OVERVIEW - Hinde Capital · course, this leads to checking emails, WhatsApp messages and news items endlessly throughout the day, which in reality can only be described as a tragedy

HINDESIGHT DIVIDEND UK LETTER / APR 17

Mark Mahaffey Ben Davies

1

Aalok Sathe

OVERVIEW

I have recently finished reading a wonderful novel with the odd title, ‘The Goose Samaritan’. Of course, I might well be biased. Having spent most of my life as a voracious reader of every type of publication, my late charge to fatherhood has reduced my reading schedule drastically over the last four years. As a result, this book feels like my first for years that I’ve read purely for pleasure. Secondly, its author is an ex-colleague of mine from the investment banking days of Greenwich Capital. I had the privilege to regularly travel with him, seeing clients across Eastern Europe, producing tales and anecdotes that I will never forget. Lastly, it invoked fond memories of my own travels around the highlands and wilds of Scotland, where I spent three consecutive summers in a campervan with my wife and two border terriers. While the scenery was every bit as magnificent as they say, the remoteness came with another huge benefit – much reduced phone and Wi-Fi connectivity.

APR 17

“The days are gone forever when our enemies could

blackmail us with nuclear bombs.”

Kim Jong-un

HINDESIGHT DIVIDEND UK LETTER / APR 17 2

As an investment manager or bank trader for the last 30+ years, I have closely monitored the news wires for potentially

market moving events over that time, or at least that’s what I’ve told myself. Unfortunately, like many people now, I feel

the need to be super connected at all times, part of which seems to be an addiction to ‘breaking news’ events. Of

course, this leads to checking emails, WhatsApp messages and news items endlessly throughout the day, which in

reality can only be described as a tragedy. It’s not just unhealthy, but also an amazing waste of time. Scotland, here I

come.

If there was ever a time when watching the news was a completely worthless enterprise, it must surely be now. Trump,

Brexit and a referendum in Scotland, in some shape or form, seem to make up 90% of the news items and my God, it’s

dull.

For my own sanity, I feel the need to summarise the situations in all these matters because we are facing years of

turgid news events on these subjects, and after this summary, the best policy would be to never discuss, debate or

read anything more on the topics ever again.

Source: FT

The approval ratings for Donald Trump’s early Presidency of are off to a poor start, the worst in living memory.

Strangely, he might be the first politician who ever campaigned on election promises that he actually intended to carry

out, rather than conveniently forget once elected, which is the norm. It now appears unlikely he will get any of his

desires passed. The term ‘Lame Duck’ President is usually reserved for outgoing Presidents during that period

between the November elections, when a successor has been elected, and the January inauguration, when the actual

changeover of power is made. Last week, the term appeared in two news articles that referred to the relative impotency

of the new Presidency.

Muslim ban, No 2 – CHALLENGE

Repeal Obama health care – CHALLENGE

Mexican wall and 20% border tax?

Provide new jobs with ‘America first’ policies

Address North Korea situation, ‘with or without’ China’s help


It has always annoyed me that Obama’s propaganda team used to boast of the miracle work that was done in bringing

in policies to promote the huge job growth from 2009 to 2016, when the unemployment rate dropped from 10% to 5%.

Clearly, this had less to do with the administration and more to do with the ups and downs of the business cycle. The

side effects of the ridiculous amount of monetary stimulus are still yet to be discovered. Unfortunately, President Trump

has a much more difficult starting point, with stocks at all time high valuations and the unemployment rate at cycle

lows.

Source: Bloomberg

Source: Hussman

Regrettably, the only Trump ‘promise’ that is likely to gain support in the US is to ‘deal’ with North Korea ‘once and for

all, with or without China’s help’. Not an ideal situation all round, I fear. Unfortunately, the recent bombing in Syria may

just be a warm-up for more global confrontations. While the early supporters of Trump’s ‘America first’ slogans, with no

more foreign excursions, are suitably dismayed, his recent detractors are now supporting him – an odd state of a

nation.

Brexit will continue to bog down the news and our administration for years and years to come, and I dearly want to

believe I can avoid this turgid situation. I didn’t vote for it because I couldn’t see the point of such negative use of our

productivity far into the future, as the truth of this is now becoming apparent. It reminds me of writing out 10,000 lines in

school detentions, only to finish and have it ripped up and told to start again.


Source: Variant Perception, Bloomberg

While I don’t know the outcome or who will proclaim themselves to be the winner for voting either way, I believe the

general standard of living measured by real wages will continue to decline and possibly accelerate lower, especially as

inflation is rising and may increase dramatically.

UK Retail Price index

Source: Bloomberg

The final news item that should be avoided for health purposes is the debate on the need for a new Scottish

Referendum. It didn’t get through last time – so best of three, I guess?

