OVERVIEW WHAT’S INSIDE - Hinde Capital...UK and Republic of Ireland on a daily basis. (Master) Franchise Model Business owners tend to go one of two ways when structuring the business:

OVERVIEW WHAT’S INSIDE

OVERVIEW

INVESTMENT IDEA #1 Domino’s Pizza PLC

INVESTMENT INSIGHTS

PORTFOLIO UPDATE - WHAT HAPPENED? Market & Sector analysis

HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (AUGUST 2017)

APPENDIX I THE WAY WE THINK

APPENDIX II HOW WE THINK

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

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4

10

14

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17

AUGUST 2017ISSUE 33 - AUGUST 2017 WWW.HINDESIGHTLETTERS.COM

Flying a Spitfire was still every boy’s dream when I was growing up some 30 years after the war

had ended. Sadly, only rich plane enthusiasts have managed it since. However, I have just come back from the IMAX cinema in Waterloo after watching Christopher Nolan’s new film ‘Dunkirk’ where I found myself as close as I am ever likely to be in terms of aerial combat in this life!

In terms of living through the sheer terror of being involved in the 1940 WWII evacuation of Dunkirk, this was incredibly real. Whether you were Army, Navy, Air Force or civilian, the IMAX huge screen and surround sound experience is overpowering and well worth the trip. No doubt it will be up for awards, as new technology remakes of classic stories invariably are, and for pure cinematography, who am I to argue. The historian critics will moan that the beaches in the movie are empty, like a winter’s day on Camber Sands, rather than rammed with half a million men and all the military hardware, and the fleeing British Expeditionary Force was forced to leave with not a single smoker among them.

June 2nd 1940 to Flag Officer Dover,‘BEF evacuated’

Captain William Tennant RN- Aka ‘Dunkirk Joe’

2 HINDESIGHT Dividend UK Letter ISSUE 33 - AUG 2017

My criticism is that it doesn’t really tell the story and so many will have

left the auditorium not much the wiser of the actual events, especially younger members of the audience. I urge anyone who is interested to watch the 2004 drama documentary ‘Dunkirk’ for a much better idea of the history to complement the more ‘realistic’ experience of the new film. After the declaration of war with Germany in September 1939, The British Expeditionary force of up to 250,000 men was sent to France to support the French defensive line mainly on the Franco-Belgium border. Nine months later in May 1940, the Germans attacked through Belgium into France leaving the proud defences of the Maginot Line virtually untouched to the south. With the speed of the ‘Blitzkrieg’, retreat to the sea was the only option. Dunkirk was gallantly defended by the French and English rear guards, enabling an incredible 338,000 men (including 125,000 French) to leave the beaches, primarily in destroyers of the Royal Navy, but also in ‘the little ships’. Some of these were sailed by civilians who had come from the fishing ports of the English south coast. There were also less well-known evacuations from Le Havre and Cherbourg, which ensured that over a half a million fighting men returned to English soil, rather than join the almost two million French Army POWs who spent the war in Germany.

Despite the miraculous salvage of men,

90% of the army’s equipment now lay in ruins or was in enemy hands in France. France surrendered, and with America still voting whether to keep their army, England stood alone awaiting the Battle of Britain, outnumbered in aircraft by 4-1. Arguably, the darkest days this island nation has ever faced. Long-time readers who have seen the charts below before in an old blog will no doubt argue its relevance today but I feel it has importance in the inverse.

In 1940, when all things seemed lost at Dunkirk, the UK stock market revisited the depression lows, having dropped over 50% from a few years previously. However,

THE COMPANY

Mark Mahaffey

Ben Davies

Aalok Sathe

HindeSight Publishing which runs HindeSight Letters is a unique blend of financial market professionals – investment managers, analysts and a financial editorial team of notable pedigree. The co-founders of Hinde Capital, Ben Davies and Mark Mahaffey, a successful alternative investment management company joined forces with the financial journalist David Stevenson best known for his regular columns in the FT Weekend, Money Week and numerous other global media titles to deliver something different in the financial newsletters segment – simply put it’s a reliable newsletter version of a managed fund.

Our writers actually run money, not just write about it, so they are the right mix of book smarts and street smarts. Truly a team of individuals that make up a formidable pool of knowledge, wherever the investing landscape shifts to.

