Yield Does Matter Most Of The Time

Includes: KLAC
by: Roger Nusbaum

Yesterday we executed a trade for most "large" accounts buying KLA-Tencor (NASDAQ:KLAC). The pick is more of a top down decision (more on that in a moment). The company makes equipment used in manufacturing many types of semiconductor; data storage, LED, solar, nano and several more. The company has been around for quite a while, its history has generally been to outperform on the way up and lag on the way down. In the last few years it has evolved into a dividend payer, currently yielding a little under 3% which is very good for a technology company. Similar to our other recent purchase, there is far more cash than debt, its PE ratio is around 10 which is low and earnings and revenue estimates point to meaningful growth over the next couple of years which paves the way for dividend increases as the company has done a couple of times before. The company's fundamentals in terms of ratios and balance sheet stacks up favorably with its competitors.

I think the more important aspect of the trade are the big picture effects on the portfolio. You may be aware that for quite a while my thesis has been for below "normal" GDP growth and below "normal" US equity returns over the course of the decade and that has been playing out. This makes increasing the dividend yield of the overall portfolio increasingly important. Additionally it looks as though GDP growth will be a little better in 2012 than it was in 2011 although still below "normal." If that plays out then it makes sense for technology to do relatively well with slightly stronger GDP so we have chosen to increase our weighting slightly to technology.

The above is from an email I sent to my colleagues in case any clients had questions about the purchase (the first word was referring to Friday). To add a little more color this is part of a series of trades to generally increase the yield of the portfolio which I've been telegraphing for a while. I spelled out the logic for this above but I think this speaks to the long term focus I try to place on the portfolio and long term themes I try to embed.

A few days ago I made a comment about the longer term slog I expect from the market in terms of looking back on this decade at maybe something like 4% annualized growth, and that for the last couple of years that is what it averages out to. Then I remembered that 2007 was up only slightly; something like 3.5% plus another 2% or so for dividends.

If this continues, then as I mentioned increasing the yield will make sense as will owning countries that appear to not be facing systemic threats (Latam, Antipodes, Scandies, parts of Asia as some examples).

During the week a reader asked why so much attention lately on dividends, why not focus more on total return. My answer was that I do focus on total return but that I've been interested in writing about yield lately. The reason for the interest is that we have been increasing the yield of late but there are still quite a few holdings that don't have much of a dividend.

Consistent with what I think I have been saying for years here, there are times where yield doesn't mean much - like 2008 and 2009 - but that most of the time yield does matter. In this instance where I have an opinion about the next few years, it makes sense to tilt in that direction. I am not making a lopsided bet as I could be wrong. The threat to the dividend thesis is if interest rates go up a lot, I mean really a lot. Yes, that is unlikely for a while but that is one of the threats.

Also part of the total return question is that if it turns out there is less price appreciation, then more of the total return needs to come from dividends.