Investment Commentary

It was a year like no other. Following a good start, rising 5% to mid February, the S&P 500 fell 34% between February 19 and March 23 as COVID-19 began wreaking havoc with global markets and economies. Recognizing the significant economic risk and with the memory of the damage the financial crisis caused still relatively vibrant, governments and central banks responded aggressively with historic monetary and fiscal stimulus. Markets reacted and the S&P 500 rallied 61% from the March 23 low to the beginning of September. From there returns seesawed; down 10%, up 9%, and down 7% over a two-month period before the market finished the year off with a 15% run over the final two months, discounting a potential economic recovery with the arrival of COVID vaccines, the conclusion of the US election (removing uncertainty) and the impact of the earlier, unprecedented stimulus. When all was said and done, the S&P 500 rose 18% for the year, including a 70% gain from the bottom in March.

Exhibit 1. S&P 500 Total Return Index 2020 Performance

Source: Bloomberg, S&P Global Indices, Bristol Gate.

The volatility was enough to drive any investor mad. Fittingly, on January 27th at 1PM ET we will be hosting a call with author, Morgan Housel to discuss his new book, “The Psychology of Money” (register here: In it, he discusses what he considers to be the 20 most important and sometimes counterintuitive lessons on building wealth, managing greed, and finding happiness. The underlying premise of the book is that building wealth has more to do with how we behave than how smart we are. With the psychological damage of 2020 still fresh in our minds, several points in the book stood out to us:

  • Reasonable investors who love their technically imperfect strategies have an edge, because they are more likely to stick with those strategies – We know our strategy is not perfect and has room for improvement, but it works for us. We believe a track record of dividend increases is an excellent indicator of financial health, growth prospects and commitment to shareholders. Companies that can grow dividends at high rates organically are generally adept capital allocators with attractive growth opportunities. They generally generate more free cash flow and typically have safer balance sheets than their peers. Those fundamental beliefs allow us to consistently stick with the strategy knowing we are investing in companies that should be able to weather periods of volatility like the one we just experienced. As Housel states in the book, we are not taking financial cues from people who are playing a different game than us. While we benchmark ourselves against various Index returns, we are solely focused on our goal of growing our income stream at high and sustainable rates. Our US Strategy returned 11.4% this year, and while it underperformed the benchmark by almost seven percentage points, it also provided an approximate 14 percentage point positive spread in income growth. Looking back at 2020, had we had perfect foresight and identified and invested in the top 65 fastest dividend growers consistent with our process (investment grade, three-year dividend history, etc.) at the beginning of the year, an equal weighted portfolio of that group would have delivered a 14% return, also below the S&P 500. Our high dividend growth strategy will not win every year, but over time it has served us well and we believe will continue to do so.
  • The power of compounding – We have long touted the benefits of high, sustainable dividend growth and the affect it can have on one’s wealth. We have traded high current yield for high dividend growth (and typically a small starting yield) because we believe dividend growth stocks perform better across full market cycles. Their rising income streams protect wealth during inflationary periods and become more valuable during periods of deflation. If we can continue growing the income stream we deliver to investors by 10-20% per year, over time, that stream will become a river and their yield on cost will be substantial. 
  • We all make decisions based on our own unique experiences that seem to make sense to us in a given moment – We sold Southwest Airlines, Boeing, Bank of America, Ross Stores, and Estée Lauder as a direct result of COVID and did not deploy cash from some of those sales immediately as we transitioned between names. Although the companies that replaced them performed well overall, in the near term they did not keep pace with the recovery of the exited group. Collectively, we estimate those decisions cost us approximately eight percentage points of relative performance. In hindsight, and compared to the benchmark return, those decisions look like terrible ones, but they were consistent with our investment philosophy focused on dividend growth (all the companies sold either cut dividends or did not grow them) and reasonable at the time given the information we had. We traded uncertainty for certainty, and we knew at the time we made the trades certainty would have a price in the near term if a recovery began. Had the stimulus not been so large or had vaccines not been discovered, that relative price for certainty could have been much lower than it turned out to be.
  • You can be wrong half the time and still make a fortune – As George Soros is quoted in the book, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.” We recently went through the exercise of looking at all the closed positions in the US Strategy between September 2009 and June 2020. Over this timeframe, our US portfolio has outperformed the S&P 500 by 150 basis points annually despite only 45% of the 104 closed transactions beating the market based on our initial cost returns. It did so because of three reasons. First, we had a positive return on 70% of the 104 transactions. The best way to make money is to not lose it in the first place – the power of compounding. More importantly, there was a positive skew to our results. Our biggest winners’ returns far outpaced our biggest losers. Our losses hurt, but they were not devastating. The 30% that lost money on our original cost, lost an average of 18%. Our biggest winners were spectacular. Eight more than doubled on our original cost, including one quadruple. Lastly, the names currently held in the portfolio contributed to the outperformance but have not impacted the quoted win/loss ratios because they are still active positions with their final determination yet to be made.
  • Be a rational optimist – There are plenty of reasons to be concerned. Sovereign debt levels are high, inequality is rising, valuations are rich, the vaccines may not solve the virus, etc. But as Housel points out, “problems correct and people adapt. Threats incentivize solutions in equal magnitude.” Over the long term, never underestimate human ingenuity and perseverance and the opportunity for new opportunities to arise. It pays to stay invested in the market over long periods of time. In the near term, after being cocooned for the better part of a year, there is plenty of pent-up consumer demand. Their substantial savings are now available for future consumption. Markets have already started to recognize that.

