Streetwise for Friday, August 2, 2019
As many readers of this column are aware, mutual funds, either bond or stock, are not among my favorite investment vehicles. Therefore, it was interesting to note the following from a recent article in the New York Times.
Dalbar, a Massachusetts research firm that has been studying the behavior of mutual fund investors for 25 years, recently reported that over the past year, and for periods of five, 10, 20 and 30 years, the average mutual fund investor has underperformed the markets for both stocks and bonds. Bond investors have generally failed to even keep up with inflation.
In the 30 years through December 2018, for example, Dalbar found that the average bond mutual fund investor earned 0.26 percent, annualized, as compared to an annual inflation rate of 2.49 percent. Over the course of an entire generation, bond investors’ money shrank more than 2 percentage points a year in real terms.
This miserable record is not necessarily the fault of the bond market. The benchmark Bloomberg-Barclays Aggregate Bond Index returned 6.1 percent, annualized, over those 30 years. If you had held an index fund that simply tracked the bond market you would have earned about 6 percent a year, fees included.
The Dalbar results for 2018 are especially painful. The inflation rate was 1.93 percent, so investors would have had to earn that just that to tread water. Instead, the average stock fund investor lost 9.42 percent, for a gap of more than 11 percentage points.
Bond fund investors did a bit better. Their average investments declined “only” 2.84 percent, so they lagged inflation by more than 4.7 percentage points.
Data for stock mutual funds, when compared to the S&P 500 index, underperformed the index through Dec. 31 of last year by 5.88% over 30 years, 3.46% over 10 years, and 4.35% over five years.
In other words, the average stock mutual fund investor has lagged the stock market, while investors in bond mutual funds haven’t kept up with inflation.
Ok, so what about dividend paying stocks, a mantra that has been discussed here on numerous occasions. Looking at what are referred to as the Aristocrats, or stocks that have been raising dividends for at least 25 years of which there are 57, earned their keep in the first half of the year with a solid overall performance…even though they lagged the market.
Through June 24, the S&P 500 index had a year-to-date return of 18.7%, compared with just under 16% for the Dividend Aristocrats. The Aristocrats also held up relatively well during last year’s fourth-quarter market rout. They returned a negative 8.6%, compared with a negative 13.5% for the S&P 500.
A basic weakness of the Aristocrats is that there are too few from which to choose. Reducing the selection criteria to 10-years of increasing dividends increases the field to 267 candidates.
Regardless of which of the two universes you might decide to select from, keep in mind that you are only performing an initial cut of companies to be investigated. From there, two other critical steps are necessary.
The first is to determine the intrinsic value of any company you select, whether it is from a dividend achiever, an aristocrat, or even a company that does not fall into either of those two categories.
As I have described previously, you want to perform a discounted cash flow analysis, on a specific parameter, such a free cash flow to the firm or the dividend flow if the company pays dividends. You want intrinsic value higher than the current share price by about 5% or more.
One web site that will calculate the free cash flow to the firm intrinsic value is ValuePro.net. However, some of the data for a company may need to be updated. Keep in mind that you are looking for a relative value. Whether the intrinsic value is 8% or 12% or 37% higher than the share price is somewhat irrelevant.
If the answer you receive using ValuePro is not consistent with what you would like, check the data being used carefully. Finally, remember that you still need to evaluate a company’s financial performance. Intrinsic value alone is a good start but is not enough.
Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com. Phone calls accepted between 9 AM and 3 PM at (941) 706-3449. For back columns please go to www.RuddReport.com.