The absurdity that sees most 16 to 24-years-olds in Scotland keen to do their patriotic duty (maybe they should drop

the voting age even lower next time?), clearly demonstrates their naivety in believing that their standard of living would

not fall off a cliff if they gained independence. See the UK’s Real wages chart above and draw a straight line

downwards, if you want an idea of what the outcome would be.

Who knows if there will be any news left after I have removed these three items from my daily reading, or maybe I

should just head for the hills of zero connectivity again, especially if Donald Trump is leading us into WW3.


Trench humour from a recent blog.


CONTENTS

Inside this edition of the UK Dividend Letter you’ll find:

OVERVIEW 1

INVESTMENT IDEA #1 BT GROUP PLC 7

INVESTMENT INSIGHTS 14

PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS 19

HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (APRIL 2017) 21

APPENDIX I THE WAY WE THINK 23

APPENDIX II HOW WE THINK 24

Our main investment idea this month is:

1. BT Group PLC


INVESTMENT IDEA #1 BT GROUP PLC by Mark Mahaffey

BT Group PLC

Price (£) 310.0

Turnover (£mm) 19,042.0

Net Income (£mm) 2,588.0

Market Cap (£mm) 31,076.0

Fwd P/E Ratio 11

Dividend Yield (%) 4.60%

Payout Ratio (%) -

Total Debt to Total Equity (%) 191.8%

FCF to Market Cap (%) 9.7%

ROIC (%) 18.7%

BT Group plc (BT/A: LSE) is the holding company that owns British Telecommunications plc. More commonly known as BT, it is a multinational (operating in approximately 180 countries) telecommunications provider that is based in London, the UK. The group’s origin can be traced back to the formation of the Electric Telegraph Company in 1846, which was one of the first organisations to develop a nationwide communications network (this was later followed by the General Post Office). BT is listed on the London Stock Exchange and is now led by Gavin Patterson, having been floated in 1984 after being de-nationalised. Despite deregulation and increased competition, the company is still the elephant organisation within the communications industry and its services cover:

Fixed-line telephony

Mobile telephony

Broadband internet

Fibre-optic communication

Digital television

IT services

BT, across all its offerings, generates over £18bn in revenue with a market capitalisation of approximately £31bn. It is

one of the UK’s largest employers in with over 102,000 individuals working for the group.

Telecommunications Industry & Birth of BT Group

The use of ‘electrical’ telecommunications is something that we take for granted in the modern world and we can date

its origins to the late-17th century when British physicist Robert Hooke demonstrated that sound could be transmitted

mechanically along wires. The concept of the complex telegraph was invented by Charles Wheatstone and William

Fothergill Cooke over 100 years later and was demonstrated to the directors of the London and Birmingham Railway,

between Euston and Camden. This machine consisted of needles pivoted on a dial that contained the letter of the

alphabet. By sending an electrical current through it, any of the needles could be pointed to a particular letter. Words

were slowly built up using this method to form complete sentences that were transmitted between two points. There

were various telegraph instruments in the first half of the 19th century, but by far the most famous and widespread,

mainly because of its simplicity and cost, was Samuel Morse’s version, which ultimately connected the world with a

series of dots and dashes for decades.

https://en.wikipedia.org/wiki/Charles_Wheatstone

https://en.wikipedia.org/wiki/William_Fothergill_Cooke

https://en.wikipedia.org/wiki/William_Fothergill_Cooke


Over time, a network of private telegraph companies was spawned until the Parliament Telegraph Acts of 1868-1870,

which nationalised the industry, and it came under the authority of the UK Post Office. Six years later, Alexander

Graham Bell took this technology to the next stage by creating what is now known to us today as the telephone,

uttering the first ever words spoken: “Mr Watson, come here, I want you,” to his assistant in the next room. Bell’s

representative offered to demonstrate the telephone to the British Government. The Post Office Engineer in Chief,

Richard Culley, said his department had full details of the invention and commented that “the possible of the telephone

appears to be even more limited than I first supposed it…”

The Telephone company was set up and this new venture offered the first commercial telephone service in the UK, and

then the first public telephone exchange with eight subscribers.

By 1891, a link between London and Paris was set up, giving birth to the international telephone service. Wireless

telephony was the next step as Tesla and Marconi battled it out. Marconi later demonstrated his service in Holborn on

the site where BT now has its headquarters. Significant research and development finally led to the first wireless

signals being sent over a distance of up to nine miles in 1896, ultimately resulting in the first cross-Atlantic wireless

signal being processed.

Over time, the UK’s telephonic system advanced rapidly with the first automated public exchange opening in Surrey in

1912, which meant that customers could make calls without going through the operator. The General Post Office

(originally established by Charles II in 1660) took over all the new telephone companies. As a result, all postal and

telephonic communications were now under the government’s umbrella. Post-WWI, the UK’s telephone services grew


quickly, with the number of handsets growing as prices fell. As time went on, people started to realise the full benefit of

Alexander Graham Bell’s invention.

