SA Credit Spreads vs SA Actuaries Yield Curve; Apple(Buy); Retirement and your NAV.
Warwick Langebrink
Acacia fixed Income analysis for October: (If you want to unsubscribe from this bi-weekly / monthly analysis, please send me an “UNSUBSCRIBE”)
· Yield curve rates have dropped 20 – 30 basis points since the beginning of October (particularly in the long end of the yield curve) – Investors have been moving from equities into fixed income. Increased foreign investments into SA bonds (higher demand for SA bonds causes yields to drop), and consequently the Rand has strengthened from around 11.20 to 11.04 ZAR:USD.
· Corporate Bond yields have followed suit. Corporate Bond yields have decreased.
· Credit Spreads (the spread (or distance) of Corporate Bonds above the yield curve) remain high.
· Included below are two articles that I found interesting from Seeking Alpha:
o Retirement Strategy: Apple Could Conceivably Double Its Dividend By 2016 (Article included below)
o Retirement Investing For Income ONLY: Doing It The Right Way (Article included below)
Kind regards
Warwick Langebrink
+27 11 268 0530 (SA)
+27 82 610 0444 (mobile)
Retirement Strategy: Apple Could Conceivably Double Its Dividend By 2016
Oct. 21, 2014 11:19 AM ET | 71 comments | About: Apple Inc. (AAPL)
Disclosure: The author is long AAPL. (More...)
Summary
· If any one company has the complete ability to become a future dividend aristocrat, my pick is Apple.
· Another astonishing quarter will also increase cash reserves.
· As far as I am concerned, the stock is cheap right now.
I have the same crystal ball as everyone else, yet it was not that difficult for me to write this article just a few days ago on my opinion of Apple(NASDAQ:AAPL) as a future dividend aristocrat. Of course, it was not about the virtues of its products, both old and new, but on the staggering return of shareholder value that led me to forego adding shares of any current dividend aristocrat to the BTDP and to increase my holdings of AAPL shares.
Now we have confirmation from its latest blowout earnings report that this company has virtually no equal when it comes to revenue growth and earning power.
Apple® today announced financial results for its fiscal 2014 fourth quarter ended September 27, 2014. The Company posted quarterly revenue of $42.1 billion and quarterly net profit of $8.5 billion, or $1.42 per diluted share. These results compare to revenue of $37.5 billion and net profit of $7.5 billion, or $1.18 per diluted share, in the year-ago quarter. Gross margin was 38 percent compared to 37 percent in the year-ago quarter. International sales accounted for 60 percent of the quarter's revenue... "Our strong business performance drove EPS growth of 20 percent and a record $13.3 billion in cash flow from operations in the September quarter, said Luca Maestri, Apple's CFO. We continued to execute aggressively against our capital return program, spending over $20 billion in the quarter and bringing cumulative returns to $94 billion."
Simply astonishing, plus the forward guidance speaks volumes for next year as well.
· revenue between $63.5 billion and $66.5 billion
· gross margin between 37.5 percent and 38.5 percent
· operating expenses between $5.4 billion and $5.5 billion
· other income/(expense) of $325 million
· tax rate of 26.5 percent
When Seeking Alpha broke the news on its earnings and guidance, I found one comment to be of particular interest:
(click to enlarge)
If there is any one single person who has a handle on technology stocks, Ashraf has my vote. He says it was a "stunning result", I completely agree and second that opinion. The list is short of those companies who have ever had better quarters, and can be found right here.
(click to enlarge)
As noted in the comment above, it does appear that Apple could actually have the single largest quarterly earnings of all time the next time it reports. As you can see, it already holds 4 of the top 8 spots with that distinction.
So what does this mean for shareholders?
Remember this graphic?
Well you can toss it out the window for now. With the latest earnings report, Apple is now knocking on the door to having nearly $200 billion in cash and cash equivalents. During the company conference call, Tim Cook had this to say:
Our strong results continue to generate significant cash and we're extremely happy that this has enabled us to make substantial investments in Apple's future, while retaining - while returning cash to our shareholders.
Who would argue with this statement? Not me, which is why I believe that any dividend growth investor who seeks out future dividend aristocrats as well as owning the established ones cannot deny that Apple appears on its way to be part of the elite group of dividend aristocrat stocks.
