My investment approach for long term growth is primarily based on dividend growth methodology. Where do my dividends get paid from? It is the combination of profitability, cash flow, income, prudent money management, etc. With the current state of economy in United States (and other parts of the world) majority of the corporations are facing negative growth. In such a scenario where will I get my dividends or dividend growth from? Dividend growth investing is about a long haul like running a marathon (instead of short dash to finish line). However, in these challenging environments dividend investors need to look at the macro economic scenario and understand how it will play out in long haul over a period of next 10 years to 20 years. Let me begin with my thoughts on some of the key dooms day scenario being widely discussed in this economic environment.
At a very basic fundamental level the root cause of today’s economic malaise is free credit to everybody. No matter how many crime scene investigators we get, it can be traced back to availability of cheap money. Whether it is free credits, our penchant for cheaper products, cheap manufacturing goods, cheap labor, and so on. At hindsight, had this free and cheap money been managed and controlled in prudent manner, the situation would have been completely different. Isn’t it ironical that government and bureaucratic leaders are using the same very tool that destroyed it, i.e. cheap money, to solve it? I believe we will need to come out of this bankrupt approach otherwise we will continue to see more pain coming our way.
Continuing further, the President is persistently using his oratory skills for fear mongering. I really do not understand what our leader is trying to tell us by continuously instilling fear of dire straits, constantly reminding we are on verge of another depression era, and nearing collapse financial system. Every nation in this world wants to do business with US because of its strength in free market system, strength of its institutions, innovative and entrepreneurial business environment, and open minded consumer base. However, when the head of nation is projecting negativity, why would world want to listen to US, why would they invest or do business with US. Won’t they lose confidence? President needs to create an environment of confidence by his actions, provide a roadmap for recovery, and demonstrate by execution. I continue to believe that in near-to-intermediate term, i.e. next 12 to 20 years, US will continue to be focal point and driver of the global economy. History shows us that every bust is followed by a boom albeit of a different economic form or shape or pattern. Looking back 100 year or more we can see boom and bust in different sectors such as first in textile industry, then infrastructure industry, then automobile industry, then space and airline industry, then hardware and software industry, and finally real estate and financial industry. I would agree that functioning of institutions, relationship with other economic centers, and its role will be different. The US GPD may shrink couple of trillion dollars from 13 trillion, but still it will be the largest economy. In US, the shifting pattern of demographics combined with free market system, democracy, rule of law, and entrepreneurial environment will throw open new growth sectors and a newer business environment.
Continuing further, we have another school of thought which says BRIC nations will be the driver the global economy. I would go only so far as saying that for next 12 to 20 years, BRIC nations will be the catalyst in global growth. I am still skeptical about BRIC nation’s ability to provide leadership to the global stage. China still has a long way to go in demonstrating trust among in own people first and then among League of Nations. History suggests that world domination comes only after prosperity of its own citizens. A nation cannot dominate beyond its borders with struggling and constrainted population. Similar issues plague Russia. Brazil is still just a potential and needs to show political maturity and independent thought at world stage. The real contender, India, is too diverse, too much democratized, and busy with inconsequential bickering with neighbors. Both India and China will need to show their supreme colors in regional affairs before they can be the captains of global teams. While in long term evolutionary basis, 30, 40 years down the line, one may see the change, but I don’t expect this to see within 20 years time frame.
Continuing further, still another school of thought is demise of US dollar. Surely, there may be some rational logic behind its hypothesis and I would agree to most of them. However, there is fundamental flaw in this chain of reasoning. While there is lot of talk of demise of dollar, it does not talk about its replacement? Which currency in the world will replace US dollar? The oil Dinar is too monarchy, Chinese Yuan has trust issues, Russian Rubble is too baron-istic, Japanese Yen is not supported by economy, and Indian Rupee is still searching an its identity and role at world stage. The nearest contender is European Euro. But it is still in its infancy, in a sense that it still needs to shows its resilience amidst fragmented political landscape and various global economic cycles. Just 8 months ago three oil men started purporting the replacement of dollar-based world oil trade with either Euro or Yen. What happened? I don’t think this was first attempt in recent past.
With this contextual background, and on a relative global economy basis, I continue to believe in the fundamental strength of US economy. I do see that at world stage the alternatives to the US economy are developing, but they are still not there to take its place. There is still quite a bit of time left (perhaps a generation) before that happens. Here in US we are facing some head winds and perhaps may continue to do so in near future. I cannot predict when this will end. Once this ends, the way we look at economy, the business environment, and institutions may have different forms and operating procedures, but in the end they will continue to exist. I can say that in next 10+ years, there will be quite a large number of corporations that are still standing on their own strengths. Dividend investors need to continue to look for them and invest in them.
As a dividend investor, my favorite hunting ground is the list of dividend aristocrats. One can see that they have had a pretty decent ride for the last 30-40 years on the back of growth in US economy. Along with the US economy, these companies were consistently growing their revenues (and hence the earnings). Managements consistently shared this bounty with the share holders. Now today, in general, dividend aristocrats as a group are struggling to find new source of growth in revenue and earnings. Most of the dividend aristocrats (not all of the companies) are focusing to increase earnings from internal efficiencies or cost reduction initiatives, because they are hard pressed for growth in revenue. How long this can continue? Dividend investing is long term process. Therefore, I foresee that the pool of companies in dividend aristocrat will continue to churn. For every corporation that looses aristocracy status, there is large list of dividend champions and dividend achievers waiting in line to grab aristocracy status.
For dividend investors, this is where El-Erian’s notion of world collision comes into play. According to the author, emerging markets will be growing faster and provide higher contribution to earnings in next 30-40 years. In that case, doesn’t it make sense to sow some seeds by investing in dividend-based companies in emerging markets?
One of the issues for dividend investors is that there is very little public information on companies in foreign markets. If companies do not have ADRs then it is difficult, if not impossible, to find the details of such companies. Additionally, the regulatory framework and governance may not be as advanced as developed world. Here I am comparing the basic minimum requirements and not a full-proof system.
Other way to look at this is US companies or multinationals who get most of their earnings from foreign markets. Such companies have operating history, dividend payment history, management’s performance, presence in US markets, etc. A recent study (read here), dissects source of earnings for top 10 companies in S&P500 index. This article brings out the fact that top 10 companies by weightage in S&P500 index (with approximately 22% contribution to index) derive 44% of total financial contribution from foreign markets. It is likely that if we dig deeper, we will find more such companies and this 44% contribution may even surpass 50% cumulatively for all S&P500 index companies. While we do not have the same investment vehicles as used in El-Erian’s example, the Harvard Endowment Fund, dividend investors surely have US-based companies and/or multinational companies. Investing in such companies provide a very good proxy for investing in international and/or emerging markets.
For dividend investors, this is a good fit into my observations above that emerging markets will be catalyst for growth. Also it helps us build dividend portfolio using the existing US financial infrastructure.
In summary, even though we are passing through the dark economic tunnel and we may not see light, but eventually we will come out of it. There is no dead end, world still needs food, roads, energy, consumables, security, etc. The US economy and US/developed multinational corporations with sustainable business models will continue to play a significant role and continue to be profitable. Investors need to follow them, monitor them, and as individual situation allows continue to invest in them.