Exhibit 2. US Personal Savings Rate

Source: KKR.

Bristol Gate US Equity Strategy

During the quarter, the US Strategy returned 8.8% compared to 12.2% for the S&P 500 Total Return Index. Positive vaccine news in early November and the conclusion of the US election led to a significant trend reversal with some of the most beaten-up US equity segments posting strong gains into year end.

Starbucks, Broadcom and Intuit were the three largest relative contributors to returns, each benefiting from improved sentiment around an economic recovery following vaccine news. Moody’s, American Tower and CME Group were the three largest relative detractors in the quarter.  Moody’s struggled as investors questioned the strength of issuance volumes in 2021 following a robust 2020. American Tower lagged as investors digested the impact of higher customer churn following the merger of T-Mobile and Sprint and the potential for higher rates led to the real estate sector overall lagging the broader market. CME was a drag as interest rate derivative volumes remain subdued with interest rate volatility suppressed because of government stimulus.

During the year, the US strategy returned 11.4% compared to the 18.4% for the S&P 500 Total Return Index. According to S&P Global Indices, Apple, Amazon and Microsoft accounted for 53% of the SPX’s total return. Excluding those three stocks, the Index would have returned 8.6%. If the list were expanded to include the next seven largest contributors (only one of which paid a dividend and had no dividend growth), 77% of the Index’s total return was generated by the top ten holdings. Put another way, the other 495 stocks in the Index collectively returned 4.3%. All ten of the top contributors were technology or technology related stocks. The IT sector alone accounted for 64% of the Index’s return. Simply put, diversification hurt returns in 2020.

Relative to other dividend focused strategies such as the S&P 500 Dividend Aristocrats (up 8.7%) and the Dow Jones US Select Dividend Index (down 4.6%), the US Strategy continued to perform well.

For the year, the portfolio companies at year end on average delivered 14.8% dividend growth (median 14.0%), well ahead of the S&P 500’s cash dividend increase of 0.1% (median constituent increase 5.3%). 2020 proved to be a more challenging year for dividend paying companies in the broader index, with the number of dividend payers at year end falling to 385 from 423 in 2019 and those having raised their dividends post COVID (Q2-Q4) averaging 8.3% vs. 9.8% in 2019 (source: S&P Global Indices). Looking forward and including the changes made to the portfolio after year end (discussed below), our expected dividend growth for the companies in the US Strategy is 14% in 2021. This compares to the near zero growth consensus estimates and dividend futures are implying for the Index.

At the end of 2009, like today, the concentration of market returns was high and aggregate dividend growth in the Index was low. As the economic recovery broadened, the subsequent dividend growth our Strategy achieved was amongst our best (2011-2015). If vaccines, stimulus and savings are the seeds for a broad economic recovery this time around, we believe the rally in tech stocks in 2020 will broaden in 2021 and our opportunities to produce higher dividend growth will also expand going forward.

Exhibit 3. US Strategy Returns & Risk

Net Returns

Following year end, two changes were made to the portfolio along with all positions being rebalanced on January 7-8. Danaher was sold and replaced with Thermo Fischer Scientific. From its peak on November 6th, Thermo underperformed the S&P 500 by approximately 20 percentage points to year end. Reasons for the poor relative performance include positive vaccine news, lower expectations on COVID-19 diagnostic testing, a rotation out of year-to-date winners and an expensive valuation relative to historical levels. We viewed the pullback as a good opportunity to add a historically great capital allocator that is ideally positioned over the next several years to capture the opportunity related to innovation in the bio/medtech space. We like Thermo’s leading position in the global life sciences market, its scale, stability of its consumables focused business, its strong operating model and its opportunity to deploy capital via M&A.

While we continue to believe Danaher has great prospects as a business going forward, we get similar exposure to the life science and diagnostic tools market with Thermo but better forecasted dividend growth and a more reasonable valuation (25x forward earnings for TMO vs. 34x for DHR).

