How stock buybacks lifted the Net Payout Yields model

Author: Mark Holder, Stone Fox Capital

Covestor model: Net Payout Yields

Disclosure: Long VALE, ETR, GPS, NLY, CSCO, LO, LOW, WLP

This Stone Fox Net Payout Yield model was up 4.8% in August versus a 2.0% gain for the benchmark S&P 500. The model rebounded sharply from a weak performance in July.

As mentioned previously, one goal of this model is to slowly trim the amount of positions back closer to 20 after reaching 26 a few months back due to mergers and partial positions. Hence, the model reduced holdings down to 24.

Express Scripts (ESRX) was sold as the merger with Medco Health (MHS) led to the reduction of share buybacks. Considering the company doesn’t pay dividends, it left the net payout yield (NPY) heading towards zero. The stock was sold at $62.49 on the spike higher following strong earnings.

This sell further highlights the ability of the model to be opportunistic when a position no longer meets the set criteria. Instead of having a rigid sell point at a quarter end, the model is able to trade positions when the market presents an ideal time.

The weakest stocks were Vale S.A. (VALE) and Entergy (ETR). The two stocks make for an odd couple as material and utility stocks typically don’t trade in the same direction. Vale has been weak due to slumping iron ore prices as China demand drops. Entergy has seen investors rotate out of conservative stocks for higher growth ones.

Naturally a slew of stocks had a good month. The biggest gain though came from Gap (GPS), which jumped over 20% for the month. This gain came following a strong month in July that helped push it to the largest holding in the model.

Other big gainers were Cisco Systems (CSCO), Lowes (LOW) and WellPoint (WLP). All of these stocks were amongst the weakest performers over the summer so the large rebounds weren’t that big of a surprise.

The advantage of owning large buyback stocks, as highlighted during August, is that these stocks benefit from weakness. The companies are able to buy more stock at the lower stock prices allowing for larger rebounds.  All of the top performers in August were the stocks focusing on large buybacks with relatively small dividends.

Conversely, the weak stocks were the ones such as Entergy, Annaly Capital Management (NLY), and Lorillard (LO) that pay the highest dividends in the model.

As pointed out in the last couple of reports, as each day passes the market gets more and more comfortable with the ability to avoid a major financial collapse in Europe. The market has clearly tired of the relentless headline risk that never comes to fruition. Investors were slowly moving out of cash into dividend stocks., and now a small portion of investors are moving into growth stocks.

The main risk for domestic markets and stocks remains the fiscal cliff and pending election. In fact, stocks have become very complacent with the looming danger and little progress towards resolution. The most at risk stocks could be those of high dividend payers that have had an exceptional run. These stocks might face the headwinds of higher tax rates that pushed them down at the end of 2010.

Regardless of the markets, the average stock in this model yields greater than 10% with the majority of yields coming from buybacks. This provides huge support if the market turns weak again.

Disclosure: Performance discussed is net of advisory fees. Certain investments discussed are held in client accounts as of September 21, 2012. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.