blue chip, page-20

Joewolf,

Your point on the banks being dubiously blue chip is well-made in the context of their funding mix being inextricably interwoven into a whole lot of extraneous factors ebbing and flowing (and indeed, sometimes outright lurching manically, such as during the GFC) over which they have no control.

So you’re right, if one of the key criteria one wants to apply in affording “blue chip” status, is that the management of the enterprise in question, needs to be able, overwhelmingly, to be the undisputed architect of the destiny of said enterprise, i.e., they need to be in control of their own price list (i.e., the need to have some pricing power, which the Big 4 in Australian unequivocally do have, as witnessed by their ability these days to ratchet their own rates up or down independent of the RBA movements, despite all the wailing and gnashing of teeth...and don’t get me started on their ability to raise all manner of sundry revenues in the form of fees).

[In fact, commentators refer to the major banks in Australia as the Big Four. Their oligopolistic behaviour since the GFC has led me to the view that the banking system in Australia is really just ONE BIG bank with four brands called ANZ, Commbank, NAB and Westpac that carry out a charade called competition]

Another thing “blue chip” organisations should be able to do is have some influence on the prices of their inputs (aka supplier independency...WOW and WES do this extremely well).
Clearly banking executives have no control over what happens in global capital markets. In fact, as you rightly point out, during the once-a-generation black swan event they become downright vulnerable.

However, the redeeming feature in this regard is their position of criticality within the economy: the banking sectors isn’t some peripheral cog in the economic gearbox like tourism, or agriculture or retailing. Banks form that central gear right, smack bang in the middle, around which all other gears rotate. Retail can stall (like it has) and life goes on. Similarly for agriculture, mining, tourism, construction etc. But banking is a different kettle of fish altogether.

And the Federal government stepping in during the GFC to guarantee deposits is a huge statement to this end, rendering the major banks to be protected species, in a way. By way of analogy, the government is highly unlikely to say to Woolworths and Coles, “Good, news, boys, we’re going to guarantee the freshness of the fruit and veggies you buy from the farmer”.

So, after all that diatribe, I’ll offer to meet you half way, Joewolf, and say that the banks are the closest thing you can possibly get to being blue chip, without actually being so.


In terms of my emphasis on dividends, this is actually a subject that I am not prepared to debate, I’m afraid.
I am a manic disciple of dividend growth.

A fundamental tenet of shareholder value creation is growth in dividends per share in real terms.
Fact.

This is really the subject of a finance theory thesis, but suffice to say that companies that can grow DPS by, say 7% to 10%, year-in-year out irrespective of what happens in the world will be characterised by highly attractive investment attributes, including:
- Unique business models with pricing power, both in terms of the products they sell or the services they provide, as well on terms of the inputs they purchase
- Scalability and low capital intensity
- Granular customer base (i.e., no dominant customer(s))
- Low risk of product obsolescence
- Low supplier dependency
- Conservative accounting standards
- Honest, competent management (don’t scoff, it’s very rare phenomenon...in my opinion about one-in-five executives running publicly listed companies are honest, and only one-in-twenty of them REALLY comprehend fully what it is that creates value for shareholders)

Such companies, who are able to grow dividends over time, will see their valuations rise commensurately over time, too (not in a straight line, but rise it will).
That’s not a moot point.
It’s an axiomatic truth.

Case studies of this truth include ARP, BRG, RHC, WOW

Finally, and this is my favourite hobby horse, the reason a commitment by management to real dividend growth is important is that creates a boardroom culture of capital scarcity, i.e., the philosophy of the board must be that, of the surplus capital that is generated in any given financial period, the first allocation should go towards paying shareholders 5% to 10%more than they received last year, and that which remains can then be put towards growing the business. This has the effect, in my experience, of focusing the collective boardroom minds onto just the most value-accretive investment decisions.

All too often, I find, company executives don’t see capital as being finite – seemingly it can always be replenished in the bottomless pit called the equity market. This leads them to do too many cavalier, imprudent things (like pay too much to acquire other companies...often to paper over deficiencies within their own organisations that they are incapable of rectifying)


Finally, in terms of Washington H Soul Pattinson:
By a bizarre co-incidence, I at one stage of my career sat on some or other investment committee chaired by Rob Millner. His focus on dividends is one of his trademarks. Hhe particularly loves buying stocks immediately cum-dividend (referring to dividends as “drinks”, as in “...CBA goes ex-div on Friday, so if we buy it now, we get three drinks in the next 13 months”).

As for SOL being able to invest in risk on your behalf, my investment style has an aversion to risk, and I happen to disbelieve that someone else can invest in excessively risky stuff and make an appropriate return out of it, so it doesn’t make sense for me to sub-contract speculating to a third-party, no matter how good an investor I think he or she is.

Without having the data to corroborate it, my intuition is that the value created over the years by SOL has come from their investing patiently in “blue chips” (that have grown dividends in excess of inflation), rather than the “risky” things they’ve taken on.

Thanks for the debate

Cam