That being said, Apple's current dividend yield of 1.88% does not show up on many DGIs' radar. Being beneath the magic 3%, which historically has kept up with inflation, has kept it off of many dividend growth investors' core holdings list. Basically the same issue as having a share price of about $700 before it split 7:1 earlier this year. Take a look at this article, which was written just after the company split its stock.
Looking back, it almost makes my opinion far too conservative, and as of now, I will make a prediction based on the current earnings, the forward guidance, Tim Cook's remarks, and my observation of the current dividend yield, as well as cash and cash equivalents.
My "Prediction" Based On Facts We Know, As Well As My Opinion
Within the next 2 dividend "increase" announcements, I believe Apple will be paying $.94/share per quarter in dividends, which is double its current $.47/share.
While I do not believe that the share price will wither away, it might come under pressure, as some genius analysts might see the latest earnings as yet another brilliant deduction that Apple has peaked, and therefore lower its ratings. I would say that on any dip, this will create a buying opportunity.
If my thesis plays out, by buying Apple right now and having its dividend increased to the levels I am predicting they will be, dividend growth investors will have their 3.00% yield very easily. On top of that, the share price should eventually top $140/share with just a 14 PE (the forward PE is currently 13.15), which reflects an approximate 40% increase just in its share price, to go along with a doubling of its dividend down the road.
As a matter of fact, the current 29% pay-out ratio probably will not move up at all. That also tells me that the dividend will continue being increased well into the future.
My bottom line? Apple stock is cheap, the company is still growing at an astronomical rate, and it has basically done everything any shareholder could possibly ask for.
As for Carl Icahn, the $200 share price he pegs Apple at right now could very well come to fruition without his personal agenda of having the company buy back (more) shares.
Apple should be in every single retirement portfolio, in my opinion, period.
Disclaimer: The opinions of the author are not recommendations to either buy or sell any security. Please remember to do your own research prior to making any investment decisions.
Retirement Investing For Income ONLY: Doing It The Right Way
Oct. 20, 2014 7:42 PM ET | 149 comments
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Summary
· The Pure Income method of providing long-term reliable retirement income is unique in its approach.
· Stock price is no longer the factor used in assessing the performance of a true income portfolio.
· The Pure Income method for long-term, reliable income is simple in concept but requires work to execute.
· Establishing investing objectives is the MOST IMPORTANT step in building a Pure Income portfolio.
· The Pure Income method will work for some retirees, but not for others.
This will be first in a series of articles on using the pure income method of investing for income during retirement. In these articles, I'll cover the following topics:
1. Should one consider using a pure income approach to providing reliable income?
2. The Pure Income Portfolio: The CORE, the ALTERNATIVES and the POISON Part I
3. The Pure Income Portfolio: The CORE, the ALTERNATIVES and the POISON Part II
4. Section Criteria for the securities of a pure income portfolio: a 7-Step Process
5. Income Diversification: The most important step in building a pure income portfolio
6. Collecting dividends, monitoring securities and having fun!
It is important to provide a small disclaimer at the top of this somewhat lengthy series of articles. It is NOT my intent to convince anyone that the pure income approach is the approach they should adopt in providing long-term, reliable income during retirement. My objective in this discussion is to clarify what I think the pure income approach is to providing life income, point out the inherent benefits and risks, and in so doing, and provide the retiree enough information to determine whether a pure income approach will work for them or not. For some, it will… for some, it will not. Operational information is only useful to the extent it allows for informed choices, and hopefully, this series of articles will facilitate informed choices.
A "Pure" income approach to Long-Term, Reliable Retirement Income?
Pure Income Investing for those whose goal is primarily (or entirely) reliable income over retirement years, is both a philosophy and a process. It is philosophical in that it requires the investor to adopt a new investment paradigm where the investment concern is no longer the risk of loss of value but has instead been replaced by the risk of dividend reliability. It is a process because there are procedures the investor must use to ensure the dividend will be forthcoming as planned… a process that does not involve the price of the security. Those who wish to adopt… or think they may wish to adopt… a pure income approach to providing reliable and consistent income must think about this carefully. Why so? Well, simply put, old habits are hard to break. There is a propensity to think of pure income in the context of total return. But in discussions to come, I'll demonstrate why the philosophy and process of pure income and total return are like oil and water: neither is right or wrong… they just don't mix together very well.