CONTRIBUTORS

CO-FOUNDER & CFO OF HINDE CAPITAL

CO-FOUNDER & CEO OF HINDE CAPITAL

ANALYST

ISSUE 33 - AUG 2017 HINDESIGHT Dividend UK Letter 3

despite all of the desperate days ahead, when winning the war seemed a distant hope, the stock market marched higher. It had priced in the worst news and when that didn’t happen, higher prices could be the only outcome.

In today’s stock markets, we are clearly not pricing in disaster. In fact, in my opinion, we are pricing in only the very best outcome, where market participants are totally unconcerned about any future worries. Maybe we would be better off showing the German stock market in the 1930s, as below. With the German 3rd Reich controlling most of Europe, having driven 500 miles into Russia unopposed in six weeks, their stock market was at the highs, what could possibly go wrong?

Like many, I enjoy history books of all kinds, especially those with relevance to markets. I also try to imagine how the historians will write up our current times and try to keep questioning myself on my assumption that we are pricing in a perfect outcome, which even it if continues

for a while longer, is unlikely to make the gains worthy of the risk.

To my observations, we are priced for:

• Interest rates to stay at zero or low forever• Price/Earnings, Price/Revenue multiples to stay

elevated for years• Profit margins to be maintained• Very low unemployment with the workforce’s desire

for higher, ‘competitive’ wages never met• Assets from equities, bonds and property remain

forever on a high plateau• Inflation stays sub 2.5% forever• Central bankers, having created trillions of extra

money supply out of thin air, are never punished for their actions

And most importantly, after seeing the film, we – in the developed and emerging world – are priced to a reasonable extent for no global conflicts, where all wars are fought in far-flung dusty climes and won by US backed forces. Where there is no likelihood at all of our lives and our children’s lives being threatened by war.

Hopefully, when change comes, as it surely will, it will be just another financial crisis. This will probably be bigger than the last one, but we will go more into perfectly priced investments in the insights section. In the meantime, we should not by any means be complacent and take what we have today for granted. Historically speaking, we are on very thin ice, in more ways than one.

Source: Wealth, war and wisdom- Barton Biggs Source: Wealth, war and wisdom- Barton Biggs

Source: ‘Wealth, war and wisdom’ - Barton Biggs


The first store in the UK was opened in Luton in 1985. By the time the group went public in 1999, they had

opened over 190 stores that covered approximately one-third of UK households. By that point, they had also sold over 7,000,000 pizzas across the UK. With over 30 years of experience in the UK market, the group owns over 1,000 stores and 35,000 affiliates. With the pizza group making over 85 million pizzas a year, Domino’s looks to focus on quality, service and image. They are committed to the use of fresh produce wherever possible. One aspect that the directors made sure would set it aside from its competitors is the use of fresh (not frozen) dough. The dough has a special recipe and is prepared on a daily basis at the firm’s purpose built production centre in Milton Keynes. Dedicated refrigerated transport vehicles then deliver the trays of dough balls to all the Domino’s stores across the UK and Republic of Ireland on a daily basis.

(Master) Franchise Model

Business owners tend to go one of two ways when structuring the business:

• Build a chain of stores• Franchise their business

Creating a franchise typically involves the owner of the business licensing the business to a third party individual/group. The third party operator is then able to run the business while distributing goods/services using the franchisor’s business name and systems for an agreed period of time. The operator initially pays an upfront fee to the franchisor and then an ongoing fee (% of the revenues or profits).

INVESTMENT IDEA #1DOMINO’S PIZZA PLC

BY MARK MAHAFFEY

Price (£) Turnover (£mm) Net Income (£mm) Market Cap (£mm) Fwd P/E RatioDividend Yield (%) Payout Ratio (%) -Total Debt to Total Equity (%)FCF to Market Cap (%) -ROIC (%)

264.0360.671.81,362.418.62.95%

38.1%

53.3%

Domino’s Pizza plc

Domino’s is a global pizza brand (food delivery service) that was founded by James and Tom Monaghan in 1960. The company was formed in Michigan when the brothers purchased a small pizza store called DomiNicks. The company has now grown into a global food service provider where each of their menus vary by region. Despite starting as an enterprise that delivered pizza, the company went on to add Chicken wings, pasta, submarine sandwiches and desserts to their food collection. In 1998, Domino’s founder, Tom Monaghan, announced his retirement and sold 93% of his stake to a private equity group called Bain Capital.