We also added Applied Materials to the portfolio, funding it with the sale of Tyson Foods. Applied Materials is one of the world’s largest semiconductor equipment manufacturers (semicap). We believe the semicap industry is attractive with high barriers to entry. It is effectively an oligopoly with various competitors being leaders in their respective segments. Applied Materials is the largest by market share overall with dominant positions in several individual segments. The industry’s semiconductor clients are highly profitable and have rising relevance due to several secular drivers such as cloud computing, machine learning and the internet of things. Capital intensity within semiconductor manufacturing is rising as leading technology nodes become more complex and require more processes. In our view, Applied Materials represents a compelling opportunity within the sector due to its discounted valuation compared to peers, improved profitability, a troughing flat panel display equipment market (10% of sales) and recent share gains in its core semicap segment.

Our investment thesis with Tyson did not work out as expected. While the company’s beef and pork segments did meet our expectations, its chicken segment continued to struggle, and the company’s challenges were compounded by COVID-19 throughout the year with consumers shifting consumption from restaurants to at home and several the company’s plants experiencing higher absenteeism and shutdowns. Compared to Tyson, we believe we have added a much higher quality company in Applied, with superior secular growth opportunities, higher margins and much better forecasted dividend growth (high teens for Applied vs 10% for Tyson).


Bristol Gate Canadian Equity Strategy

During the quarter, the Canadian Strategy returned 3.7% compared to 9.0% for the S&P/TSX Composite Index. Like the US, positive vaccine news in early November led to a market rotation seeing some of the most beaten-up market segments posting strong gains into year end. Brookfield Asset Management, Toronto-Dominion Bank and CCL Industries were the three largest contributors to returns, Waste Connections Inc, Quebecor and Canadian National Railway were the largest detractors in the quarter.

During the year, the Canadian strategy returned 1.1% compared to the 5.6% for the S&P/TSX Composite Index. More than half of the TSX’s total return was due to Shopify Inc, which finished the year with a 178% return, becoming one of the largest weights in the Index in the process. Shopify does not pay dividends, remaining outside of the Strategy’s investable universe. The second-best performing sector was the Materials sector, with gold mining companies benefiting from the rising price of the commodity. Barrick Gold alone contributed over 0.5 percentage points to the TSX’s annual return. Conversely, the Energy sector was the worst performing sector with a negative 26.6% return for the year.

Relative to other dividend focused strategies such as the S&P/TSX Canadian Dividend Aristocrats (down 1.85%) and the Dow Jones Canada Select Dividend Index (up 0.30%), the Canadian Strategy continued to perform well.

For the year, the portfolio companies at year end on average delivered 14.5% dividend growth (median 9.8%), well ahead of the TSX’s cash dividend increase of 1.0% (median constituent increase 2.9%). 2020 proved to be a more challenging year for dividend paying companies in the broader index, with a number of dividend payers either holding their dividends constant or outright cutting them. Looking forward and including the changes made to the portfolio subsequent to year end (discussed below), our expected dividend growth for the companies in the Canadian Strategy is 13.1% in 2021. This compares to the 2.4% consensus forecast for the Index.

Net Returns

Following year end, two changes were made to the portfolio along with all positions being rebalanced on January 12. Enbridge was sold and replaced with Thomson Reuters. Thomson Reuters is re-introduced in the portfolio after engaging in strategically transformative changes with the sale of its Financial & Risk segment (Refinitiv). The business is now centered on providing news, data, and information to professional markets. It is a market leader in the three main segments in which it participates with a mostly recurring revenue model and high retention rates that provides good visibility. Thomson Reuters has been a consistent dividend grower for decades through its several different iterations and we are excited about its opportunity as a professional services software provider in the digital age.

Enbridge was removed primarily due to reduced dividend growth. Lower oil prices from depressed economic activity due to COVID-19 made producers less willing to ship oil through pipelines, negatively affecting pipeline companies’ stock prices. A less favorable political environment for new pipelines further contributed to our decision to sell.

We also replaced UnitedHealth Group with Zoetis. UnitedHealth performed excellent for the strategy since its February 2018 inclusion, enhanced by our quarterly rebalancing approach. We continue to believe that it is an excellent company and pursued the change for portfolio fit and dividend growth reasons, two of our process pillars. Both companies remain in the US strategy portfolio. Both companies are included in the Healthcare sector but have different drivers and risks. UnitedHealth is focused in providing healthcare coverage in the U.S., whereas Zoetis is a global drugs manufacturer for pets and livestock. Finally, we forecast higher dividend growth for Zoetis.


Firm Update

It seemed highly improbable in mid March that we would be able to tell our investors they would earn a return of over 11% and that the dividend growth of the portfolio would exceed 14% for the year 2020. Looking back, we are reminded of another important investment tenet “It is time in the market not market timing”.  Our experience and evidence show that great companies re-establish themselves more quickly while lower quality ones become non-financeable and are left to languish.