In 1943, a research team at the Post Office, led by engineer Tommy Flowers, designed and developed Colossus, the

world’s first programmable electronic computer. This new advancement consisted of over 1500 electronic valves and

played a crucial part in cracking the infamous German Enigma code during WWII.

Many of these innovations happened over a short space of time, with the first transatlantic telephone cable being laid

between Scotland and Canada in 1956. Queen Elizabeth II made the first telephone call using Subscriber Trunk

Dialling two years later. This new system enabled customers to make their own long distance phone calls for the first

time without the help of the operator.

The General Post Office was the monopoly supplier to the telecoms industry within the UK. The General Post Office

group controlled both the telecommunications and postal services within the UK for over half a century until the British

Telecommunications Act 1981 separated both services and eventually led to the BT Group becoming a public limited

company. This parliamentary act saw the transfer of the state-owned telephone network from the Post Office to the

new statutory corporation, British Telecommunications, which was later branded as ‘British Telecom’, and has ever

since become part of the group’s recognisable brand.

This year alone, BT Group’s share price has fallen over 15%, but since the close of 2015, the firm’s market

capitalisation has fallen by over 30%. It is very difficult to find anything but negative articles in the mainline press and

the list of reasons for investors’ concerns has grown.

Ofcom Investigation into BT & Open Reach Relationship

Battle for football rights


BT Italia scandal

BREXIT

Pension concerns

But how much of the bad news is priced in?

The telecoms industry and some parts of the media world have taken a severe beating over the past eighteen months.

A series of events (listed above) have seen BT’s share price trading at its current, depressed levels. Like all of its

competitors, the BREXIT vote saw investors running away from the communications giant (despite being a defensive

stock), as many individuals have been worried about the UK’s long-term economic stability. Investors are particularly

worried about the way that consumer-spending habits may change particularly when it comes to the BT’s sports

subscription services. Furthermore, shareholders have been worried about whether the firm would pay ‘over the odds’

to retain the rights to televise live football. These worries alone have created serious negativity around the firm’s share

price.

With BT growing into the mega communications company that it is today, regulators become concerned that the firm

had too much power within the market. BT with its subsidiary group, called Openreach (who have laid a significant

proportion of the fibre optic wiring across the UK), has grown in authority year on year. Furthermore, their work has

extended into Europe, expanding their reach. Given the combined group’s pricing power, regulators repeatedly

intimated that BT and Openreach should be split into two entities.

Source: Bloomberg

BT Group enters the HindeSight Dividend portfolio for the first time this month. We believe the negative factors that

investors have been worried about are now reasonably priced into the firm’s current value. BT is a leading

communications provider on a global scale with a particular focus within the UK and Europe. It currently trades with a

forward P/E of 11x and offers a well-protected dividend yield of 4.6%. Should the market have fully discounted all of the

negative news to date, British Telecommunications offers significant upside from its current levels. In the meantime, it

is a defensive stock by nature.

Telecommunications Industry

The telecommunications industry has suffered over the past year, as the whole sector has fallen with many investors

allocating away from defensives. Relative to the last ten years, the telecommunications sector is trading at around its

lows. This negative movement over the past twelve months has been accentuated by the TalkTalk hacking and BT’s

Italian accounting scandal, which has forced the general telecoms index lower. It is comforting to see weakness within

an entire index, as opposed to a single name within the industry group. Given that there is general weakness across all

the names, the probability of unilateral changes, such as consolidation across the industry, will rise, resulting in a re-

rating process.


Ratio of FTSE 350 Telecom Index/ FTSE 100 Index

Source: Bloomberg

With the FTSE100 trading at all-time highs, cyclicals have outperformed defensives over the past year. However, being

at its all-time high, the index is starting to show signs of topping. Throughout history, investors have psychologically

shifted into defensive stocks/industries in search of value when the market has rolled over, often not soon enough.

Ofcom Investigates BT & Openreach

Openreach is a subsidiary of BT Group that owns a significant proportion of all the pipes and cables across the UK.

These pipes and cables help to connect homes and businesses throughout the country and their work has even

stretched into Europe. The group was formed over ten years ago when Ofcom (the UK regulator) suggested that BT

Group should create this ‘independent’ subsidiary group to help implement certain undertakings that helped to

guarantee rival telecom operators were given equal access to BT’s local network.

Since its formation, Openreach has been in charge of managing BT Group’s local access network. This connects

customers to their local telephone exchange, which starts at the main distribution frame (within the exchange) and

ultimately finishes at the network termination point at the end users’ premises. It is Openreach’s job to provide equal

access to BT’s local access network. Ultimately, Ofcom forced the formation of this group, as they believed BT had too

much power within the industry.