DPG is the master franchisee of Domino’s in the UK and Republic of Ireland. Since the business of the group was purchased from DPII in 1993, it has developed to become the leading UK home delivery pizza brand by sales, and was listed on the London Stock Exchange in 1999. The UK business is listed on the FTSE250 with David Wild steering the company to success. Domino’s UK is headquartered in Milton Keynes with a market capitalisation of over £1.3bn.

CO-FOUNDER & CFO OF HINDE CAPITAL


Domino’s Pizza Structure

Domino’s Pizza Inc. (DPZ US EQUITY) has a master franchise agreement with its international counterparts who are then in charge of developing the business in the region they sit in. Typically, the master franchisee pays the franchise company a significant initial fee for the exclusive rights to develop the territory. Then its pays a royalty payment to the franchise company, which tends to be a function of the sales made by each individual franchisee in that particular territory.

In each domestic market, Domino’s Pizza enables independent owners to open additional franchise stores. Domino’s, like many other franchises, charges a royalty fee, and a percentage is paid to Domino’s Pizza Inc.

Within the company structure, each franchise agreement is typically for a ten-year period, which can be renewed for another ten-year period. Aside from the normal franchise fee, which is at least £280,000 (this number tends to grow year on year), Domino’s also charges a 6% marketing and advertising fee that is based on the sales that are made in each domestic region.

Franchisees are chosen very carefully for their commitment and entrepreneurial approach. Many tend to be existing workers who want to now own part of the business. Domino’s works with the franchisees to select the right store location, and an agreement is signed whereby Domino’s owns the lease and then sub-lets to the franchisee. This means that Domino’s grow their network of stores without committing significant capital. If the franchisee chooses to leave the Domino’s system, then the management company still controls the location. Domino’s sells the supplies to the franchisee at a marginal cost.

Domino’s Pizza currently has agreements in the following regions:

• India• The United Kingdom• Mexico• Australia• Turkey• South Korea• Canada• apan• France• The Netherlands

Brief General History

The three dots on the firm’s logo represent the three stores that Tom Monaghan had originally planned to open. His business idea was simply to deliver a hot and freshly made pizza in the quickest yet safest time possible. At the time, Tom Monaghan used a little known format called franchising, which enabled others to invest in opening their own pizza store. This quickly snowballed and enabled the company to expand the Domino’s chain around the world.

• 1985 – Domino’s opened their first store in Japan• 1993 Second American franchise•1995 –The firm had

expanded to over 1000 international locations• 1997 – Opened its 1500th international location,

opening seven stores in one day across five continents• 2014 – Over 6000 international locations • 2016 – The firm’s Indian operation opened its 1000th

store in India alone, with its popularity-growing.

Domino’s use of technology to expand was demonstrated in New Zealand, when it delivered the world’s first pizza by an unmanned aerial vehicle using the DRU drone. The company has faced huge challenges, such as introducing itself into the Chinese market. This market was a worry, as the consumption of cheese has not always been high, given that many of the locals are lactose intolerant. Furthermore, many Chinese residents suggested that they would want a place to go and eat rather than a delivery/pickup option. Despite this, they have beaten the odds and demand across Asia/Africa has soared.

Products

Pizza is the main focus at Domino’s with its traditional, specialty and custom pizzas available in a variety of crust styles and toppings. They now also offer a range of other products, such as:

• Pasta• Bread Bowls• Oven-baked sandwiches• Chicken wings

Domino’s Pizza Inc(Master Franchiser of Domino’s Pizza)

Domino’s Pizza Group(International Partners)

Franchisees(A Committed & Entrepreneurial Group)


Since it was first founded, the company has always kept things relatively simple compared to other so-called fast food chains to ensure efficiency. Throughout its history, Domino’s menu has consisted of one pizza in two different sizes (12 inch and 16 inch) with a range of toppings.

Over the years, the group has tried to introduce a range of products, which have worked out with varying degrees of success:

• Buffalo Chicken Kickers• Chicken fingers• Philly Cheese Steak Pizza• Vegan pizza (only in Israel)

Since March 2017, Domino’s share price has fallen by over 30% as the company has come under pressure from online order aggregation platforms, such as UberEats, Deliveroo and Just Eat, who have created a marketplace where takeaways can compete.

