You can find out everything you need to know about a stock from its price chart: That’s a Wall Street adage frequently cited by market technicians over the years, and I for one fully agree with it.
The trick is finding the right interval of time to measure. And more times than not, that’s not nearly as easy as you might think.
Take, for example, the performance of Enterprise Products Partners LP (NYSE: EPD), now the largest master limited partnership (MLP) owning energy infrastructure in the US. An investor looking at a 12-month price chart would see a stock that’s been generally in an uptrend, though one punctuated by a few sharp up- and down-moves. His or her conclusion would be that Enterprise Products is a healthy and indeed growing company.
Someone looking at a chart of the prior 12 months, however, would likely arrive at a far different conclusion. Starting in mid-2008, Enterprise units plunged sharply from $30-plus to the high teens a few months later. The price then bounced along at that level before recovering to the mid-20s.
Of course, Enterprise’s extreme volatility that year was part and parcel of the historic credit crunch/market meltdown and the recovery that began in March 2009. The climate of fear surrounding that debacle claimed even highly rated corporate bonds as victims, leaving only US Treasury bonds as beneficiaries.
Viewed in a vacuum, however, Enterprise’s unit-price performance during the crisis was alarming indeed. And sadly, more than a few investors bailed out then at horrific lows, taking it on faith that the unit-price plunge signaled the collapse of yet another high-dividend-paying company.
What kept us from making the same mistake was the business numbers Enterprise kept putting up, even though the world seemed to be collapsing around it. The most important numbers were the continuing quarterly dividend increases, as management continued to generate rising cash flow from its growing base of stable energy infrastructure assets.
Dividend growth was clear evidence that Enterprise was still rock-solid, and that its market value would recover when Wall Street stabilized. Unfortunately many investors viewed things differently. That is, the ongoing dividend increases were no compensation for the pounding Enterprise was taking in the market. Deciding that was more than they could bear, they sold out and locked in their losses–and have no doubt come to regret their move ever since.
Enterprise is far from the only example of a rock-solid business that took an extreme beating in 2008, only to lift off to new highs by 2010. The mayhem of that year mauled smaller fare like Atlantic Power Corp (TSX: ATP, NYSE: AT) far worse. The owner of stakes in US power plants and power lines touched a low of barely $4 in November 2008, ironically the very day it announced a dividend increase. Shares today, however, are now more than three times that level.
That positive story of weathering the worst US credit/economic/market crisis in 80 years is told clearly by Atlantic Power’s price chart of the past two years. And the company’s success adding cash-generating assets is painted clearly by the picture of its one-year price chart.
The same holds true of Enterprise, and it’s an accurate picture for both companies, which continue to build rising cash flow streams for investors. Enterprise Products, for example, has now boosted its payout 24 consecutive quarters and shows no signs of slowing down.
Atlantic Power, meanwhile, now projects it can pay out at the current rate under an absolute worst-case scenario into 2016–even if current power sales contracts expire and aren’t renewed and management finds no new projects worth investing in. This is an as yet unusual way for companies to present data on dividend safety. But Atlantic has increased the target from 2014 to 2016 this year already, in part to the addition of a stake in an Idaho wind farm that will sell power to the local utility at generous rates for 20 years.
I remain very bullish on both companies’ ability to generate wealth, in large part with a growing stream of distributions. Enterprise has the added advantage as an MLP of being able to pay out a sizeable chunk of its distributions as a return of capital (ROC). ROC isn’t taxed when paid but rather is deducted from an investor’s cost basis. Taxes are only paid when the MLP is sold, and then only at the rate for long-term capital gains. Atlantic is a corporation but has the added advantage of paying dividends in Canadian dollars, providing a natural hedge for US investors against the US dollar.
My larger point here, however, is the price charts for Enterprise and Atlantic do paint accurate pictures for these companies, if you use the correct interval to gauge. Conversely, however, the charts at other times and intervals have presented an extremely misleading picture of the underlying health of these companies and their wealth-generating potential.
That’s definitely food for thought when considering the health of individual stocks as well as that of the overall US market and economy. All summer, stocks have rocketed up and down in response to the prevailing market view on the economy. The fading of worries in response to solid corporate earnings in the second quarter triggered the sharp rally of July, wiping out losses from the May Flash Crash. Fears that US and in fact global growth are fading are behind the renewed selloff of the past few weeks.
The result is a picture for the market where the facts can be shoved into just about any theory or forecast. A six-month chart of the Dow Jones Industrial Average, for example, looks decidedly bearish, with the peak of early May followed by a downward progression of successively lower highs and lows. A one-year chart of the Dow 30 is less clear, as something like a classic “head-and-shoulders” top in spring was broken by the July rally. The two-year graph looks a bit better, while the five-year shows a market still well below the high set in late 2007.
Clearly, it’s been difficult to make money buying market averages the past 10 years. History, however, shows many such times over the past century–including the 1970s, when runaway inflation made real returns even worse than those we’ve seen recently. And encouragingly, they’ve always been followed by further periods of growth and powerful market returns.
Will this time be different? Has America’s boom time ended? This past weekend, not one but two groups staged rallies in Washington, DC, and about the only thing they agreed on was that things were going wrong in the country and needed real change.
That’s a mood that seems to be reflected throughout the US and along all political persuasions. If polls are to be believed, for example, Republicans will pick up numerous seats and quite possibly control of the US Congress in the upcoming midterm elections. Yet many of those same polls show that Republicans as a party are still less popular than the Democrats.
