29.05.2019

Polar Capital

The importance of growing dividends

Dividend growth is an important driver of long-term equity returns. Within equity markets, the rallying of bonds usually prompts market strategists to focus on bond proxies, equities that behave like a bond with low sensitivity to the macro backdrop and reasonable dividends. We see, however, a critical distinction between ’true’ and ’perceived’ bond proxies.

 
Ex-growth companies with flat and high dividend yields are ’true’ bond proxies. With no growth in their underlying earnings, these types of stock are effectively risky bonds. Investors are not guaranteed their principal back, and the ultimate return is heavily dependent on the multiples paid at purchase and achieved at exit. This leaves investors exposed to broader market de- and reratings.
In comparison, a ’perceived’ bond proxy is a stock with regular, albeit unspectacular, growth. This dull growth is underpinned by a strong business model and the stock has a low earnings sensitivity to the generic macro cycle. A cheap entry point into this profile of stock results in a combination of a valuation margin of safety and dividends that compound over time
Investors must be wary of optically attractive, high, ex-growth dividend yields. In a world starved of yield, markets are not yield inefficient. A 9% dividend yield is often too good to be true and investors should therefore consider other valuation metrics in order to assess how attractive the price really is.
It is also worth highlighting that a more modest but growing dividend stream will become a higher-yielding stock over the medium term. A 4% yielding stock with 6% growth yields the same amount per share as a 6% ex-growth stock by the seventh year of growth. Moreover, the 6% growth is likely to translate into capital appreciation from a rising share price.
Reasonable if unspectacular earnings growth protects investors against the effects of market deratings. A stock with growth will be on falling P/E multiples as the earnings base compounds higher over time. Over longer timeframes, this compound earnings growth can materially outweigh the effects of a lower valuation multiple.
Picking out-of-favour companies is central to finding stocks with good yields and still reasonable growth. The dividend yield of a stock will be inversely correlated with investor sentiment regarding that stock. Loved growth stocks will typically be priced for perfection with investors accepting no or a very low dividend because of promised strong future growth. Conversely, when stocks are hated dividend yields will be much higher to entice investors to buy the shares.
We try to buy stocks when their cash flows are cheap (ie their dividend yields are high) and sell them when their cash flows are expensive (ie low dividend yields). Good and growing dividend payers typically strike a good balance of retain and return: companies that generate sufficient cash flows to pay a reasonable dividend, but also reinvest in their businesses for future growth. A common mistake in income investing is to get this balance of retain and return wrong.
When looking for long-term equity returns it is crucial to look for companies with growing dividends. Therefore, it is crucial to focus on stocks that provide regular, unspectacular growth instead of high-yielding, ex-growth stocks.
Nick Davis
23 April 2019