These platforms have helped consumers to locate top-ranking local takeaways in their areas and select them on a ranking system that is continuously updated and based on the ratings of their peers. With Domino’s opting not to sell through this platform as they want to sell directly to customers, these platforms have technically become direct rivals to the Domino’s business.

Domino’s plc enters the HindeSight Dividend portfolio this month. For all the negativity in the past 12 months, we now believe this is priced into the stock’s valuation. Domino’s

Source: Barclays Research


has dominated the UK pizza business over the past 30 years and currently trades on a forward P/E of 19.3x.

Increased Competition

Across the world, the food delivery market stands at over £70bn or 4% of food sold through restaurants and fast-food places. More specifically, the delivery market in the United Kingdom accounts for approximately 2.75% of the overall food market. Over the years, the most common format has been a situation in which the end consumer places an order with a local vendor and they deliver the food to your residence. However, like many other sectors, the introduction and progression of digital technology has reshaped the market. Customers, who are regular online shoppers, now expect the same level of service when ordering their lunch/dinner online.

There are two types of online food delivery platforms:

Aggregators – these emerged over 15 years ago, offering access to multiple restaurants through a single online portal

New Delivery – allows customers to compare offerings and order meals from a group of restaurants through a single website.

The rise in food delivery options, such as Just Eat and UberEats, has created serious competition for the likes of Domino’s and its peer group. An increasing number of consumers are now using these aggregating platforms to order their takeaway food. This is providing more choice, improving the service as a whole and attracting more customers. It is this network effect that is growing the client base, month on month.

The increased level of competition has put significant pressure on Domino’s and its peer group. Over the past few years, Domino’s has produced a string of impressive results that have seen its value rise rapidly. However, the company reported a surprisingly negative set of results earlier this year, which saw its like-for-like sales growth (representing the past year) decline abruptly.

According to industry analysts, the structural growth story for the takeaway sector remains strong. However, while dealing with the long-term threat from aggregators, Domino’s is also having to deal with a short-term issue posed by more traditional competitors, such as Pizza Hut, who are starting to add to the competitive environment through their pricing strategy:

It is evident that Domino’s is not immune from an increase in competition. However, according to analyst research (when looking at Deliveroo), the proportion of consumers that use Domino’s and Deliveroo (as a % of Domino’s customers) is only 11%.

This is relatively a small and manageable number, especially given that a number of consumers tend to use the likes of Deliveroo to order cuisines other than pizza and, therefore, the level of overlap seems to be minimal. Furthermore, investors’ worries seem to be overextended, as many of the aggregators do not have the same level of reach across the country as Domino’s.

With each Domino’s store well established and the brand name speaking for itself, this is a competitive advantage that seems to have been overlooked. Each franchise is adaptable and has a high level of control over the products being sold; Domino’s is well placed to weather any threat from a disruptive source or more traditional rival. Lastly, when comparing Domino’s to localised threats, the pizza





giant is supported by a significant budget to help amass its market share over a long-term period. Even if like-for-like sales growth declines, each franchise site tends to make significant EBITDA. Given that this advantage does not decline, the incentives still remain to expand new sites, driving further profit growth for the company.

Technology

Domino’s has always been a nimble and adaptive company. They have had to reinvent themselves multiple times and recently demonstrated their iterative process in the digital age. For Domino’s, more than 50% of their orders come through digital channels. However, they are now teaming up with technology giants to give customers the ability to place an order through Amazon Alexa and Google Home. The group is trying to innovate and stay ahead of the curve, investing and integrating into tomorrow technology, today.

Furthermore, Domino’s has always been focused on the convenience of its customers. Having introduced a more user-friendly experience through its website and created a mobile-app for an easy one-click ordering process, the company has, over the years, been at the forefront of technological innovation within the takeaway industry. The firm’s ability to push the boundaries was demonstrated once again when they started testing DRU – Domino’s Robotic Unit, in 2016. DRU is able to navigate from a starting point to its final destination, always selecting the most optimised path to travel. This autonomous delivery unit has been designed to create efficiencies in the future, which should help bring costs down in the long-term, and to keep customers orders piping hot and drinks icy cold whilst travelling on the footpath at a safe speed. This will enhance the user experience and help drive sales going forwards.

International Expansion

With its long and well-established track record in the UK and Ireland, the group recently decided to expand into Germany, Iceland, Norway and Sweden. Out of these, the best opportunities seem to be emanating from Iceland/Norway and Sweden as penetration of large pizza delivery companies in those countries is currently low. The firm’s German venture comes through its 33% stake in Joey’s Pizza, which is one of the largest Pizza businesses in Bavaria.

