Saturday, November 13, 2021

Financial Sector Rebalance

After completing the first initial version of my Dividend Town screener last weekend I spent some time tweaking the Tech sector. Fortunately most of the holdings acquired on the initial purchase were in great shape. 

After updating weekly data in the screener this morning and comparing to the Dividend Town portfolio, it was pretty clear my Finance sector needs some work. Of all the current holdings, only one made the initial cut of the screener, TROW. 

Current Holdings

I must admit that the initial purchases had some methodology, but it likely wasn't well thought out. As long as we learn from our mistakes there's always time to course correct. Let's look into a one of these to see why they don't make it into the new screener.

  • Aflac - Love the duck. What else do I love? 
    • Love the yield. 2.32%
    • Love the 5-year dividend growth rate: 7% per year.  Up 14% per year for the last 20.
    • They'll go ex-div on Nov 16th and likely hike up their dividend yield by 6%,
    • Good value at 10.9 P/E vs. Financials at 13.2.
    • Low earnings payout ratio, growing EPS since FY16. 
    • Reduced shares outstanding by almost 1/3 since 2011. 
So what's the problem? What's missing? Oh. No growth. Flat as a board. Now I'm not the sharpest guy, but I believe their main revenue come in two sales channels: insurance premiums and duck plushie proceeds. I don't have that segment breakdown, so we'll assume primary sales are premium related.

Google Trends for Insurance Claims in US

So if operating margin is level for 5 years and net profit margin growth is mainly driven by a lower tax bill, what's the draw? 1) Strong balance sheet, 2) Share repurchase with cash proceeds, 3) Rinse and repeat?  

Based on what I'm seeing, I would be betting on a sales flattish company to continue to manage expenses effectively, mitigate any higher insurance payout ratios with no revenue growth backstop and plow remaining cash into share buybacks. Core competency is managing expenses for share appreciation, not growth.

Price to Book (5 yr)
While I'd rather have more growth potential, there is something here to be said about generating additional value in share price. We saw nothing has really changed in the last 5 years, however Price/Book ratio tanked in March 2020 and the price has been rerating towards that 1.4 - 1.5 range ever since.  If I'm betting the P/B continues to rerate to 1.3 then there should be 15% upside along with a nice yield over the shorter-term.

Looks like it's worth holding onto in the interim but will watch closely. For everything else, my Dividend Town screener is suggesting some higher quality stocks.  They are lower yield, a little higher P/E but dividend growth rates & revenues are accelerating nicely and look undervalued or at value. We'll hold onto TROW, AFL and rebalance the remainder of the Finance sector on Monday.  

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