Go Ahead: Change My Life!!
The transition from employment to retirement is, in every sense, a "Life-Changing Event." This means that, like leaving our parents' home, marriage, a major lifelong illness, having the first baby or graduating from college, we're going to have to change how we are living. Most life-changing events happen to us, fortunately, when we are young. But for most, retirement is a life change that occurs later in life, when our elder-brains are less adaptive than they were during our first life-changing events. Retirement is hard on the brain, as we must now change our lifestyle from what we have adapted to and grown attached to over the years… and change it quickly. Gone are the commutes, professional working relationship dynamics, job travel and job goals and the anxieties/rewards that go along with them. Now these have been replaced by sleep-ins/stay-ups, serious hobbies, extended vacations, a 24/7 spouse, trying to remember what day of the week it is and recreating. But for most, the major change is the loss of the paycheck. How will this paycheck be replaced? Is there a pension? Some deferred comp? Social Security? Some form of life annuity? Or do we simply have our savings to look to and a bunch of tough decisions on what to do with it?
For those leaving employment with their life savings providing a large chunk of retirement income, there will be decisions that must now be made. Should the retiree seek out professional investment advice, and if so, from whom? Buy a low-worry income product from an insurance company? Self-manage investments by using what was learned while accumulating? One alternative getting attention these days might be to manage these savings for the pure income they can produce. New retirees may find this thought appealing. They don't have to consume the principal, they don't have to deal with what investments to sell, how much to sell and when to sell it. And perhaps most importantly, this concept seems easy to understand: buy the stock, collect the dividends and get on with retirement. "Hey, can I do that?"
Well, pure income investing sounds deceptively easy, as a "Dividend" is an easy concept to understand: Buy a fistful of income-producing stocks and watch those dividends come rolling in. Unlike Modern Portfolio Theory, the inbound cash happens automatically every month or quarter without all the portfolio-management-gobbledygook attached and after the trading commission paid in initially buying these stocks, over the quarters and years ahead, there are absolutely no direct or indirect expenses having to be paid! That's ZERO expenses!! "Yes indeed… I CAN do that!"
But at some point in this process, the retiree needs to wrestle with these thoughts: Where are those dividends actually coming from? Will they continue for the next month... quarter… year… 10 years? Will they grow to keep up with inflation? Will they be cut for some reason? Can a dividend cut be foreseen? If so, how? Now things start to get a bit more complicated. Is there a way to ensure that these nice dividends that flow so easily into my brokerage account each month will continue flowing? Well, yes, there is... but this is going to require some work.
But first things first... is a Pure Income approach even feasible?
What Have I Got and What Do I Need?
For most, this is an easy question. The total savings available to meet household income need may be entirely in their Traditional IRA (TIRA) plus perhaps retirement savings also held in a Roth IRA (RIRA), with little except perhaps emergency funds in a taxable account. Some will have little in IRAs and most in taxable accounts. Most will likely have a combination. And some will have savings in weird places such as limited access transference trusts, Sec. 409(a) deferred comp plans, or retirement plans that may not be transferable to an IRA. Generally, it is convenient to rollover former employer retirement plan balances to one's TIRA, and to hold as few separate TIRAs or RIRAs per individual as is feasible. It is also preferential for most to have both spouses' IRAs and taxable accounts (if not held jointly) at the same institution. This simply makes things easier to manage. For taxable accounts, a service-oriented brokerage such as Fidelity, Vanguard, Schwab or TDAmeritrade are popular with income investors. Remember, an income investor is focused on income, not trading services. So services such as bill-pay, ongoing bank transfers, a bond brokerage (for some), easy-to-understand monthly statements and the ability to electronically transfer annual 1099 data (taxable accounts) are the kinds of services an income investor will be interested in.
