term volatility. So, while performance thus far has lagged the two benchmarks I’ve chosen, I believe that, given the turmoil in financial markets over the last few months, this portfolio’s performance has been admirable for its purposes. Provided we see acceptable capital appreciation by the end of the year.

Abbott Labs (ABT)

Abbott Labs is the best performing stock in the portfolio up nearly 15% and, on a technical basis, it would seem that the stock is quickly approaching the ends of an intermediate term base and would be poised for a breakout above $59.50 which would also represent 52-week high.

Abbott Labs is one of the top performing big pharmaceutical companies from a revenue growth stand point, though quarterly earnings growth does not seem to have followed suit. Cash flows have been erratic over the last few years so its hard to get a sense of general trends. If I were truly invested in this stock, I would want to take a look at what Abbott seems to be doing that is resulting in rather irregular financial performance. While the trailing twelve months P/E is in the high 40s, this is due to a huge nonrecurring expense in Q4 2006. Forward P/E on Abbott Labs is actually just 18 and thus the company is trading at only a small premium to other industry giants such as Merck and Novartis.

Autoliv (ALV)
After a GM announcement to buy more auto safety products from Autoliv in late August, the stock went on a tear through September and October. The rally seems to have sputtered out quickly in November and the stock is now trading back at its end of August price range. Were this not a long-term portfolio, I would have sold this stock earlier this month. But, since there has been no significant negative changes to this stock’s operational performance or its dividend policy, I will continue to hold through the year.

Bank of America (BAC)
Bank of America’s stock has been hit hard as has nearly every other financial company over the last month. It seems that subprime turmoil is far from over and I may have been a bit pre-emptive on my purchase of Bank of America. Part of me was drooling at the near 5% dividend the stock carried in August. It turns out, the stock is now trading with a 5.6% dividend. And, it is trading at valuations well below the Graham Number (P/B * P/E = 22.5). One can never know when this financial turmoil will end or when banks will finally recover but, given enough patience, it would seem that Bank of America is a fail safe investment. Collect 5% dividend and wait for the stock price to soar as the market corrects back towards and above fair valuation.

Vector Group (VGR)

It would seem that the purchase of Vector Group at the top of its recent uptrend was a risky proposition. After all, stock purchases are all about “buy low, sell high.” Vector Group, however, boasts a 7% dividend and to me this meant that the company had recently materially improved its financial condition and, thus, management had increased dividend payout. In that sense, I would say worst case for Vector Group’s stock was a period of P/E contraction, or base formation, in the near future and not a free fall depreciation in the stock price. Thus, I bought for this portfolio happy to collect dividend and wait for whatever future price movement was to come. It would seem from stagnant performance in the stock over the last month, that Vector Group’s stock is in fact hitting a proverbial base and time will tell where the stock goes from there. Until then, 7% dividend is quite an acceptable return especially from a stock which pays on a quarterly basis.

Masco (MAS)
My original investment idea on Masco was that the company had been hit hard, as many home furnishings manufacturers have, due to the housing market slump, but that it had the qualities to better withstand the housing market slump and lead any future rebound. I believed that since Masco’s offerings include things like paints and stains as well as international efforts, the US housing slump might not have as great an effect on Masco’s performance. Unfortunately, I was not entirely correct. Barring the recent gains on its quarterly earnings report, Masco’s stock did not bottom as I predicted, but fell severely.

That being said, Masco’s prospects do seem to be brightening. In its recent earnings report, management indicated that earnings were flat from the year ago quarter. Not usually a good thing, but a win for a company forecasted to have double digit earnings declines. Furthermore, it pointed towards results on the high end of its yearly earnings guidance.

The good news through all of this is that Masco’s operations are pointing towards its problems bottoming. The company has maintained margins despite lower sales and has made smart acquisitions to broaden its product offerings and help to offset some of the damage the housing slump has done to its core business.