Q:  Why do focus on dividend-paying stocks? A : Historically, dividends have accounted for half the total return of the stock market over the last 100 years. Since dividends are as important as capital gains, our view is to focus on higher dividend-paying stocks to enhance total returns. Moreover, yields on bonds have dropped so low that we think constructing a portfolio of higher yielding names and generating a 5% cash return can become an alternative to bond investing. Q:  What is your investment strategy? A : We look for dividend-paying companies that have the capacity to boost yields in the future as the company generates higher cash flows. We employ a bottom-up, fundamental research approach in selecting companies and invest in approximately 30 to 50 names that meet our financial strength and dividend yield criteria. Our extensive search for yield includes equities, MLPs, REITs, preferred stocks, convertible securities and any other investment type that meets our criteria. As shares appreciate to the point where yields are no longer attractive relative to the alternative of low risk bonds, they generally become candidates for sale. Although we tend to eliminate names that are cyclical, are financially leveraged as part of the operating model, or have significant exposure to commodities, if a name is reasonably priced and the yield is attractive enough we may consider investing in it. Q:  Would you highlight the steps in your research process? A : Our research process starts with running a screen on all dividend-paying companies worldwide. Having a manageable list of about 100 to 200 names from a universe of more than 1,000 names, we choose the best 30 or 40 names that meet our quantitative and qualitative screens. Not only do we continually evaluate and review how these companies operate, but we also swap to other names when we find a better relative value. For instance, if two companies are in the same industry with both yielding 5% but one is paying 90% of its free cash flow as the dividend and the other is paying out 50%, we select the latter because the potential for dividend growth is higher. We like the concept of a dividend with good potential to grow as well as a high dividend portfolio which gives us more defensive posture in the portfolio. We look for companies with a consistent high free cash flow, a proven history of above average dividend and a dividend growth that matches cash flow growth. If we see deterioration in dividend, cash flow or future growth potential, we are not averse to selling the stock or lowering the exposure. Q:  How do you swap names in the portfolio? A : This year we have added European names as many companies are trading at big discounts compared to their U.S. counterparts. For example, the U.S. based telecom operator Verizon used to yield 7% or 8% and now the yield has dropped near 4%. Verizon is dealing with a big competitor in the face of AT&T while bidding for spectrum purchases, whereas Swisscom AG, a telecommunications provider in Switzerland, has highly leveraged private companies for competitors and thus Swisscom dominates its market and areas of expansion. Swisscom was adding faster speed broadband and the stock was yielding between 6.5% and 7% when we started building a position. The company generally had two competitors and both of them had been acquired with lot of debt on the balance sheets and limited capital spending capacity to roll out broadband compared to Swisscom. In spite of its high capital spending needs, Swisscom was still growing its cash flow while managing to increase dividend. We foresaw the capital spending could go down as Swisscom finished the broadband rollout, in which case they could ramp up the dividend even more. What is more, Swisscom’s debt ratios were not very high and their balance sheet was clean. For us, Swisscom offered a better investment opportunity with higher dividend growth capacity than what we could see in Verizon at the time. Another example of our selection process would be companies in the oil sector such as Exxon Mobil. Although the company is popular with investors because of its 2.5% yield, our detailed work has led us to better investment opportunities. Canadian Oil Sands, which has a partnership with Exxon Mobil, is yielding 6% and the company is increasing production in an attempt to further improve cash flows. Furthermore, the company is a good acquisition prospect as Exxon is a 25% partner in that deal and Exxon has invested in more deals in the area. We are investing in the same assets with a much higher yield, and the company does not have that many capital spending obligations leaving a lot of free cash flow for investors. Another stock where we have a significant stake is Thai Beverage Public Company Limited. This Thailand-based company yields about 5%, but while it appears to be quite attractive on the surface relative to other brewing companies. The payout ratio was about 60% and we were skeptical they could boost the payout, but dug deeper. We think a company paying out a lot more money in relation to the cash flow is probably not a situation