Smart Investing


November 18, 2011


Overcoming volatility fatigue

Last week, I wrote about volatility fatigue, and this week, I will show you the numbers of how volatility fatigue can cost you money.

Let's assume in 1999 you invested $100,000, and today it is worth $165, 000. You may be a little disappointed because your portfolio has only increased 65 percent.

I will point out that during that same time frame, the S&P 500 was only up 27 percent, but that does not impress — you still are not satisfied with your 65 percent gain. So you say, "I’m done, I’m getting out of the market until things get better."

If you're my client, I will tell you to be patient and that you own good companies in your portfolio. There is nearly $10 trillion in cash on the sidelines, the average price-earnings ratio on our companies is 11 times, and this is a great time to be invested.

I will also suggest we assume that we make 8 percent on your portfolio in 2011. Then, next year we do even better, earning 20 percent, because problems, or headline risk as it is called, doesn’t last forever. As I’ve said many times before, don’t let the market dictate that you should sell when prices are low.

If you hold good companies, the market will someday do the opposite and give you more for the company — be patient. The reason you need to be patient is to get that higher return. You may be thinking, "If I wait two more years and I get that 8 percent return in 2011, and a 20 percent return in 2012, my portfolio is only going to increase 93 percent, versus the 65 percent."

If you do the math correctly with compounding just by waiting another 14 months, your total return nearly doubles your 65 percent return to 114 percent. Be patient, you will be rewarded.

Sometimes, on my radio show, I receive a call from a listener who is excited about a company paying a big dividend with a high yield. I saw a similar headline in Barron’s last week, which read, “A Gusher of a Dividend.” It teased with the company paying almost a 9 percent yield.

The company I’m referring to, Seadrill Ltd., an offshore drilling contractor, provides offshore drilling services to the oil and gas industries worldwide. It also offers platform drilling, well intervention and engineering services. As of March 31, 2011, the company owned and operated 54 offshore drilling units, which consist of drill ships, jack-up rigs, semisubmersible rigs, and tender rigs for operations in shallow and deep-water areas, as well as in benign and harsh environments.

Seadrill was founded in 1972 and is based in Hamilton, Bermuda. The company trades under the symbol SDRL.

When I first hear about a high dividend, I immediately think of the dividend payout ratio, which tells me how much of the earnings are used to pay out that juicy dividend. For Seadrill, I was surprised to learn its payout ratio is only 61.4 percent. That tells me the dividend is safe for now, but keep in mind that the board of directors sets the dividend rate, usually every quarter, so that rate is not locked in.

Looking at the earnings going forward, I see a mean estimate of $3.28/sh. Based on the mean of 14 analysts for the year ending December 2012, I must say with a current price around $33/34 that is a forward PE of only 10.4. Using a multiple of 20, the stock price would be trading around $66/share. So this is positive.

Sales are looking good for the company as well, climbing 24 percent year over year, nearly twice that of the industry average of 13.4 percent. There seem to be some problems in the oil well services industry with the earnings per share. They were off 54 percent year over year. Fortunately for Seadrill, it had an increase of EPS year over year of 62.4 percent.

Return on equity also looked good at 37 percent, versus the industry average of 6 percent. Receivable turnover looks good as well, at 6.5 over the last 12 months, comparing very nicely to the industry average of 4.8 times.

Now that I’ve given you all this great information on this company, let me post some warning signs for you. Current ratio is only 0.95, half the industry average of 1.82. In pointing out potential problems with liquidity, such as low current assets to current liabilities, what really scares me is the debt-to-equity of 144.2 — more than three times the industry average of 43.8.

Seadrill's dividend may be safe for a long time, but that would be hoping that everything turns out OK, and sometimes it doesn't. I think you know what happens to a stock price when a company cuts or reduces its dividend. The stock falls, sometimes by 20-30 percent. So keep in mind that if the company needs to cut that dividend for any reason in the future, and the stock falls by 30 percent, at a 9 percent yield it will take 3.3 years to break even. There goes your gusher of a yield. Don’t be greedy when chasing yield. It can hurt your overall portfolio return.

Wilsey is president of Wilsey Asset Management and can be heard every Saturday at 8 a.m. on KFMB AM760. Information is provided by Reuters.


November 18, 2011