If one looks back 50 years, the return profile of stocks was much different. The expectation of an investor was that a material portion of their return would come in the form of dividends. Today, the combination of a much more greased pathway to scaling businesses, the advent of tax-efficient stock buybacks, and cultural acceptance of returns coming in the form of increased share prices over time versus more certain coupon payments has made stocks paying fat dividends a thing of the past.
If one looks at a low cost dividend stock ETF, Vanguard Dividend Appreciation Index, one will only find a paltry 1.9% dividend yield. It is mostly made up of the largest and most durable businesses – that have above average growth, but that pay out a minority of their earnings in the form of dividends.
To be sure, they also buy back stock, so the total shareholder yield is higher than 1.9%, but one can’t eat dinner on buybacks today.
If one looks at a more aggressive dividend fund, GQG Global Quality Dividend Fund, it sports a 5% dividend yield. More than tasty to satisfy a dividend focused equity investor. But under the hood, one sees that a number of highly cyclical businesses drive the distributions to shareholders:
Personally, I don’t feel strong conviction owning these sorts of businesses. That’s personal psychology versus data driven comparisons of what is most optimal for long term returns. But ignoring one’s psychology is recipe for freezing / making bad decisions when markets go south.
So can you have your cake and eat it? Do stocks exist that are high quality businesses, have a diversified set of products, and pay out the vast majority of earnings to investors? And that can grow organically despite paying out those earnings?
To date, private asset managers are the only group of stocks I have found that fit the bill. They tend to have the following characteristics:
- Low debt or net cash positions
- Highly scalable business models with little incremental capital needed
- Locked-in revenue for years via long duration fund lives with no LP withdrawal rights
- Pay out somewhere between 30-100% of cash flow
- Run by management that tends to excel at efficient capital allocation
Generally speaking, I would expect companies with the above characteristics to trade at above average multiples. Alas, today for the most part they do not. My best guess as to why is:
- They generally invest in smaller / non-investment grade companies
- They generally utilize healthy amounts of leverage
- It’s a people business, and your advantage can walk out the door
Private asset managers can indeed fail as businesses. But the key thing to note is that given their revenue is locked in, if one pays a low enough multiple, one doesn’t really have to pay for future success.
Furthermore, certain private asset managers have captive funds that won’t leave if performance falters. Private asset managers have locked in captive funds via public BDCs, owned insurance vehicles, holding company assets, and more. This places a soft floor under which revenues can be underpinned.
As such, in my own personal decision making fork in whether to invest incremental public equity allocations to aggressive dividend funds versus additional private asset managers, I continue to lean towards the latter until something changes.
Note: This is not investment advice, do your own work.