Building Wealth Over 40 Years: Investing Insights With Industry Veteran Kent Hughes

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In our August episode, Greg interviews longtime friend and fellow financial advisor Kent Hughes. Kent has worked in the industry for over 40 years, focusing his investment strategy on quality and market indices. During his career as an advisor, Kent's expertise has earned him placement on both the Forbes and Barron's Top Wealth Advisor lists.
 
Greg and Kent begin the episode by discussing the evolution of the investment industry over the past four decades, the impact of technological advances on market information, and investor behavior. The duo also delves into market expectations, secular bull markets, and the potential effects of AI on investing.
 
Following their conversation, Greg mentions that he was able to speak with the investor relations department at Snap-on, and concludes the episode by providing answers to the questions we had about the company from the previous episode. 
 
 
Timestamps:

00:00 Introduction to The Dividend Mailbox
 00:45 Interview with Kent Hughes: A Journey Through the Financial Industry
 03:33 Changes in the Financial Industry Over 40 Years
 05:35 Lessons Learned and Biggest Mistakes
 08:13 Impact of AI and Investor Expectations
 12:29 Economic Outlook and Market Predictions
 17:21 Commercial Real Estate Concerns
 19:25 Forecasting Future Returns
 25:50 Investment Strategies and Dividend Growth
 32:36 The Importance of Dividend Growth
 34:07 Historical Performance and Market Trends
 36:27 Understanding Compounding and Market Sentiment
 39:37 Favorite Investment Books and Influential Figures
 43:40 International Investing Considerations
 49:20 The Competitive Advantage of Patience
 55:43 Snap-on: A Potential Investment Opportunity
 01:00:53 Closing Thoughts and Key Takeaways

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Transcript

[00:00:00] Greg Denewiler: This is Greg Denewiler and you are listening to another episode of The Dividend Mailbox, a monthly podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks. When they grow over time, a funny thing happens, you create wealth.

Welcome to episode 38 of The Dividend Mailbox. In this episode, we're going to begin with an interview with somebody that I have known for a long time. He's been in the industry from day one in his career, and we both have seen a lot. The industry has changed, but in some ways it's still very much the same. So, I think there's plenty here that you'll enjoy. And then after we go through the interview with Kent, we will then just do a quick update. I did have a conversation with the IR department, investor relations person at Snap on, so, we will finish up with a quick update on a few issues from the last episode.

So, today we have Kent Hughes with us, who is a longtime friend of mine and also, a fellow financial advisor. I actually went to school with him. We met in an— actually, I believe it was an accounting class. We both had a pretty strong interest in investing. I started in the industry in 1979, part time and then went full time in 1981 for a firm out in Denver. Kent started in 1982. He went to work for Merrill Lynch and has been there ever since, going on 40 years. One reason why I think you might find some value in listening to this is we're going to go back and kind of look at the industry over the last several decades and some things that we've done right and some things that maybe we could have changed. But one of the things that Kent did in his career, which is one of the reasons why he manages over $500 million is that he pretty much from day one started with buying quality— really sticking to the middle of the road. And a part of this will be just the mindset of being an investor for 40 plus years.

One thing I will mention just real quick— compliance wise, Merrill Lynch will not let their brokers mention an individual stock. So, that is why we're not going to go into any specific companies, but we are going to talk about markets. So, with that, Kent, I'm glad to have you on. 

[00:03:23] Kent Hughes: Great to be with you, Greg.

[00:03:26] Greg Denewiler: We both have managed money for a long time. What I would like to ask you is just what's your impression— how has the industry changed or do you feel it's changed? And from an investor standpoint, do you think things have gotten better or are there more challenges? Just kind of what's your impression of what 40 years has meant in the investment management business?

[00:03:53] Kent Hughes: Well, to take a last part first, I think it has changed dramatically for the better. Most of us are now working as fiduciaries and that is a much better system than, in my opinion, than the commission based system that we all started with years ago. In some ways, it has not changed. People still need to— they have money, they need to save for retirement, they need to save for their kids college, their wedding. You and I do either equities, fixed income, and in that regard it really hasn't changed. But one thing that's changed dramatically is we used to really be the information source. We've had various vendors over the years, but if someone— they had to call us to get a stock quote, they couldn't look on their phone. They didn't get the quotes until the next day in the paper. And a lot of things like that, we were the information source. They would say like, “What's going on? Why is the market way up or way down?” There wasn't CNBC or Fox Business News, anything like that. So, I think that's one thing that's really changed.