in which they are going to be able to expand their dividend payout in the future. Thai Beverage has three basic operations – a beer business, a spirits business and a non-alcoholic business that includes bottled water and sodas. When the company emerged on our radar they did not have any debt and the balance sheet looked solid. What we found out at the time was that the Thai government had raised the excise tax on beer and spirits considerably, thus lowering the consumption of beer due to prohibitive pricing. At that stage the large cash flow contribution to Thai Beverage from its beer business dropped to zero. Also, a lot of the non-alcoholic soda and bottled water business was also hurt in the recent devastating floods in Thailand, with cash flow from that segment declining to zero. Consequently, the entire company’s cash flow was being driven by the spirits business that was growing at about a 15% to 20%. We found that the whole company was trading for about seven or eight times just the spirits business cash flow, so we felt confident that we were basically getting the beer business and the non-alcoholic business for free and the spirits business at a discount growing at 15% to 20%. We were very comfortable with that story, and as we dug a little deeper we tried to see how they were going to improve the non-alcoholic and beer businesses. The company had a reasonable plan underway where they took over the Pepsi distributor in Thailand and switched to beer production for the export markets of China and Myanmar. Since Pepsi was no longer going to be bottled in Thailand, they were converting that factory into another non-alcoholic soda and bottled water production. Moreover, the acquisition came with a big customer list, so they were able to run their existing product lines through the whole distribution list. Now that the floods have receded Thai Beverage has ramped up these factories again, and they are starting to see positive cash flows. In another recent development, the company has also been heavily involved in the Asia Pacific Breweries takeover by Heineken at a huge premium. Thai Beverage bought a 30% stake, which gave them a blocking control on any asset sales. Q:  How do you deal with emerging market companies reporting rising sales that are mostly driven by inflation? A : For the most part, the companies we invest in are focused on growing their volumes and expanding their businesses. Our emerging market portfolio would include Thailand and a Coke bottler in Australia, Coke Amatil, which has the Indonesian license and sells more beverage volumes. We are seeing very rapid unit growth in both situations as the companies enter virgin markets. This type of growth exceeds inflation simply because the companies are increasing volume sales by expanding into new markets. The bulk of the portfolio is essentially focused in developed markets. At any given time, half of portfolio allocation is in the U.S. and significant holdings are in Western Europe and Canada, totaling as much as 85% of our assets. Q:  Do you hedge your currency exposure? A : We do not hedge currencies. Our general view is that over the long term the value of the business and global developments will outweigh any currency changes. From a short-term standpoint, we are not currency traders and we think it is too costly to try to hedge everything. What we would rather do instead is maintain a diversified portfolio across different geographies. Q:  How do you build your portfolio? A : We typically hold between 30 and 40 names, and we may occasionally increase that number to 42. At the time of a purchase we limit our position size below 5%. Although appreciation may push that to 6%, we tend to scale it back if it is poised to reach higher levels. We generally keep sector limits below 30% and limit industries to 25%. For benchmarking purposes we use the S&P 500 Index and the MSCI All Cap World Index, and we maintain the average portfolio turnover about 20% to 25%. We try not to overemphasize any one country or a sector. At a sector level, we take concentrated positions within groups. We have had periods with a lot of exposure to master limited partnerships with cash flows linked to tobacco settlements, but that has come down a little as of late. Q:  What risks do you primarily focus on? A : Using our careful selection of stocks, we do a lot of risk control to ensure that we are getting compensated enough through attractive dividends. In addition, we continue to focus on the fundamentals relating to dramatic changes in a company, its potential to grow dividends at a 6% or 7% rate, as well as acquisition plans involving borrowing. As we are constantly looking at how a particular company is allocating cash, we may decide to exit our position if we do not agree with the company’s management. Overall, our risk control revolves around our determination to find companies that make us feel confident in their financial strength and sufficient trading liquidity. Additionally, in our final analysis we control risk with continual monitoring of management actions and decisions regarding cash flows.