Over the years, Openreach has been criticised for its broadband service speeds, which many individuals have

suggested created a less competitive environment. In tandem, BT Group has been accused of abusing their ‘control’

over Openreach by underinvesting in the UK’s broadband infrastructure. Eventually, a cross-party report by the British

Infrastructure Group found that a significant proportion of broadband customers did not reach Ofcom’s minimum

Internet speed level. After a long review period, a large number of MPs called for Openreach to be split from BT Group,

as they believed that the piping and cabling giant would perform better controlled as a separate company. This created

panic across the firm’s investor base, as Openreach accounts for approximately 40% of BT Group’s revenues. Ofcom

was quick to bat these suggestions away as they felt that splitting the communications provider would be an extremely

expensive process from a time and costs perspective. This was primarily due to the firm’s complicated pension

structure and land contract issues. Despite Ofcom pushing back on the MPs’ demands, shareholders were alarmed by

this news, which was immediately evident when the firm’s market capitalisation fell sharply.

Luckily, the situation is not as bad as investors had first feared. Spinning off Openreach as a completely new entity

would be a rather difficult prospect, according to Ofcom. Therefore, the regulator believes that Openreach should

become a legally separate company within the BT Group, as this would be a quicker and less expensive solution.

Under last month’s new agreement, in March 2017, over 30,000 BT staff members would be transferred to the new

Openreach operations, which would have an independent CEO and Chairman. Despite having this new set up,

business and investment decisions would ultimately remain under the control of the BT board. The new structure


worries certain individuals as they believe “nothing has changed’, but the news should please investors as BT Group

technically remains in control. With the firm being the sole owner of the new company, it would retain control of

Openreach’s bank account, which is a significant proportion of BT Group’s revenues.

More significantly, for the communications giant and its shareholders, Ofcom has agreed that the firm could retain full

ownership of the network assets. Investors had feared that the group would incur hundreds of millions of extra costs if

this was not the situation, which would ultimately be felt by the investors. A loss in assets would have potentially forced

credit rating agencies to downgrade BT Group. This clearly would not have been a positive outcome as their debt

would become more expensive, adding a strain on the balance sheet. This agreement, therefore, acts as a respite for

the group and its investors. Given the threat of a lengthy legal battle now disappearing, we believe that BT Group is in

a strong position to re-rate higher with such substantial uncertainty being dispelled.

Football Television Rights

Televising live football has become a significant part of BT Group’s offering. It was only three years ago that the

company shocked the industry (and Sky TV) by agreeing a deal with the football governing body. Three years on and

its hold on these televised games was once again under threat by Sky TV.

City analysts had feared for several months that BT Group would pay ‘over the odds’ to retain their television rights. As

a result, investors took these rumours in a negative manner, which further added to a fall in the company’s value, which

it had already suffered over the past 12 months. But despite the many rumours, it retained its exclusive rights to show

European football in the UK after holding off competition from Sky TV. It would also pay less than was believed by

many people. Keeping the Champions League rights was a significant result for BT Group and its expansion within the

communications industry. Following their victory, BT Group is now interested in talking to other organisations, such as

Channel 4 and ITV, who would like to televise certain games in future.

Winning the television rights will once again prove to be a feather in their cap. Industry experts had worried the firm

would have gone backwards and not diversified their business enough if that they had lost them. The same experts

were also worried about the cost that BT would incur in retaining its TV rights, and these fears vibrated throughout the

firm’s investor base.

Having understood that the firm has retained its football rights for a price less than expected, we believe this will build a

strong platform for it to move forward and help it to gain positive traction once again. The firm is now looking to make

further strides following their successful retention, such as televising these premium matches through a variety of social

media platforms. This was first tested out last year when they televised the Champions League Final live on YouTube.

Italian Scandal

At the start of the year (2017), more than £8bn (or over 20%) of BT Group’s market capitalisation was wiped off when

the firm announced an accounting scandal within its Italian unit. The company had initially intimated potential issues

but the extent of the problem was unknown. Its board lambasted the “improper behaviour” within their Italian unit and

announced an investigation into the alleged false accounting methods that were used over several years. It was

reported that the mismanagement would eventually cost BT Group approximately £500m and these headlines saw the

company’s share price plummet, with the firm suffering its biggest ever one-day fall in its history. News of the situation

created severe nervousness for thousands of pension plans, as BT Group has been a mainstay holding to date given

its large-cap status.

Despite the extent of the scandal, experts believe that these accounting issues will be cleared up as the management

team has significant experience in dealing with complicated situations. BT Group is also fortunate because its ability to

generate free cash flow suggests that it will be able to cope with this negative movement as a firm and navigate to

safety. With all the pessimism seemingly priced into the firm’s share price, which has had a couple of months to settle

since their announcement, we believe that any positive news going forwards will help the company to regain a

proportion of its losses.