Important Information: This document is provided for the sole use of the intended recipient and it shall not and does not constitute an offer or solicitation of an offer to make an investment into any fund managed by Polar Capital. It may not be reproduced in any form without the express permission of Polar Capital and is not intended for private investors. This document is only made available to professional clients and eligible counterparties. The law restricts distribution of this document in certain jurisdictions; therefore, persons into whose possession this document comes should inform themselves about and observe any such restrictions. It is the responsibility of any person or persons in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained in this document is not a financial promotion.  It is not designed to contain information material to an investor’s decision to invest in Polar Capital Funds Plc – European ex UK Income Fund. SUCH INFORMATION, INCLUDING RELEVANT RISK FACTORS, IS CONTAINED IN THE FUND’S OFFER DOCUMENT WHICH MUST BE READ BY ANY PROSPECTIVE INVESTOR. This document is only aimed at professional clients and eligible counterparties as defined by the European Directive n° 2004/39/EC dated 21 April 2004 (MIFID) as the same has been applied into French law by articles D. 533-11 and D.533-13 of the French Code monétaire et financier. This document is not destined for non professional clients who do not have the experience, knowledge or competence needed to take their own investment decisions and correctly evaluate the risks involved. Shares in the Fund should only be purchased by professional investors. Any other person who receives this presentation should not rely upon it. The law restricts distribution of this document in certain jurisdictions, therefore, persons into whose possession this document comes should inform themselves about and observe any such restrictions.  It is the responsibility of any person or persons in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. This document does not provide all information material to an investor’s decision to invest in the Fund. Before any subscription, it is recommended that you read carefully the most recent prospectus and review the latest financial reports published by the Fund. The Key Investor Information Document, full prospectus, articles and latest annual report are freely available upon request from BNP Paribas Securities Services, the centralising agent of the Fund in France: BNP Paribas Securities Services, 66, rue de la Victoire, 75009 Paris, France. Contact: Zaher Aridi, Tel: +33(0)1 42 98 50 57.
Statements/Opinions/Views: All opinions and estimates constitute the best judgment of Polar Capital as of the date hereof, but are subject to change without notice, and do not necessarily represent the views of Polar Capital. This material does not constitute legal or accounting advice; readers should contact their legal and accounting professionals for such information. All sources are Polar Capital unless otherwise stated.
Third-party Data: Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved in or related to compiling, computing or creating the data makes any express or implied warranties or representations with respect to such data (or the results to be obtained by the use thereof), and all such parties hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any data contained herein. 
Holdings: Portfolio data is “as at” the date indicated and should not be relied upon as a complete or current listing of the holdings (or top holdings) of the Fund. The holdings may represent only a small percentage of the aggregate portfolio holdings, are subject to change without notice, and may not represent current or future portfolio composition. Information on particular holdings may be withheld if it is in the Fund’s best interest to do so. It should not be assumed that recommendations made in future will be profitable or will equal performance of the securities in this document. A list of all recommendations made since the launch of the Fund is available upon request.  This document is not a recommendation to purchase or sell any particular security.  It is designed to provide updated information to professional investors to enable them to monitor the Fund. 
Benchmarks: The following benchmark index is used: The MSCI Europe Daily Total Return Net excluding UK, Euro Index. This benchmark is generally considered to be representative of the European equity market environment (excluding UK). This benchmark is a broad-based index which is used for comparative/illustrative purposes only and has been selected as it is well known and easily recognizable by investors. Please refer to http://www.msci.com/ for further information on this index. Comparisons to benchmarks have limitations as benchmarks’ volatility and other material characteristics that may differ from the Fund. Security holdings, industry weightings and asset allocation made for the Fund may differ significantly from the benchmark. Accordingly, investment results and volatility of the Fund may differ from those of the benchmark. The indices noted in this document are unmanaged, unavailable for direct investment, and are not subject to management fees, transaction costs or other types of expenses that the Fund may incur. The performance of the indices reflects reinvestment of dividends and, where applicable, capital gain distributions. Therefore, investors should carefully consider these limitations and differences when evaluating the comparative benchmark data performance. Information regarding indices is included merely to show general trends in the periods indicated and is not intended to imply that the Fund was similar to the indices in composition or risk.
