His investment philosophy page starts with one of my favorite Warren Buffett quotes:
“Time is the friend of the wonderful business, the enemy of the mediocre…It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Todd’s overall investment philosophy likely aligns closely with many long-term dividend growth investors. His investing philosophy is outlined in the 5 bullet points below:
- Maintain a patient, long-term mindset
- Own companies with economic moats that are good stewards of capital
- Keep trading costs to a minimum
- Avoid investing fads
- Pay attention to dividends
Without further ado, my interview with Todd is below. Please note that Todd’s opinions expressed here are his own and not those of his employer.
You have an impressive investing background. Please tell my audience a little about yourself and your investing background.
Well, I’ve been very fortunate to work for some great companies and with some excellent investors and analysts. I’m also very lucky to have gotten my foot in the door at Vanguard out of college.
I didn’t know a thing about investing and Vanguard took a chance on me as an entry-level registered representative. Though being on the phone all day wasn’t all that enjoyable, I got to talk about the Vanguard funds and speak with thousands of private clients. It was a great way to learn.
Frankly, I can’t think of a better place to begin your investing career than at Vanguard. You’re immersed in the right type of lessons from the start – costs matter, diversify, put clients first, simplify, stay the course, and so on.
The Jack Bogle school of investing, in other words. Even though I’m more of an active investor, those lessons have stuck with me and served me well. Being a long-term investor, for example, you naturally keep trading costs and taxes down, both of which are performance drags.
After Vanguard, I moved to the Washington, D.C. area and took a job with SunTrust Asset Management, where I helped portfolio managers manage high- and ultra-high net worth client accounts. It was there that I saw first hand how powerful dividends can be.
Some of the clients and their descendents were living off dividends from investments made 30-plus years prior. I thought that seemed like a good model to emulate: buy good companies, stay interested, be patient, and reap the benefits later.
My next job was with The Motley Fool in Virginia and later in the London office. Like Vanguard, the Fool is a tremendous place for a young investor to learn. You’re empowered to make important investment decisions and openly share your opinions with the public – two things typically reserved for only the most senior analysts at other firms. It’s the best way to learn investing: put yourself out there, make tough decisions, get feedback, and improve.
My next stop was at Morningstar in Chicago, where I worked as a sell-side analyst for 3 ½ years, covering the paper and packaging industry. Working side-by-side with very intelligent analysts who lived and breathed economic moat analysis was another great learning experience. I was also lucky to lead Morningstar’s equity stewardship methodology where I examined how management teams allocated capital.
Last year, I moved back to my hometown of Cincinnati, Ohio to work for Johnson Investment Counsel, where I’m a buy-side analyst.
It’s been an eventful and fun 13-plus years in the industry. I can’t imagine doing anything else.
Would you classify yourself as a dividend investor, value investor, or something else entirely?
I would classify myself as a business-focused investor. I want to own great businesses, pay a good-to-fair price for them, and let time and compounding do the heavy lifting for me.
What I mean by a “great” business is one with durable competitive advantages, a skilled management team, and a solid balance sheet. The vast majority of the companies that interest me pay dividends, as I think there’s something to be said for a company that consistently generates a lot of cash and shares its wealth with shareholders.
That said, I wouldn’t not invest in an otherwise great business just because it doesn’t pay a dividend today. Such companies could prove to be tomorrow’s dividend superstars, after all. Every company eventually enters the mature growth phase and winds up having more cash than they can appropriately reinvest.
What motivated you to write Keeping Your Dividend Edge?
Given all the interest in dividend income in the low-interest rate environment, there’s naturally been a lot of discussion around the topic. As I read other books and articles, I felt much of the discussion around dividends was missing three major factors, all of which I wanted to address in the book.
First, the rise of buybacks as an alternative means for returning shareholder cash has changed the dividend landscape in some important ways. Not necessarily for the worse, but it’s changed nonetheless. Today’s investors need to know how their companies prioritize buybacks and dividends and how well management executes on buybacks. Buybacks can help drive dividend growth, if used properly. The trouble is that many management teams lack a cohesive buyback strategy and have lackluster track records of repurchasing their stock at good-to-fair prices.
Second, competition has intensified due to globalization and the rapid pace of innovation. Even the bluest of blue chips today aren’t immune to disruptive threats, so it’s no longer enough to buy blue chip dividend payers, not look at them for 30+ years and hope everything works out. I’m all for patience, of course, but I also think it’s important to keep tabs on your companies’ competitive positions over time.