Pension Deficit

There is a pension crisis looming for several large companies within the FTSE 100. Just like Royal Mail, which we

wrote about last month, BT Group has a similar problem. However, their pension deficit is the second largest in the

world (potentially £11bn), behind DuPont. This has created serious concerns for many investors who are starting to

take notice. This situation is a drain on the firm’s cash flow and could eventually derail its expansion plans or even go

as far as halting their dividend payments. Despite investors’ fears, many forget that some parts of BT Group’s scheme

are guaranteed by the government, just like the Royal Mail. Furthermore, with UK inflation now rising and expected to

increase further, bond yields will increase going forwards, automatically lowering the firm’s pension liabilities. City

analysts still believe that it produces enough free cash flow to cover its 10% dividend growth, while also plugging the

hole in its pension fund.

Most companies with a defined benefit pension plans are doing their utmost to convert to a contribution led

programme. BT Group is no different. Given that the firm currently produces enough underlying cash to cover its

liabilities, these pension funding fears may also be overdone.


Analysts’ Corner

BT Group is a market leader within the communications industry and has been considered so far to be a leading

member within the FTSE100. The company is well covered by the analyst community, who over recent months have

turned positive on the firm’s situation. The firm is currently being attributed with an average 12-month target price (TP)

of 389p, representing an upside of over 24% from current levels.

Summary

The company trades at a large discount to itself and its peer group. The industry as a whole has performed poorly over

the past twelve months without a doubt. Looking at the firm’s performance over the past five years, it is currently

trading just above its four-year low and its shares have been weighed down by the significant bad news we’ve

observed, as discussed earlier.

Source: Bloomberg

With the stock having now had time to settle, our models suggest that most of the bad news is priced in and, as such,

we believe that it is now the ideal time to start building a position in BT Group. The firm has a strong management team

with several years of experience that will help it through its recent troubles. Despite all of the negative events, the

company tends to produce free cash flow throughout the business cycle. It offers a large dividend yield of 4.6%, which

is supported by its ability to generate ample cash.


INVESTMENT INSIGHTS

Better to be lucky than smart is the old adage. Well, I was very lucky, but not smart to buy a house in London in 2001, and sell it in 2015 and downsize to the East Sussex coast. Oddly, in the last week, two unconnected people have asked me why I didn’t lever up more in 2001 on my house purchase. Of course, with all the benefit of hindsight, anyone who could have done so should have levered themselves to the hilt, as prices soared four-fold and more in the following 15 years due to a variety of factors.

Unfortunately, in 2001, it was not that obvious, believe me. The tech bubble had imploded and the stock market was in

severe decline from the 2000 highs, although the much worried about millennium computer bug was noticeably absent.

But the prices that were being paid for London property were at their all-time highs and people at that time could still

remember the 1991 property crash where thousands went into mortgage negativity equity and lost their jobs and

houses. For my house purchase, I put down 40% and got an interest only mortgage for the 60% remaining. When I

asked both enquirers if they could guess the interest rate I had to pay for my very competitive mortgage, linked to the

base rate at that time, neither was remotely close to the actual rate of 6.49%!!! Not only was I buying the highest price

in the history of property for my house, but I was also spending most of my salary on paying the whopping monthly

interest cost. Trust me, I felt very levered and in wasn’t clear that house prices were taking off until at least 2005, and

even the 2008 crisis barely dented the huge surge in prices until last year.

Price to income valuations, Russians leaving and stamp duty increases have all had an effect of finally ending the

party, probably for the foreseeable future, maybe even a crash?

An interest only mortgage of 6.49% seems ludicrous in today’s marketplace. If this was suddenly the case now, most

people would be unable to pay their current mortgages and very few would be taken out.

Most people’s portfolios, aside from property, is made up of the traditional split of bonds and equities, whether they are

conscious of it or not, especially in their pension plan, which is managed by an investment manager. While many think

of bonds in terms of government bonds, like UK Gilts or US Treasuries, that are issued and redeemed at 100 with bi-

annual coupon payments over the fixed maturity, the corporate bond market plays a large and very important function

in providing funds to corporates from invest.

As you would expect, corporate bonds have similar characteristics to government bonds. Usually, a fixed coupon and

maturity date, issued and redeemed at par. The difference with corporate bonds is that the risk of repayment is now the


company’s, rather than the government’s. Risk tends to be qualified by long-standing credit agencies like Moody’s,

Standard and Poors and Fitch. The table below shows the generally accepted credit ratings.

AAA credit is generally reserved for developed country governments and exceptionally creditworthy corporates and we

work down the scale from there.

An investor must understand the capital structure of corporate financing to make a choice between bonds and equities.