What kind of climate that creates this January in the nation’s capital will be interesting, to be sure. It’s likely to make things more hospitable for extending preferential tax rates for dividends and capital gains–visit www.DefendMyDividend.org and sign the petition if you haven’t yet–and less so for environmental causes. Beyond that, it looks like compromise will be the only way any changes will be made, which history shows is usually a positive for investors.
Today’s political mood, however, runs completely parallel to the fear that continues to reign supreme in the stock market. And more than anything else, it remains the story behind the picture of US stock market performance.
Emotion is always the greatest enemy of rational investment decisions. Sometimes, greed will cause investors to overpay for some stocks and overstay in others. But right now, fear is the overwhelming sentiment among investor. And the greatest mistake being made involves selling solid positions at low prices while ignoring obvious facts.
Today’s Wall Street Journal, for example, ran a story titled “The Decline of the P/E Ratio.” The conclusion, stated plainly in the first sentence, is that price-to-earnings ratios (or any other measure of valuation for that matter) aren’t worth paying attention to anymore, as “investors fixate on the global forces whipsawing the markets.” The author went on to invoke the 1930s as an example of when “economic uncertainty” outweighed value concerns.
That’s pretty scary stuff, particularly for income investors who by nature have to buy and hold to collect their dividends and interest. Fortunately, it has little or nothing to do with successful investing, at least for those who take the time to pick their own stocks and don’t settle for betting on market averages.
Again, the greatest example is right in front of our eyes: The 2008-09 crackup and the price charts of the dividend-increasing companies that weathered it. The Atlantics and Enterprises of the world went down with the selling. But when the market stabilized, investors did come to recognize their value and pushed them to new highs in short order.
The key for them as companies was that strong underlying businesses that weathered the tough macro environment also enabled them keep on paying and growing their outsized dividends. The key for their investors was recognizing their value as businesses, which ultimately transcended the headlines.
That’s still the key now. Headlines or no headlines, if a company’s business is still generating the cash to grow its dividend, it will keep paying out to its investors. The companies that have kept paying us the past two years have proven their mettle in the worst environment in 80 years. That’s no guarantee they’ll do it again in a future debacle, but it’s about the best possible indication they will.
Question of the Week
- What’s going on at Yellow Pages Income Fund (TSX: YLO-U, OTC: YLWPF)? I read the second-quarter earnings report, and it looked good, but the stock has gone down this month.
The Yellow story is slightly different from the cases of Enterprise Products and Atlantic Power. But it makes much the same point of how economic worries are affecting stock prices.
Yellow’s underlying business has been affected to a far greater extent by the recession than either Enterprise’s or Atlantic’s. The main reason is the rapid changes affecting the directory information business and the varying success of management’s attempts to deal with its impact on revenue.
Unlike US directory companies, Yellow was quick to recognize the rise of the wireless Internet as a substitute for printed directories, and that businesses would shift advertising budgets accordingly. Starting almost from the time it was spun off from BCE (TSX: BCE, NYSE: BCE) in 2002, the company began a massive migration of its business to the web. As a result, it’s been able to grow its Internet directory/advertising business at a faster rate than its print business has declined.
Online revenue is now 25.6 percent of its overall business and grew at a 16 percent rate in the second quarter, even excluding the impact of acquisitions. And management looks for that growth rate to accelerate in the second half of 2010, thanks in part to new product introductions. Overall distributable cash flow and revenue were flat in the second quarter versus year-earlier levels.
Where management has been considerably less successful is in its efforts to grow certain specialty publications, notably those specializing in automobiles and real estate. These were understandably badly hit during the 2008-09 contraction; their pain was the main reason Yellow cut its distribution by nearly a third in June 2009.
There are signs of recovery, but they would be battered again by any future economic slump. Management itself has cited concerns that small and mid-sized businesses remain cautious on their spending. That’s one reason why so many brokerages have reduced their estimates for earnings of late, which in turn is the main reason why the stock has slumped since hitting a post-2008 crash high in late April.
Ultimately, this volatility will prove meaningless if the company can stick to its dividend target after it converts to a corporation. This event is now expected to take place on Nov. 1, at which time the company will be renamed Yellow Media Inc. The company will also reduce its current monthly dividend of CAD0.0667 to a new rate of CAD0.0542.
The new annualized rate of CAD0.65 equates to an extremely generous yield of 12.5 percent after conversion. But with no buys, eight holds and one sell among the nine analysts covering Yellow, the implication is obvious: There’s a lot of doubt the company will able to hold the new rate after conversion.
Yellow’s second-quarter distributable cash flow covered its current distribution by a 1.75-to-1 margin and the post-conversion payout by 2.15-to-1. Meanwhile, management introduced a target of CAD0.95 to CAD1 per share in cash earnings for 2011, which would produce a payout ratio of 65 to 68 percent, comfortable dividend coverage that would also enable acquisitions, debt reduction or share buybacks.
The bet Bay Street appears to be making is that economic conditions will force Yellow to do again what it did in 2009: Slash forecasts and therefore its distribution. Such low expectations mean a successful bet against them will be extremely profitable.
It all boils down to Yellow’s numbers and whether management can continue to produce. If it can, the stock’s a super value no matter how gloomy the economic headlines become. If it can’t, there’s likely to be more downside. And that risk is why most investors are best off just sitting tight with what they have rather than really loading up.
Editor’s Note: For additional information on this topic, check out Roger Conrad’s latest report on High-Yield Dividend Stocks.
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