[00:05:04] Greg Denewiler: Okay. Well, you are right. When I started, when we both started, the business was pretty much entirely commission. So, it has changed a lot and it is more of a fiduciary standard today, which is, I think, a positive. Probably the biggest change in the industry has been the source of information and how easy it is to come up with it now. It almost feels like when we started, it was black and white television and it was three channels, and now there's content everywhere. So, from that aspect, what do you feel is the most significant lesson that you have learned?

[00:05:43] Kent Hughes: Oh, that's a really good question. Of course, I would say the most significant has been how efficient markets are, and we'll get into that in more detail later. One lesson I've learned is when you own a really good stock that's gone up and gone up a lot, and you think it's expensive and you think, “Gosh, I should get out of it.” Hold back some. I don't want to put a%age on it, whether you keep half or keep a quarter, keep three quarters, but it's holding on to winners. Like you've done a great job of this. I would say that's one lesson I've learned. Some of these lessons I already knew from business school, but it was just hammered home after 42 years of doing this. For example, equities over time are just such an amazing wealth builder, at least, you know, the last hundred years and certainly my 42 years. Again, that's a lesson I didn't really have to learn, but it's amazing on the job. We will see clients that they never really had a very high income, but they put a big%age of their money and diversified common stock mutual funds. And it's just remarkable how much more network they have than maybe another client who has extremely high income, but hasn't believed in equities and doesn't have nearly the same investment results. 

[00:07:15] Greg Denewiler: Well, this question may be a form of what you just answered, but along the same train of thought, what do you feel is your biggest mistake? And if it's any one thing, what would it be?

[00:07:23] Kent Hughes: One of the biggest mistakes I think I've made is, and I'm working on it, is just to improve my listening. If I could do one thing over, I don't necessarily want to say mistake, but if I can do one thing over, once I could have afforded it, I would have hired some kind of communication coach and really worked on the art of listening. That's such a huge part of our job. I know this podcast is about investing and I know your listeners want to hear about our investment approaches and we'll get to that. But, absolutely, I would say that's one thing I would have done differently. 

[00:08:03] Greg Denewiler: I definitely agree. Listening is a huge factor because this is a relationship business.

Turning a little bit more towards investing. With all the information now that we have at our fingertips and basically on your phone, do you think investor expectations have changed and how do you feel about AI? Do you think it will change investing significantly or have much of an impact at all?

[00:08:34] Kent Hughes: As far as the AI portion of the question, this is a relationship business and empathy is important. The most important day in a lot of clients lives— since the men typically die first— the most important days in a woman's life is coming in and going over the accounts after her husband has died. You're not going to get that kind of empathy from AI, not yet. So, it's a relationship business. It's built on trust, which takes a long time. You have to earn it. But I think as far as on the investment side of AI, if everybody has AI, then nobody has comparative advantage. 

[00:09:23] Greg Denewiler: I would agree, actually, if you believe in the efficient market theory at all, and that there is a risk premium in it, theoretically, AI should take that out, which means returns should fall dramatically. There's really no extra reward for investing in the stock market. So, personally, I just don't think AI is really an issue. 

I think investor expectations have actually gone up and a big piece of it is driven by social media and the access to really immediate information. Its giving investors the confidence that they know more, but do they really know what to do with all the information that they have? I think it's a little bit of a false confidence. All this information, if it's actually helped investors improve their returns, then why after decades and really going back for a century, returns for the stock market have centered around 10%. But the statistics show that only about 5% of the time do returns fall within *% and 12%. Returns are either less than 8%, or they're more than 12% about 95% of the time, and that continues to hold. So, if information has been a good thing, or if information has helped, then why aren't returns a little smoother than what they are?

[00:10:57] Kent Hughes: Right. One thing that just is fascinating— if you look at the last 97 years, 37 of those years, the Standard and Poor's went up 20% or greater. To answer your earlier point, only 6 times has the S&P in the last 97 years landed between 8% and 12%. So, while it is averaged 10, like you said, it rarely does it.

