During this period of uncertainty, we have spent time speaking with our investors. Through these conversations a number of common questions come up. We have put together this FAQ to help answer them.
Has the thesis/strategy wavered at all?
Not at all. We believe our evidence-based approach of combining data science with fundamentals to identify a collection of the best expected dividend growth companies of the highest quality is a sound investment strategy. Owning these types of companies is the best way to preserve and to grow wealth over time and through all market and economic cycles.
Will there be dividend growers in the S&P 500 this year?
More companies have suspended or canceled their dividends so far this year than in the previous 10 years combined.
As of April 24, there have been 11 decreases and 20 suspensions among S&P 500 companies. Goldman Sachs is forecasting that S&P dividends will fall by 25% in 2020 and earlier this month S&P 500 dividend futures contracts were implying a nine-year time to recovery for dividends. While the economic outlook may appear to look dire, we do not believe all companies’ dividend policies will be negatively affected. Many companies are financially healthy and have taken actions to ensure financial flexibility is maintained if this is a protracted downturn. Some are even beneficiaries of the current environment. Looking to the global financial crisis in 2008 and 2009 as a reference, we note approximately 240 and 160 S&P 500 companies increased their dividends in each of those years, respectively.
Are any of your companies at risk of cutting dividends?
Given the current environment, we believe leisure and entertainment companies (travel, hotel, restaurants, etc.) energy and more discretionary parts of retail will be the most at risk of cutting their dividends. As the recession caused by the coronavirus unfolds, we expect banks and consumer finance companies may also be at risk of dividend cuts. While we have no exposure to energy, we do have indirect exposure to travel and direct retail exposure through our ownership of Estee Lauder, Visa, Mastercard, Ross Stores, Allegion, Sherwin Williams, Home Depot and Starbucks. We believe all of our companies should have the financial ability to continue paying a growing dividend, and many have recently reaffirmed the intention to do so. However, Estee Lauder has suspended its next quarterly dividend and we continue to monitor the situation closely.
As you have been historically overweight to consumer discretionary, what is your outlook for this sector?
As discussed above, the consumer discretionary space has been one of the hardest hit as social distancing has taken hold globally. It has also been one of the best performing sectors since the market bottom on March 23. How the sector performs going forward depends largely on the duration of government containment and stabilization efforts. It appears we are on a path to normalization as some governments are relaxing mitigation efforts, but confidence will only return once broader testing, tracing, therapeutics and, ultimately a vaccine becomes available.
Our process is sector agnostic and designed to lead us to where the dividend growth will be. Following the financial crisis, the consumer discretionary sector proved to be a good place to find high dividend growth. Today, names in healthcare and staples are quickly rising up our prediction ranks. The longer it takes for life to return to normal, the more likely it is we see a different sector mix in our top dividend growth predictions than we have in the past.
How is the model performing in this environment?
Our model is performing in line with our expectations and is doing a great job of capturing and adapting to information in a timely manner. The data fed into our model is from various sources over various frequencies. The information contained in higher frequency data, such as price and analyst estimates, led to an approximate four-point decline in our average prediction for the group of top dividend growers between February and March. This direction is consistent with our fundamental expectations, and like the model’s performance in 2000 and 2008, resulted in the average dividend growth of the top growers in the low double-digit range.
We know that as volatility increases or we encounter new situations, our model’s accuracy decreases. Models are generally good when new information comes from a similar distribution as the trained datasets. If the new information is very different from the trained dataset, the output accuracy degrades. This usually happen at the tails of the distributions where training datapoints are scarce. The current environment can be categorized as a tail situation, or outlier, where the model has not had the opportunity to observe enough training points. Despite the degraded accuracy in outlier situations, our back testing shows that our model maintains its strength over both the naïve (prior year’s dividend growth) and analyst estimates as each of those groups deal with the challenges of infrequent events. However, in the case of analyst estimates they carry their own inherent weaknesses and biases.
Which factors does the model now suggest have significant importance? Has that changed since January?
The model has not changed and only gets trained once a year. As well, the input features have not changed since the last time the model was re-trained. Generally, the features that were significant, remain so. What is changing is the value of the inputs as new information becomes available. The group of features in the input dataset which changed more dramatically are mainly related to the analyst estimates, price returns and economic data. Fundamental features can be considered low frequency data and their impact on predictions will manifest within a quarter or two.
It must be also emphasized that even in situations like COVID-19, models are still informative. Dividend prediction accuracy is not the only thing that matters. General direction and ranking or categorization are important as well. Our model continues to do a good job in getting the fastest dividend growers as a group right, even though individual company dividend growth accuracy falls. This information, combined with the human part of our hybrid process helps us overcome the aforementioned shortcomings of the analytical model during tail events such as this.
To learn more about how Bristol Gate uses data science and machine learning, please read Data Science at Bristol Gate.
Disclaimer: This is presented for illustrative and discussion purposes only. It should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities and it does not consider unique objectives, constraints, or financial needs of the individual. Under no circumstances does this piece suggest that you should time the market in any way or make investment decisions based on the content. Investors are advised that their investments are not guaranteed, their values change frequently, and past performance may not be repeated. References to specific securities are presented to illustrate the application of our investment philosophy only, do not represent all of the securities purchased, sold or recommended for the portfolio, and it should not be assumed that investments in the securities identified were or will be profitable and should not be considered recommendations by Bristol Gate Capital Partners Inc. The information contained in this piece is the opinion of Bristol Gate Capital Partners Inc. and/or its employees as of the date of the piece and is subject to change without notice. Every effort has been made to ensure accuracy in this piece at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and Bristol Gate Capital Partners Inc. accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. We strongly recommend you consult with a financial advisor prior to making any investment decisions. Please refer to the Legal section of Bristol Gate’s website for additional information at www.bristolgate.com.
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