Once all accounts are organized and added up, the next step is calculate what the household needs from these accounts each year. This requires constructing a household cash flow estimate for the first year of retirement, paying attention to all those household expenses that have stopped due to stopping work, as well as all those household expenses that now exist due to the retirement. Rather than talking more about it, here is an example for a soon-to-be retired couple:
Total Gross Household Income (SS and Pension) | 59,868 | |
Fixed Household Expenses | 39,748 | |
Variable Household Expenses | 35,865 | |
Discretionary Expenses | 17,740 | |
Total Household Expenses | ||
Total Estimated Household Expenses | 93,344 | |
Required from Savings | 33,476 | |
Investable savings (IRAs and taxable accts) | 697,417 | |
Portfolio Annual Required Yield | 4.8% |
Is it possible to build a pure income portfolio yielding an inflation-adjusted 4.8% yield? Yes… but this will require a bit more income risk than, say, a 4% income portfolio. Now, let's look at the next step and what I consider the MOST IMPORTANT element of a pure income portfolio as would apply to this couple:
What are the Investment Objectives?
This may seem like a silly question. I mean, isn't it a foregone conclusion retirees want reliable income in retirement? Well, yes… for most. But some retirees may have additional objectives they wish their investments to provide. Here are the more common:
1. Minimum required yield. This calculation, as shown above, is derived from an analysis of household cash flow and the amount of savings the retiree has that can be used to invest for income. It is the vital first step for those considering this method of investing for pure income. As the required yield rises, income risk rises, until the income risk is too high to be practical and therefore may require that the savings principal be consumed, as would be the case in a "traditional" portfolio drawdown that gradually draws down an investment portfolio over retirement years or by using an insurance product such as a single premium immediate annuity (SPIA) where each monthly payment is made up mostly of the principal (amount originally given to the insurance company). What is the maximum yield one should not exceed for reliable retirement income? 5%? 6%? 8%? For initial screening purposes, most retirees would likely put their maximum yield risk tolerance in the 6% to 8% range in today's market. This is a moving target, and will be discussed in greater detail in future articles.
2. Reliability of income. This means the income, like an employment paycheck, will be there regularly, and will have a low risk of fluctuation and a lower risk of being reduced or even eliminated.
3. Growth of the income sufficient to keep up with inflation. This can come from the investments organically growing their dividends over the years ahead, or it may come from the excess income the actual investments produce that are accumulated and used to supplement future household income streams as inflation rises and household annual income necessarily increases.
4. Liquidity. The ease with which investment securities may be converted promptly (usually same day) into cash with minimal loss due to trading costs, tax or trade-based market adjustments. This will be a priority if the retiree feels that a need could arise that would require an unplanned invasion of the principal of the investment portfolio.
5. Capital preservation of the investment principal over the decades ahead. The conventional assumption is that the retirement savings will be consumed (decumulate). Capital preservation may be a priority if the retiree wishes to maintain their investment capital to meet future possible household major expenses, such as assisted living, "Buying-In" to a Continuing Care Retirement Community (CCRC) or perhaps to establish a testamentary special needs trust (a trust created at one's death in their estate) to provide for a disabled child or grandchild or perhaps to provide for a grandchild's college fund or a highly-valued charitable organization.
6. Ease of transfer to surviving spouse to manage. If this is a couple and one of this couple is the one who builds and monitors the income portfolio, how well will the surviving spouse be able to continue the management of the income portfolio? Will the surviving spouse even have any interest in doing this? This criterion is often overlooked, yet under certain conditions, it may be one of the most important income objectives.
For this retiring couple in the example above, the following table lists their income investing objectives and the priority of each:
Investment Goal Priority | |||||
For an Income Portfolio | |||||
Moderate | Moderate | ||||
High | High | Moderate | Low | Low | |
Income Reliability | X | ||||
Income Growth | X | ||||
Liquidity | X | ||||
Capital Preservation | X | ||||
Ease of Operation | X | ||||
The importance of determining income need and establishing income investment goals cannot be overstated. These criteria determine which income securities will be used and which will not.
Reality Check!
At this point, it is probably worth stopping for a moment and assessing whether this kind of investment approach will work for you, the retiree. I have said nothing about return on investment, market risk or any measure of total return in the statement of investment objectives... and I will say nothing about this in the articles ahead, as it is rarely a factor in a pure income portfolio. If this deeply offends your investment sensibilities, it may be appropriate to say "no thank you" at this point, and go back to managing a total return investment portfolio. But if you are not so offended or if this seems reasonable or you are just curious, read on.
With these first steps firmly established, my next article will focus on the primary "Core" income securities classes, the "Alternative" income classes and of equal importance, securities/investing strategies that should be avoided for purposes of long-term, reliable income.