Food Inflation

Many investors throughout the world are worried about rising inflation. It has also been a worry for many of Domino’s investors as all of their items are impacted by rising input costs. By creating a basket of items that tend to be affected by inflation (orange juice, wheat, corn and sugar), we can see that the price of these raw commodities has actually weakened and, going forward, you would expect this to have a positive impact on Domino’s financials over the course of 2017.

Analysts’ Corner

Domino’s is a leading pizza delivery provider. Trading on the FTSE250, the company is well known by the analyst community, who seem to have a neutral view on its current price level. The firm is being attributed with an average 12-month target price (TP) of 362p, representing an upside of just over 30%.

Summary

Domino’s trades at the trough of its P/E cycle, having suffered over the past twelve months due to investor fears that have culminated from a variety of avenues including:

• Food inflation• The threat posed by aggregator platforms and its

general peer group

Source: Hinde Capital & Bloomberg



Despite all these worries throughout its history, the firm has shown resilience and a constant commitment to changing with the times. They have always been inno

vative and demonstrated this once again by carrying out tests on autonomous vehicles. Furthermore, many investors have been worried about the threat posed by aggregator platforms, such as Deliveroo and UberEats, but we believe this may be overdone now. Since the very beginning, Domino’s has navigated through difficult times,

guided by a very experienced management team. Despite all of its historic hardships, the company has always managed to generate positive free cash flow.

With the firm having very little debt and its other fundamentals trading at a potential turning point within their own cycle, we believe that it is an ideal time to start developing a position.




INVESTMENT INSIGHTS

If you read many of the ‘expert’ financial opinions today on investing in the equity market, the consensus will

focus on low-cost Exchange Traded Funds on equity indices, starting with your home country. The belief that in the long-run equity markets always tend toward higher prices, while most of the returns come from large compounding dividends, is generally borne out by history. It is certainly better believed when the stock markets are at cyclical highs as they are currently.

In the table below are the stocks selected back in early

2008. Some may not seem as ‘blue chip’ as others, but times change. We will take it from our reader’s letter that he thought this was a fairly defensive, low risk and dividend-paying portfolio with the ability to experience growth as well. You can see some household names, banks, supermarkets, and so on. You can see the ten-year price change and the differing nominal returns with the total returns, which include all the dividends, regular or special with capital repaid and share adjustments. Many people will be surprised at the

We are always looking for topics for our letter, especially the Insight section. One of our readers has helped us this month by sending in his early 2008 ‘blue chip’ portfolio that he constructed at the time. Although he closed out the portfolio within a few months for a small loss, being worried about the overall stock market, we can still analyse the portfolio and discuss the buy and hold strategy.


extent of the differences between losses and gains, with Premier Oil losing 80% and United Utilities gaining 105% in total return, but this is typical of any long-held portfolio.It is the total return which is key. This is the actual return of the portfolio held for that period with all the dividends and disbursements received and reinvested. No income has been taken from the portfolio. The charts show the movement of the portfolio over time.

Unfortunately, the starting point in this case was not the best, coming one year before the depths of the great financial crisis, with both portfolios experiencing 50% losses earlier on. Thank God, the canny reader was an ex-city trader and didn’t hold it for that period. But over time, the power of mean reversion and monetary press printing with the dividends meant the portfolios clawed their way back. Today, the nominal portfolio is down 12% but you have had all the benefits of potentially living on the income, while the total return portfolio is up 30%. It has to be noted that this gain has happened all in the last year. In March 2016, the total return portfolio was flat for the eight-year period.

What does this tell us about a buy and hold strategy? Firstly, the starting point is very important and secondly, dividends continue to make up a major part of any long-term returns for large cap companies, maybe. But the assumption that even with a poor starting point, all comes good in the end is a poor one. The long term can be far longer than you expect. And what if you not only need to live on some income from the investment but also, heavens above, have to unavoidably take some monies out of your portfolio at a low point. Your portfolio recovery would be much worse. The chart below shows a theoretical cash withdrawal of 25% of monies at the 2009 low point and subsequent muted recovery.