The challenges ahead are no different in many ways than when we started. Investors were and still are desperately seeking income. They have few alternatives as interest rates are even lower today than they were back then. As we have mentioned in previous letters, chasing yield often carries significant risk.

Going forward we are pleased to let you know that being a signatory to the UN PRI Principles for Responsible Investing is more than a declaration. We are working seriously towards upholding our commitment and believe it will serve the best interests of all our stakeholders.

We believe the quality attributes of the companies we call “Bristol Gate” stocks are far more attractive than those of most other income investments. Their ability to grow, both protects capital, as we have witnessed this past year, and helps our clients live well by growing their future income. We believe our unique evidence-based process that has consistently combined Data Science with solid fundamental analysis is a winning formula.

It is a privilege to work in a business with dynamic characteristics. It encourages us to learn continuously, to try new ideas and solve problems in new ways. By constantly striving to improve our skills, not just in the investment area, but across our entire business, we are positioned to provide a great option for investor capital.

It is also a privilege to have the clients that we do, who have stuck with us and continued to entrust us with their hard-earned capital despite the periods of market volatility. Together with our Bristol Gate team, we have enjoyed significant growth in the “year like no other.” Thank you for standing with us.

Yours sincerely,

The Bristol Gate Team

Important disclosures
Gross returns in this report refer to the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite. No allowance has been made for custodial costs, taxes, operating costs, management and performance fees, which will reduce performance. Allowance for withholding tax in the US strategy composite is partially reflected in the composite returns for periods commencing January 2017 and after. The Net returns for the Bristol Gate US Equity Strategy Composite and Canadian Equity Strategy Composite are reflective of the maximum management fee charged by Bristol Gate of 1% and 0.70%, respectively. Past performance is not indicative of future results.
The Bristol Gate US Equity Strategy Composite was formerly known as the Bristol Gate US Dividend Growth Composite until April 1, 2015. The Composite inception date was May 15, 2009. The Composite consists of equities of publicly traded, dividend paying US companies and is valued in US Dollars.
The Bristol Gate Canadian Equity Strategy Composite was formerly known as the Bristol Gate Canadian Dividend Growth Composite until April 1, 2015. The Composite inception date was July 1, 2013. The Composite consists of equities of publicly traded, dividend paying Canadian and US companies and is valued in Canadian Dollars.
The S&P 500® Total Return Index measures the performance of the broad US equity market, including dividend re-investment, in US dollars. The S&P/TSX Composite Index measures the performance of the broad Canadian equity market, including dividend re-investment, in Canadian dollars. This index has been provided for information only and comparisons to the index has limitations.
There is the opportunity to use leverage up to 30% of the net asset value. Leverage is not used as an investment tool to enhance returns, but for cash management needs of certain composite portfolios.
This Report is for information purposes and should not be construed under any circumstances as a public offering of securities in any jurisdiction in which an offer or solicitation is not authorized. Prospective investors in Bristol Gate’s pooled funds or ETF funds should rely solely on the fund’s offering documents, which outline the risk factors associated with a decision to invest. No representations or warranties of any kind are intended or should be inferred with respect to the economic return or the tax implications of any investment in a Bristol Gate fund.
Bristol Gate claims compliance with the Global Investment Performance Standards [GIPS®]. To receive a list of composite descriptions and/or a presentation that complies with the GIPS® standards, please contact us at Bristol Gate Capital Partners Inc. has been independently verified for the periods commencing May 2009 until December 2015 by Ashland Partners International PLLC and from January 1, 2016 – December 31, 2019 by ACA Performance Services.
A Note About Forward-Looking Statements
 This report may contain forward-looking statements including, but not limited to, statements about the Bristol Gate strategies, risks, expected performance and condition. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events and conditions or include words such as “may”, “could”, “would”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate” and similar forward-looking expressions or negative versions thereof.
These forward-looking statements are subject to various risks, uncertainties and assumptions about the investment strategies, capital markets and economic factors, which could cause actual financial performance and expectations to differ materially from the anticipated performance or other expectations expressed. Economic factors include, but are not limited to, general economic, political and market factors in North America and internationally, interest and foreign exchange rates, global equity and capital markets, business competition, technological change, changes in government regulations, unexpected judicial or regulatory proceedings, and catastrophic events.
Readers are cautioned not to place undue reliance on forward-looking statements and consider the above-mentioned factors and other factors carefully before making any investment decisions. All opinions contained in forward-looking statements are subject to change without notice and are provided in good faith. Forward-looking statements are not guarantees of future performance, and actual results could differ materially from those expressed or implied in any forward-looking statements. Bristol Gate Capital Partners Inc. has no specific intention of updating any forward-looking statements whether as a result of new information, future events or otherwise, except as required by securities legislation.