In the case of bankruptcy and potential liquidation, senior bonds have the highest claim on any residual value of the

company’s assets and common equity the lowest. Equity investors often get wiped out in these events.


A current selection of current bonds from Killik stockbrokers are shown below. Killik has given them their own risk

rating in the last column. It should be evident that the gross and net redemption yields (that take into account the

coupon and price paid) are pitiful, especially for the higher rate taxpayer.

Source: Killik & Co

Why bother, when there’s all the risk and no return? The only way to find higher yielding bonds is to move further down

the risk curve into the murky world of retail bonds and mini-bonds. In my humble opinion, the risks on these FAR, FAR

outweigh the potential returns. Do not be drawn in by 6+% yields because the bank pays only 1%. You will be lucky to

get the first two years coupons in many instances and we haven’t even hit a bad economic patch. If you want to invest

in highly speculative small companies, no doubt with little in the way of tangible assets or cash flow, at least buy their

equity and not their debt product, as you will have a big upside possibility, as well as downside risk.

But this wasn’t always the case. Investors who invested in corporate bonds before 2010 had a far luckier time for

making solid returns.

The historic five-year swap price (LIBOR), shown below, is used by most traders as a benchmark to price their

corporate bonds. Typical large corporates like Vodafone, Tesco and BATS spread to the curve would have been 50-

100 bps over. So the average returns for the bog standard corporate bond investor pre-2010 may well have been in the


7-8% range – a real return that could be used for income needs or excellent capital compounding, doubling your

money in less than ten years.

Source: MoneyWeek

Source: Bloomberg

Source: Bloomberg

It is unclear whether people truly understand how lucky they have been in the past in their investments, be it property,

bonds or equities. Neither is it clear whether they truly understand how exposed they are currently. Holding these

investments are seriously strained valuations but at least they maybe have mark to market gains. Think of the poor

investor starting now, how bad are the cards that have been dealt to him in the hope of a good risk adjusted return.

Historically at least, interest rates had a reasonable correlation and were spread to the underlying inflation rate. When I

bought my house in 2001, when mortgage rates were 6.49% and corporate bond yields were 7-8%, the retail price

index measured inflation just over 3%. We can argue at what spread interest rate products should trade over the


inflation level, but we have been happy in the past to average 2-4% over. Last month’s RPI number was an uncanny

3.2% as well, yet we all know interest rates are still stuck near zero. The near universal belief is that any inflation seen

here is temporary, either as a result of a base effect of last year’s oil price rise or the Brexit induced sterling currency

weakness. And how could the Central Bank or the market let interest rates rise above the inflation rate to 5-6% again,

knowing full well that the economy would collapse with all property, equities and bonds to boot?

Unfortunately, I don’t think the market will be that forgiving. The Bank of England and investors all around the world are

pinning a tremendous amount of faith on a belief with no historical basis whatsoever.

"All great events hang by a hair, I believe in luck, and the wise man neglects nothing which contributes to his destiny."

– Napoleon Bonaparte


PORTFOLIO UPDATE - WHAT HAPPENED? MARKET & SECTOR ANALYSIS

UK Market Valuations

UK INDICES PRICE/EARNINGS PRICE/BOOK DIVIDEND

RATIO RATIO YIELD (%)

FTSE 100 INDEX 38.36 1.84 3.85%

FTSE 250 INDEX 28.23 2.15 3.05%



HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (APRIL 2017)

Portfolio Update and Construction


PORTFOLIO UPDATE

Next PLC

On the 6 April 2017, Next PLC paid a special dividend of 45p.


APPENDIX I

THE WAY WE THINK

We passionately believe that dividends really, really matter.

William Thorndike in his fascinating book ‘The Outsiders - Eight Unconventional CEOs and Their Radically Rational

Blueprint for Success’ examined one of the most important aspects of running a business a CEO must undertake:

Capital Allocation. He summarised how a CEO deploys capital in order to best utilise cash flow generated from his or

her business operations. Essentially, CEOs have 5 ways of deploying capital:

Investing in existing operations

Acquiring other businesses

Repaying debt

Repurchasing their own stock (buybacks)

Paying dividends

Dividend payments are a crucial operation in creating stakeholder wealth. It is this aspect of a business that we are so

fixated by – the propensity for a company to produce and continue to grow dividends so that we may accrue wealth

over a generation. But as readers will know we can’t just grab stocks with the highest yield for fear that this signals

some cash flow or even solvency issues for the firm. So it is with this very real threat in mind we explore only well-

capitalised FTSE 350 companies.

This letter’s purpose is to help inform readers on dividend investing so that they can construct a portfolio of sound UK

dividend stocks based on our recommendations.

Our prerequisite is that any stocks selected for this letter must be liquid, well-capitalised with a strong free cash flow

and a progressive dividend policy.