If we look at the last 20 years of the FTSE nominal and total return charts, we can see that an equity portfolio has twice so far seen 50% losses in that period before 100% gains. The argument for long-term pound cost averaging by your IFA might seem strong, but we have spoken to many clients in 2003 and 2009 who saw these losses as very real. Only the benefit of hindsight allows us to praise the power of long-term holding.

Maybe the investors in the Japanese stock market over the last two decades felt the same but it hasn’t worked quite so well. But that’s different, right? The UK property market and UK stock market always goes higher, surely? No matter what happens, even after Dunkirk!

John Hussman of Hussman funds tells us that the CAPE (Cyclically Adjusted Price Earnings), normalised for profit margins, is currently trading at 40 times. Only once in history has it traded higher, in the week of March 24th 2000, before the stock market collapsed. Hussman’s Median Price/revenue chart has us at the most extreme in history by any reckoning.

More than ever, we are paying prices for stocks versus their earnings and potential earnings. Historically, at these


multiple levels, the investor’s wealth has typically suffered huge drawdowns. While the consensus outlook is more blue sky with not a care in the world, time may not be on our side.

For a simple example of the current situation, look at Exxon Mobil, one of the largest oil companies in the world. Five years ago, when oil was still trading over $100/barrel, Exxon’s earnings were $32bn a year, roughly 10X Price/Earnings multiple to the then market capitalisation size of $350bn. As we all know, the oil price has fallen 50% to sub $50/barrel, so it should come as no surprise that Exxon’s earnings today have also halved to $15bn a year. What should come as a surprise is the market capitalisation is still $350bn because the P/E ratio is now 20X earnings!!! Why on earth would investors think that paying DOUBLE the historic value of Exxon’s earnings is a good deal? The only answer you typically hear is, well interest rates are so low, what else can I do?

One of my favourite quotes is from ‘The Magnificent Seven’ when the chief baddie utters: “If God did not want them sheared, he would not have made them sheep,” which is appropriate I feel at this juncture.

Is there a safe way to invest in equities today, then? Arguably, today, like in 2000 and 2007, it is one of the

worst times in history to have invested in equities, whether you’re just starting or are fully invested. What stocks might you pick for your ‘blue chip’ long-term buy and hold portfolio today? Shell, BP, HSBC, British American Tobacco, Taylor Wimpey, perhaps?

Would you not worry that oil companies, especially those trading at 20X earnings, might go out of business when we have electric cars in 2040? Would you not worry that crypto-currencies will challenge the banks in years to come for a share in profits when money is moved around?

Would you not worry that the world will smoke less and less and tobacco companies will have no consumers left for their product? Would you not worry that the housing market is rolling over and the government’s withdrawal from the ‘Right to buy’ will affect homebuilders hugely?

Of course, you should be worried about your personal wealth and investments at all times, but especially when you are overpaying for all your investments historically, whether they are bonds, equities or property. Complacency may be very costly.


I saw a quote today from the Head of Pantheon Macroeconomics, Ian Shepherdson, that reverberated with me:

“I’m nervous about pretty much everything,” Shepherdson said Tuesday in an interview on Bloomberg Television,

when asked where investors are being well-compensated for their risks. “There comes a point in most investment cycles where you’ve got to start thinking the return on capital is rather less important than the return of capital -- just keeping your money. Not losing anything becomes important.”


UK MARKET VALUATIONS

PORTFOLIO UPDATE - WHAT HAPPENED?MARKET & SECTOR ANALYSIS


HINDESIGHT DIVIDEND UK PORTFOLIO # 1 (AUGUST 2017)PORTFOLIO UPDATE AND CONSTRUCTION

PORTFOLIO UPDATE Domino’s Pizza plc On the 3rd of August 2017, Domino’s Pizza plc paid a dividend of 3.75p.


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 systemIn 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 I

THE WAY 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,

APPENDIX II

HOW WE THINK


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 , 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.

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 price2. The number of analysts covering the stock3. 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 30-702. 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.

EXTERNAL ANALYST SCORE (EAS)

DISCLAIMER

This newsletter is intended to give general advice only on the importance of dividends within the equity space. The invest-ments mentioned are not necessarily suitable for any individual, and you should use this information in conjunction with oth-er 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 invest-ment. 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 ster-ling 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 sell 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 men-tioned in this newsletter.

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

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OVERVIEW WHAT’S INSIDE - Hinde Capital...UK and Republic of Ireland on a daily basis. (Master) Franchise Model Business owners tend to go one of two ways when structuring the business: