MARKETS GYRATE, DM DIVIDEND GROWTH FORGES AHEAD

In last month’s commentary, we noted that third quarter earnings released through October were coming in quite strong, especially in light of the numerous economic headwinds that many had predicted would begin to pressure corporate North America by now. With quarterly reports now virtually complete, we know that 73%* of S&P 500 companies were more profitable than analysts had forecast and average earnings growth exceeded 15% for the three month period. While such news would have ordinarily been cheered by markets, it was instead overwhelmed by Europe’s escalating fiscal dilemma and the weight of accompanying investor angst. In fact, despite a massive 4%+* rally on the last day of the month, both the S&P/TSX60 and S&P 500 finished November in the red, with other major markets faring even worse for the month. These juxtapositions – strong earnings, weak markets – have created a rare imbalance, with many stocks now available at valuations not seen in several years. As a multiple of 12 month expected earnings, for example, the S&P 500 is now trading at about a 25%* valuation discount to where it has resided over the past decade. The skeptical response to this observation is that the analysts making earnings forecasts are too optimistic and future profits won’t materialize in the magnitude expected; in other words, market lethargy is correctly reflecting the business challenges that undoubtedly lie ahead, instead of Wall Street’s too rosy outlook. Rather than attempt to sort through the clash of analyst confidence and market cynicism, it’s sometimes more useful to block out the noise and examine the implicit messages that management teams are sending through their capital allocation decisions. After all, these groups are on the economic “front lines” and should have the best sense of the state of current and probable future business conditions. Having weathered one of the most sudden and severe economic contractions in modern history during the sub-prime crisis, executives are understandably guarded, with their caution reflected in the large cash balances that have been allowed to accumulate on corporate balance sheets. At the same time, cash flow generation has been strong enough to not only fill corporate coffers, but to have significant capital returned to shareholders by way of both share buybacks and dividend growth. Excluding the holdings in the Pender Small Cap Opportunities Fund, 21 of the 29 equities held in the Pender Balanced Fund have announced dividend increases so far this year at an average rate 15%. This is important for a two reasons. First, it tells us that managers are reasonably confident about the future prospects for their businesses (companies do not commit to higher dividend payments if they have any inclination that future earnings are in doubt). Secondly dividend growth helps to drive intrinsic value (and ultimately share price) appreciation. Though markets are presently taking their cue from macroeconomic data, it is unlikely that persistent dividend growth won’t eventually pull share prices along with it.

Dixon Mitchell Investment Counsel
November 30, 2011

^{*Source: Bloomberg}