Our System

Every month we will provide a write up of 3 to 4 stocks until we create a portfolio of 25 UK dividend stocks. This

will be the HindeSight UK Dividend Portfolio #1

You will be alerted by subscriber email intra-month when these stocks become a buy. Timing is critical to the

strategy, not only buying quality stocks but buying them at the right time

The entry points will then be recorded in the next monthly in the HindeSight UK Dividend Portfolio section and the

stock(s) written up in full

We will run our winners but tend to rotate every 6 months depending on specific criteria which would elevate

cheaper companies into the portfolio relative to stocks that had performed

The basis for stock and portfolio selection is derived from our quantitative systematic methodology which screens

these companies using the Hinde Dividend Value Matrix®, (HDVM®), a proprietary stock-rating system

In the section on ETPs we will highlight our investment philosophy and the investment process behind our stock

selections. This is the basis of our dynamic risk and money management in our portfolio construction for you. You

can also read the stand-alone Hinde Dividend Value Strategy document to see the methodology behind our stock

selection


APPENDIX II

HOW WE THINK

“We have met the enemy, and he is us.” Walt Kelly

Our key to long-term performance investing is premised on the following:

Systematic rule-based strategy

Systematic risk and money management

Occam’s razor, aka ‘K.I.S.S.’, Keep It Simple Stupid

Consistency

Discipline

All our investment ideas are rule-based methodologies driven by systematic and quantitative models.

Hinde Dividend Value Strategy

Hinde Dividend Value Strategy seeks to generate a total return from an actively managed basket of UK dividend-

paying stocks. The strategy selects 20 highly liquid, mid-to-large capitalised stocks on an equally-weighted basis,

which offer the highest total return potential. The 50% Hedge version of the strategy would then be subject to a

strategic Beta Hedge*, which is designed to cover 50% of the value of the UK stock basket at all times.

The 50% hedge is maintained using UK equity benchmark indices to reduce exposure to overall market volatility, but

without reducing overall total returns to the market over the long run. The Hinde Dividend Value Strategy (100%

Hedge) would deploy a full beta hedge at all times.

Hinde Dividend Value Matrix®

The strategy employs a quantitative, systematic methodology, whereby FTSE 100 and FTSE 250 constituent stocks

are screened using the Hinde Dividend Value Matrix®, a proprietary stock-rating system. We use the same system to

select stocks for any of our strategies, long-only, 50% Hedge or 100% Hedge. The only difference is clearly the extent

of the hedge on the exposure to the overall market.

The basic premise of the strategy is to accelerate returns by selecting relatively high yielding stocks which offer the

highest potential for capital revaluation. The dynamic rotation of stocks each quarter enables us to sell stocks where

the capital revaluation and dividend has been captured, and use this additional capital to invest in more undervalued

quality companies. If successful, this cycle of capture and re-investment offers the chance to significantly improve the

total return generated by the Dynamic Portfolio.

The basis of the stock selection process is the Hinde Dividend Value Matrix®, which is a derived process that looks at

3 crucial variables:

* Beta is the stock’s sensitivity to market movements, e.g. if a share has a beta of 1.5 its price tends to move by 1.5% for each 1% move in the index

1. Dividend Screen

The top ranking stocks will be those offering a relatively high dividend. A composite of the following criteria comprises

the Dividend Rank:

Relative Dividend Yield

Dividend Capture

Payout ratios

The Relative Dividend Yield assesses if a company pays a higher dividend than the Index it derives from (the FTSE

100 or FTSE 250). The Dividend Capture criteria explain how quickly and how much of the dividend is paid at any point

in time. The Payout Ratio gives a snapshot of whether a company will be able to maintain and grow its dividend. It

helps us to assess how much of a company’s revenue, profit or cashflow is paid out in dividends.

The lower the amount of dividends paid out as a percentage of profits, the healthier future dividend potential will be.

History is for once a good guide as to whether companies will continue to pay and grow their dividends. A stock with an

excessively high yield relative to its sector or the overall market is invariably showing signs of heightened risk to its

dividend sustainability and often the viability of the company itself. The screen incorporates a limit on yield dispersions

from the overall market.

The strategy is emphatically not a yield chaser. It is the Performance and Value screens that are used to assess the

total return potential of a stock by analysis of how undervalued it is relative to its fundamentals, sector and overall

market index.


2. Performance Screen

The top ranking stocks have the poorest relative performance to their index over multiple time horizons.