Regulatory Status: Polar Capital LLP is a limited liability partnership number OC314700. It is authorised and regulated by the UK Financial Conduct Authority (“FCA”) and is registered as an investment adviser with the US Securities & Exchange Commission (“SEC”). A list of members is open to inspection at the registered office, 16 Palace Street, London, SW1E 5JD. FCA authorised and regulated Investment Managers are expected to write to investors in funds they manage with details of any side letters they have entered into. The FCA considers a side letter to be an arrangement known to the investment manager which can reasonably be expected to provide one investor with more materially favourable rights, than those afforded to other investors. These rights may, for example, include enhanced redemption rights, capacity commitments or the provision of portfolio transparency information which are not generally available. The Fund and the Investment Manager are not aware of, or party to, any such arrangement whereby an investor has any preferential redemption rights. However, in exceptional circumstances, such as where an investor seeds a new fund or expresses a wish to invest in the Fund over time, certain investors have been or may be provided with portfolio transparency information and/or capacity commitments which are not generally available. Investors who have any questions concerning side letters or related arrangements should contact the Polar Capital Desk at the Administrator on (+353) 1 434 5007. The Fund is prepared to instruct the custodian of the Fund, upon request, to make available to investors portfolio custody position balance reports monthly in arrears.
Information Subject to Change: The information contained herein is subject to change, without notice, at the discretion of Polar Capital and Polar Capital does not undertake to revise or update this information in any way.
Forecasts: References to future returns are not promises or estimates of actual returns Polar Capital may achieve. Forecasts contained herein are for illustrative purposes only and does not constitute advice or a recommendation. Forecasts are based upon subjective estimates and assumptions about circumstances and events that have not and may not take place. 
Performance/Investment Process/Risk: Performance is shown net of fees and expenses and includes the reinvestment of dividends and capital gain distributions. Factors affecting fund performance may include changes in market conditions (including currency risk) and interest rates and in response to other economic, political, or financial developments. The Fund’s investment policy allows for it to enter into derivatives contracts. Leverage may be generated through the use of such financial instruments and investors must be aware that the use of derivatives may expose the Fund to greater risks, including, but not limited to, unanticipated market developments and risks of illiquidity, and is not suitable for all investors. Those in possession of this document must read the Fund’s Prospectus for further information on the use of derivatives. Past performance is not a guide to or indicative of future results. Future returns are not guaranteed and a loss of principal may occur. Investments are not insured by the FDIC (or any other state or federal agency), or guaranteed by any bank, and may lose value. No investment process or strategy is free of risk and there is no guarantee that the investment process or strategy described herein will be profitable.
Allocations: The strategy allocation percentages set forth in this document are estimates and actual percentages may vary from time-to-time. The types of investments presented herein will not always have the same comparable risks and returns. Please see the private placement memorandum for a description of the investment allocations as well as the risks associated therewith. Please note that the Fund may elect to invest assets in different investment sectors from those depicted herein, which may entail additional and/or different risks. Performance of the Fund is dependent on the Investment Manager’s ability to identify and access appropriate investments, and balance assets to maximize return to the Fund while minimizing its risk. The actual investments in the Fund may or may not be the same or in the same proportion as those shown herein. 
Country Specific disclaimers: In the United States the fund shall only be available to or for the account of U.S. persons (as defined in Regulation S under the United States Securities Act of 1933, as amended (the "Securities Act")) who are "qualified purchasers" (as defined in the United States Investment Company Act of 1940, as amended (the "Company Act")) and "accredited investors" (as defined in Rule 501(a) under the Securities Act). The fund is not, and will not be, registered under the Securities Act or the securities laws of any of the states of the United States and interests therein may not be offered, sold or delivered directly or indirectly into the United States, or to or for the account or benefit of any US person, except pursuant to an exemption from, or in a transaction not subject to, the registration requirements of such securities laws. The securities will be subject to restrictions on transferability and resale. The Fund will not be registered under the Company Act.
Country Specific disclaimers: This document has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this document and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of Shares may not be circulated or distributed, nor may Shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor Pursuant to Section 304 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”) or (ii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA. The Prospectus and Information Memorandum are available to download at www.polarcapital.co.uk alternatively; you can obtain the latest copy from the Polar Capital Investor Relations team. The Fund is a collective investment scheme but is not authorised under Section 104 of the Securities and Futures Ordinance of Hong Kong by the Securities and Futures Commission of Hong Kong. Accordingly the distribution of this document, and the placement of interests in Hong Kong, is restricted. This document may only be distributed, circulated or issued to persons who are professional investors under the Securities and Futures Ordinance and any rules made under that Ordinance or as otherwise permitted by the Securities and Futures Ordinance
Country Specific disclaimers: Polar Capital LLP (Investment Manager) is exempt from the requirement to hold an Australian financial services licence in respect of the financial services it provides to wholesale investors in Australia and is regulated by the Financial Conduct Authority of the UK under UK laws which differ from Australian laws.