As far as expectations, I think it depends on where you are within the market. If we think back, Greg, to the summer of ‘87, before the crash, expectations of returns were extremely high. If we think back to 1999 and 2000, expectations of returns were very high. At the end of 2021, with all the money sloshing around and meme stocks and SPACs, expectations were high.

So, I think a lot of it just depends on where you are. In 2002, after a 31 month bear market where 31 statements in a row says your advisor is an idiot, expectations were low. That was a 49% drop from March 10th of 2000 to October 9th of ‘02— expectations were very low. On March 9th of ’09 we dropped 58% from October 9th of 07 to March 9th of 09. That 58% drop reduced expectations tremendously. So, I think it depends on where you are within the market cycle. 

[00:12:29] Greg Denewiler: So, let's now turn to the economy. You're very familiar with several years ago, coming out of 2020, there was a huge bump in M2 money supply and it grew by more than 20%. It really was a record going back more than a century of just how fast money growth expanded. The question becomes, as we unwind that and we're in the process of doing it now, can we get through this with just a soft landing without any consequences of how all of that liquidity going into the economy— can it unwind without some major disruptions? 

[00:13:15] Kent Hughes: Yes, I do think we can get through it without a major disruption. The money supply, as measured by M2, went up about 40 to 50% in an 18 month period. So, lo and behold, we had 9% inflation in 2022. But the last 12 months, the last statistics I saw, M2 has appreciated by about 2.6%. So, we know how to get rid of inflation. It's very simple. You raise short-term rates.

You reduce the money supply, and you reduce fiscal spending. Now, that's tough medicine, it's tough politically, but that's how you reduce inflation. Those three things, raise short term rates, reduce M2 growth down to possibly go negative, and then reduce fiscal spending— of course, the third thing, uh, we're a long way from that. As far as a major disruption, I assume you're talking about a big stock market decline?

[00:14:18] Greg Denewiler: Well, to me, a big disruption is something, at least in the form of a mild recession. Because you just can't unwind all that liquidity without having an impact to at least some degree on corporate spending or consumer spending. So, it just seems to me like there's significant risk of can we get through this with just a soft landing?

[00:14:47] Kent Hughes: So, if we look at the big market declines of the last hundred years, let's just start with 1929. I think you could buy stocks with 10% down. Is that reminiscent of 2006 in the real estate market? It is to me when there was no money down. So, if we go back to 1929, The PE ratio actually was not extremely high. And in fact, we had an ever so barely positive equity risk premium. And for the listeners, equity risk premium is usually defined as the earnings yield of the S&P minus the 10 year treasury note. But if you go back and look at 1973, before that approximate 45% decline, we had negative equity risk premium. A lot.

If you go to 1987, before the crash, it was very negative. We had an earnings yield at four. We had a long-term treasury around nine. Goodness gracious, that's a minus 5% equity risk premium. And that was a pretty easy market, quite frankly, to call. Not a crash, but it was easy to say, “Wait a minute, I'm going to buy stocks at 25 times earnings, or I can just go over here and get a Treasury at 9.25%.

If we fast to 1999, and I say it that way intentionally because that whole frenzy was the very end of 99 and I think the NASDAQ rose 35 or 40% the first 10 weeks of 2000. And at the top of the market, which was I believe March 10th, 2000, the equity risk premium was minus three. So, again, very negative equity risk premium, 1973, 1987, 2000, and that's what made 2007 trickier.

I thought at the time we could have maybe a 15 to 20% drop because after all, we've gone five years from October 9th of 02 to October 9th of 07. The S& P almost exactly doubled and at the top of the market in 07. Equity risk premium is pretty close to zero. If I remember right, Greg, I think the PE was around 20.

I think the 10 year treasury was around 5%. And so, the earnings yield was 5. Yields were about 5. You wouldn't think that would precede a 58% drop.

[00:17:21] Greg Denewiler: Personally, my biggest fear is right now in the commercial real estate sector. Especially in the office space, you've got just a huge amount of debt that's getting ready to roll over and the vacancies really there have gone sky high. So, you had a situation where three, four years ago, you had these very low cap rates, meaning these office buildings were bought with the rents producing about a 3% yield, give or take up to 5%. And now we're significantly above that. So, as they roll the debt over, then they're just not profitable anymore without a significant hit to the value of the property and potentially affecting the repayment of those loans, and then the whole situation with the banking sector. 