Finally, I think the swath of dividend cuts incurred during the Great Financial Crisis altered the way companies approach their dividend policies. In the event of fundamentals deterioration, all else equal, I believe companies are more likely to cut their payout than they were pre-financial crisis. And indeed, we’ve seen a rise in dividend cuts over the last 12 months or so, primarily in the energy and commodities space, even among companies with investment-grade balance sheets. In the book, I use a few case studies – Tesco, Pfizer, and Exelon – to illustrate how investors might spot red flags before a dividend cut occurs.
The book aims to provide investors with tools for understanding and thriving in this new landscape.
What are the 3 most common mistakes you see dividend investors making?
Reaching for yield, relying too much on a company’s dividend track record rather than what the company’s capable of paying in the future, and not considering valuation.
Do you use quantitative metrics to evaluate a company’s management’s effectiveness, or in your view is it strictly qualitative?
It has to be a mix of both. If you’re making a long-term investment in a company, it’s critical to gauge whether or not you think management has integrity. You can’t make a good deal with a bad person, after all. This is primarily a qualitative exercise – does management do what they say they’re going to do? Do they put shareholder interests first? Have they sacrificed short-term results for long-term benefit? And so on.
It’s also instructive to analyze figures like return on invested capital when evaluating management skill. Have management’s capital investments and M&A decisions led to improved ROIC or are they diluting shareholder value with each transaction?
How do you determine the relative size of an ‘economic moat’ when looking at high quality businesses? Do you define this quantitatively, or qualitatively?
Again, it’s a little of both. You can look at a company’s profit margins, returns on equity or invested capital, and free cash flow generation and get a pretty good picture of whether or not the company at least had a durable advantage at one point.
The big question, though, is whether or not the company will be able to keep its durable advantages – often called “economic moats” – for the next ten years or longer. Much of that work is qualitative.
This is where being a business analyst comes into play. For example, understanding the competitive dynamics within an industry, how the company aims to fend off competition, how it might improve its position, and so on. If a company has multiple sources of advantage – let’s say it is a low-cost producer and benefits from valuable patents – then I would say the company has a “wider moat” than a company with just one moat source.
When to sell dividend stocks is not discussed often enough. What are your thoughts on the best time to sell a dividend stock?
I would sell a stock for one of three reasons. First, my thesis is broken – something has fundamentally changed at the business and what I originally thought has been proven wrong. I’ve found it helpful to keep an investments journal outlining the reasons why I bought the stock and why I might sell it. That way, if circumstances change, I can quickly review my original thesis rather than rationalize the troubles away.
Second, the stock has become significantly overvalued. I say “significantly” because you generally have better odds of determining whether or not you own an attractive business than guessing where the stock will trade six months from now. Valuation is also part art and science, so you need to be aware of false precision – that is, running a valuation model and saying, “This company is worth exactly $43.12,” – when it’s more instructive to think, “This company is worth somewhere between $40 and $45,” based on a range of reasonable assumptions. As such, I’d be hesitant to sell if a stock’s just slightly overvalued. There are circumstances, however, where there’s an overly-cheery consensus in the stock and it’s trading for $1.25 or $1.30 when you think it’s worth $1. Then I might be inclined to sell and look to buy again later once enthusiasm dies down a bit.
Finally, I’ll sell if think I have a much better place for the funds. This is a high-hurdle decision, though, and I must have pretty strong conviction in the new idea.
What is your opinion on the taxation of dividends in the United States?
In an ideal world, dividend income and capital gains taxes would decline over time to encourage long-term investment.
Back in the real world, however, I would encourage investors to practice smart asset “location” to limit tax drag. That is, to the extent possible, think about putting higher-yielding stocks in a tax-advantaged account and lower-yielding or no-yield stocks in a fully taxable account.
A CPA (certified public accountant) can help with this if you have a more complex tax situation, as each person’s tax situation is different, of course.
How long did it take you to write Keeping Your Dividend Edge?
About six months, start to finish. One of the nice things about self-publishing is that you can write, edit, and publish at your own pace.
What in your opinion is the most important piece of advice in Keeping Your Dividend Edge?
Be patient but vigilant.
Thanks for taking the time to do this interview. One final question – Do you think dividend investing will still be around (and as popular) 100 years from now as it is today?
Interesting question. The core philosophies of dividend investing will endure, though I’m sure the environment will continue to change. The investor in 1916 couldn’t fathom how much the stock market and corporate finance have changed in the subsequent 100 years. We’re in the same boat today, I reckon.
That concludes our interview.
Keeping Your Dividend edge is currently available on Amazon for those looking to explore Todd’s interesting work in greater detail.