A composite rank of the following criteria provides the Performance Rank:

Stock relative performance ranked over multiple time periods

Average of time periods taken to select rank of stocks

3. Value Screen

The top ranking stocks by key fundamental criteria show stable fundamentals and exhibit upside momentum growth

potential. The following are some of the criteria that provide the Value Rank:

Value - Price to Book (intangible book adjustment), Free Cash Flow metrics

Quality - Return on Investment and Earnings metrics

Financial Stability - Debt levels, Coverage and Payout ratios

Volatility - Stock variance, Dividend variance

Momentum - Sales Growth, Cashflow metrics

Liquidity - Minimum market capitalisation relative to index, Shares outstanding

Implementing the Hinde Dividend Value Matrix®

The FTSE 100 and FTSE 250 stocks are ranked using the Dividend, Performance and Value screens. An equally-

weighted composite rank is then taken of these 3 ranks, which provides a final ranking from which a selection of 20

stocks is made for the portfolio.

The stocks with the highest ranking are compiled for the FTSE 100 and the FTSE 250. The top 10 from each index are

then taken, subject to diversification rules, which entail that normally only 1 stock per sector per index can be invested

in. For example, if the top 10 stocks are all mining companies, the selection process would take the first of these and

then move on to select the next top stock from another sector. As long as a stock has the highest score in its sector,

the fact that it has appeared in the final ranking means it is already eligible for investment. In exceptional

circumstances, it may be that more than one stock has to be selected from an individual sector.


External Analyst Score (EAS)

This score is derived from 3 inputs that have been obtained from all the external analysts at leading institutions who are

covering the stock:

1. The 12 month target price in relation to current price

2. The number of analysts covering the stock

3. The recommendation analysis, e.g. STRONG SELL, SELL, UNDERPERFORM or HOLD

This score is used to observe the other analysts’ view of the stock and is helpful when understanding the methodology

that other analysts use to determine their 12-month target price. We ultimately get a blend of price targets that is based

on different valuation metrics.

EAS Score Output:

1. The combined score will vary from 30-70

2. A stock with a lowest score of 30 shows the majority of analysts not only have a full sell/underweight

recommendation, but also a low 12-month target price in relation to current price.

3. A stock with the highest score of 70 shows the majority of analysts not only have a full buy/overweight

recommendation, but also a high 12-month target price in relation to current price.

Note:

- On a standalone basis, the EAS score must be viewed in the following context:

Equity analysts issue far more positive recommendations than negative

If all analysts are overwhelmingly bearish or bullish, then this can signal a contrarian position be held, but this is

determinate on the where the stock is valued.

- However, in conjunction with the HDVM®, we have found the score to be useful when it is high or momentum is

turning higher, as this suggests that the stock offers deep value.

Disclaimer This newsletter is intended to give general advice only on the importance of dividends within the equity space. The investments mentioned are not necessarily sui table for any individual, and you

should use this information in conjunction with other advice and research to determine its suitability for your own circumstances and risk preferences. The value of all securities and investments, and the income from them, can fall as well as rise. Your investments may be subject to sudden and large falls in value and you may get back nothing at all. You should not buy any of the securities or other investments mentioned with money you cannot afford to lose. In some cases there may be significant charges which may reduce the value of your investment. You run an extra risk of losing

money when you buy shares in certain securities where there is a big difference between the buying price and the selling price. If you have to sell them immediately, you may get back much less than you paid for them. The price may change quickly, particularly if the securities have an element of gearing. In the case of investment trusts and certain other funds, they may use or propose to use the borrowing of money to increase holdings of investments or invest in other securities with a similar strategy and as a result movements in the price of the securities may be more volatile than the

movements in the price of underlying investments. Some investments may involve a high degree of ‘gearing’ or ‘leverage’. This means that a small movement in the price of the underlying asset may have a disproportionately dramatic effect on your investment. A relatively small adverse movement in the price of the underlying asset can result in the loss of the whole of your original investment. Changes in rates of exchange may have an adverse effect on the value or price of the investment in sterling terms, and you should be aware they may be additional dealing, transaction and custody

charges for certain instruments traded in a currency other than sterling. Some investments may not be quoted on a recognised investment exchange and as a result you may find them to be ‘illiquid’. You may not be able to trade your illiquid investments, and in certain circumstances it may be difficult or impossible to sel l or realise the investment. Investment in any of the assets mentioned may have tax consequences and on these you should consult your tax adviser. The opinions of the authors and/or interviewees of/in each article are their own, and are not necessarily those of the

publisher. We have taken all reasonable care to ensure that all statements of fact and opinion contained in this publication are fair and accurate in all material respects. All data is from sources we consider reliable but its accuracy cannot be guaranteed. Investors should seek appropriate professional advice if any points are unclear. Ben Davies and Mark Mahaffey the editors of this newsletter, are responsible for the research ideas contained within. They or any of the contributors or other associates of the publisher may have a beneficial interest in any of the investments mentioned in this

newsletter. Disclosures of holdings: None relevant to any content discussed within this issue of the newsletter

Documents

OVERVIEW - Hinde Capital · course, this leads to checking emails, WhatsApp messages and news items endlessly throughout the day, which in reality can only be described as a tragedy