It hasn't appeared to be across the entire economy. It seems to be somewhat isolated. But the one thing I have learned over 40 years is that there's always something that's not going right. And usually, what ends up having the biggest impact is something that you just can't see right now. Of course, the flip side to that is, if you're always worried about something that could go wrong, you'll never invest. But stock prices tend to reflect what's out there and they reward you for it long term.

[00:18:50] Kent Hughes: Yeah. I'm more sanguine than you are. I think the commercial real estate issues are so, widely known. I don't— you just have to be underneath a rock to not be aware of it. And as somebody who is an extreme believer in the efficient market hypothesis, I would think that would be priced in. I do sometimes say to clients, though, sometimes it seems like somebody didn't get the memo. 

[00:19:20] Greg Denewiler: Well, now I'd like to see if you can put your forecasting hat on. And I realize that you may not be able to answer this due to compliance issues, but if you can, if you had to pick a number of what the annualized return will be, what do you think the returns will be for the next decade?

[00:19:45] Kent Hughes: You're probably right. They probably aren't wild about me answering that. Let me dodge the question and then kind of come back around to it. My hero, as you know, in this business is Professor Eugene Fama. Nobel Prize 2013, I think it was, with Kenneth French on the efficient market hypothesis. And whenever he is asked that question, no matter what the P/E ratio is, he always says 10%. So, this guy is brilliant. He's way, way smarter, higher IQ than I will ever have. That's his pat answer. 

Having said that, let me answer what Merrill's broad view of that question is. We know that price to earnings ratio is the best long-term predictor for common stock prices, returns for the broad market. It's the best of a bad lot. And what's tricky about the PE today, and, and many of your listeners already know this, is we've got seven stocks, the mag seven with pretty darn high PEs— possibly deserved, and we have 493 stocks with a PE of around 15 or 16. And the 97, 98, year average is 16. So, that would make you think, “Well, if the valuation of the market is exactly average than the most likely outcome the next decade would be average, around 10%.” I thought the PE is not 16 for the S& P, it's 21 and that would suggest subpar returns the next decade. That's the view of our company. 

However, where I part ways with our company— I have waited my whole career to see my clients, my prospective clients actually believe that owning great companies builds wealth. Rich people have always known this, but for much of my career, especially living here, we are always fighting real estate. Not so, much the real estate debacle that hit Phoenix, Arizona, very hard 2007 through 2010. And I do mean 2010, it did shake the belief of real estate around here some. But we're in a long term secular bull market, and when you're a long term secular bull market, the returns are just kind of silly huge. From 1982 to 2000, I think, what was the returns then, Greg, 17 18% that 18 year stretch? And so, this secular bull market began in April of 2013, and I really do mean April, 2013. And let me explain why I use that date. The S&P in March of 2000, was around 1560, you can fact check me, but I'm in the neighborhood. And then in 2007, it peaked around 1560, give or take, then it went down to 666 on March 9th of 09. And then in April of 2013, we finally, finally punched through 1560 and boy, we didn't look back.

So, we now have a generation coming up behind us, Greg, that actually thinks you can build wealth through owning equities. Now they might also, believe in crypto, but I think that's one of the biggest changes I've seen in my career. And so, I've given you a long winded answer. I realized that I want to get back to the, what's the rate of return going to be? 24 years ago, we had 7, 000 common stocks, in United States. Today it's around 3,400. I think that excludes pink sheets, by the way. The supply of common stocks has come down drastically the last 24 years. In the meantime, we have a huge cohort population wise of millennials and Gen Z, and they want to build wealth and the assets that they can pick from in their 401ks is shrinking. So, we have, we have this undercurrent of demand while we're shrinking the supply of stocks and that may bode well for the next decade, and it could cause returns to be rather high. I would like to also, hasten to add one thing that so many strategist got wrong. I would include myself in this to a partial degree is the price earnings ratio in the 1990s and Greg, correct me if I'm wrong. I mean, it, it spent a lot of time between 20 and 25, eventually getting up toward 30.

[00:24:44] Greg Denewiler: Well, yeah, I mean people tend to use 16 for the PE long term, but for the last few decades, we've spent most of our time above that and actually into the low twenties. And I do think things are significantly better than when they were in 2000 because the big tech move going into 2000, most of the names were not profitable in technology. Or even the big ones, uh, Cisco, Microsoft, they just didn't make near the kind of cashflow that they do now. And in fact, Apple was really still struggling at that point. Today, these companies have billions of dollars of free cashflow. So, from that standpoint, they're not as speculative. I mean, there is, — you'd have to argue there is some speculation there because several of them are worth 3 trillion roughly. Are they overvalued? That's another question. They do generate billions of dollars of cashflow. Well, that's kind of a big picture overview. So, let's get down to what are you actually telling your clients?

[00:25:59] Kent Hughes: Number one, you have to identify what kind of a market are we in? And I believe we are in a secular bull market, most of the time these last 18 years, 17 years, but the bull market in bonds lasted 39 and a half years. It's just staggering. And if you told me when I got hired that my first 38 years and three months, we would have a bull market in bonds— meaning the prices went up, yields went down, I think there was only maybe what three, possibly four down years out of 39 and a half years from 1981 to August of 2020. I mean, what did then yield on the 30 year was around what, 14, 15% in 81, and it bottomed at 1% and the 10 year treasury in August of 2020, got down to 0.501%. My point being is secular bull markets can last a lot longer than just 18 years. And given the demographics and the generation that actually believes that you build wealth through owning businesses, maybe this secular bull lasts longer than history. 

Looking back between 2008 and 2022, and I do mean 15 years inclusive, we had extremely low interest rates. A lot of times, and as you go back and look, T-bills were 0.04%, 0.02%. And this is just my belief, this is not coming from Merrill Lynch. The past 15 years of very low interest rates fostered risk taking. Maybe not your clients, my clients, but at the institutional level, you know, if you're going to renew a T bill at 0.04%, you might take some of that money and put it into private equity, venture capital. So, the low rates led to risk taking. The risk taking of course then led to innovation. This innovation is now fostering productivity. We've had a few good quarters of good productivity that should lead to strong GDP growth. Which of course will lead to strong profits and strong stock market.

[00:28:25] Greg Denewiler: Well, another way I would put it is when we look at individual companies, we're looking for just simply sustainable cashflow, which translates in our mind into a growing dividend stream. So, when I go back to when I started my career, you would pitch somebody a stock. And you'd have a great stock idea and it may have a dividend of 5% at that point in 1981, but their comeback was, “Why would I want to buy something from you when I can get 17% in my money market fund?

Well, the one thing that people forget is that it's not about today. It's not where the puck is, but it's where it's going. So, the market was cheap and 17% was extremely competitive, but that was not sustainable. If you would have bought that 5% dividend back in 1980, look at where you would be 40 years later with the S&P 500 and those dividends over time, you'd be mega rich and you did not get rich holding that 17% money market fund.

In our mind, we're looking for sustainable cashflow growth, and if you can compound that over time, you don't have to start at 17%, you don't even have to start at 5%. You just let the cashflow compound, and that's how you build wealth. Coincidentally, in the past, we've had several lively discussions, to put it mildly. And they've been around, well, should you focus on dividend growth or should you just buy the S& P 500? 

[00:30:07] Kent Hughes: Yeah, I knew we'd get to this part of the conversation. I'm going to tell a story to answer that question. I Googled one time how much nightclub singers make. And I think the answer, if you could believe the internet, they work a four hour shift, make about 200. I generously gave them a hundred dollar tip. I don't know if that's right or not, but let's just say they make $300 a night. Taylor Swift— I think I read, who knows, that she makes $12 million a night. So, it takes 40,000 nightclub singers. To make what she makes in one night. And my point is you got to own them all.

Your stock portfolio has to capture Taylor Swift. It has to capture Beyonce. And the only way— if you had invested in, I know you can't literally invest in a pool of nightclub singers, but if you invest in a pool of nightclub singers 10 years ago, and you didn't include Taylor Swift in your portfolio, you didn't do very well.

So, I think the total market index, which by the way is about 75% made up of the S& P 500. I think the S& P 500 or total market index should certainly be the core. Then I think it gets into taste. Your taste might be dividend growth. Your case might be high free cashflow yield. It might be low PE, but the hard part is we just don't know what factor is going to be the best factor in the future.

So, like Merrill Lynch looked at, I think 35 or 40 different factors going back to 1985, and we found that high free cashflow yield was the best factor. But the problem is, and I asked Dr. Hendrik Bessembinder, this very question, he's an Arizona state university professor. I asked him this very question five years ago, which is, do you believe in factors? And he said, “Maybe value, but I don't have 30 years to find out.” And so, we just don't know what factors 39 years from now will be the best factor. 

What I love about dividend growth is it makes so, much sense. There's a lot of research that the second quintile high yielding stocks are the best. Now, I'm not sure that's true if you go back to 1926, but there's a lot of work that second quintile high yielders do well. And I think what's great about what you're doing, Greg, is it makes so much sense and if people will stick with it, it has at least historically really — pardon the pun, but it's really paid off. That would be my long winded answer to your question about— I think it's a good idea to make sure you own them all to capture the mag seven or whoever the mag seven will be in the future. To capture the Taylor Swift analogy. And again, I just think, uh, whether it's a high dividend yield, low PE— heck, with the benefit of hindsight, it would have been nice to have peppered everybody's portfolio with a healthy dose of QQQ. 

[00:33:31] Greg Denewiler: Well, I mean, I agree with that to a point. One of the things that we say is dividend growth is not the only thing we do, but it is the core of what we try to stick to. One thing that a lot of people I think forget is that just because you are focusing on dividends, you're really not leaving out that much of the market. Because right now, roughly 400 of the 500 stocks in the S& P 500 pay dividends. Guess what, even some of these fabulous seven names that we've seen make huge moves recently— you go back 13 years ago, Microsoft, Apple, they were dividend payers that were up in a 3% range. In that case, you still had unbelievable growth, but you also, had a great dividend and you had great dividend growth along with it. Even though starting out at a two or 3% dividend is not a big number, it doesn't even seem like it's worth messing with, if you take it out a decade and you compound the money, you're pushing 50% return without the stock market, without your stock prices having to go up at all. So, a big part of what we try to focus on is just change your perspective from looking at the month-to-month statement changes and just look at the cash that's hitting your account. And if that helps you keep in the game, even if you underperform the S& P 500 for a period of time, that's not what's important. It's just being invested.

[00:35:10] Kent Hughes: That's kind of what I was trying to say. If you can get committed to and see the results of a rising income stream, if anything we can do to help people get to the finish line is good. And I also, enjoyed two episodes ago with Daniel Paris, an acquaintance of mine. Our company, Merrill Lynch thinks equity income funds or dividends are going to take on more importance in the next decade. 

Now, part of that is based on an expectation, which may or may not happen. And that is when we see short term yields come down for T bills that are no longer, you know, 5.3%. This is a rhetorical question, but at what point will money go from money market funds into equity income funds? Is it 3%? But this is something that our leadership, led by Savita Subramanian, talks about. It makes a lot of sense to me, but what none of us know is what is that magic percent where people will go, “I'd rather be out of this money market at 3%, 3.5%, and then to a dividend stock that pays me 3.5%.

[00:36:25] Greg Denewiler: Well, here's my last question and then I'm just going to ask you a few quick ones. Do you think investors really understand the true power of compounding? 

[00:36:38] Kent Hughes: Certainly not the rank and file. No. 

[00:36:41] Greg Denewiler: Do you think the average advisor or broker does? 

[00:36:48] Kent Hughes: Wow. That's a good question. Probably not as much as we should. That's a good question. What do you think? 

[00:36:58] Greg Denewiler: Well, I would have to say no, because even I myself continue to struggle with it. It's just so easy to get distracted by all the content that's out there. The media that's constantly bombarding us. It's easy to lose sight of, it just takes time for compounding to work. And in our society now, everything seems to be totally focused on the immediate reward and we all want it right now. So, if anything, I think it just makes it a little bit more challenging. 

[00:37:41] Kent Hughes: I think I calculated one time— this is kind of interesting— if I'm off by a little bit, I don't think I'm off by a lot. I got hired on May 10th of 1982. And I think about 90 days later, I think the S&P was around 115 or so. And 90 days later, it was at 95. I mean, it dropped 15%, 20% rather quickly. I mean, I just, it's like, “Oh, Kent is hired, let's really send this thing down.” And I think that $10,000 with dividends reinvested is a little over a million dollars if you've just put it in the S&P 500. That's pretty remarkable. That's on, $10,000 and $100,000 would be $10 million.

Now, just to keep compliance happy here. We don't know that the next 42 years are going to be like the last 42. And I actually don't think they will be as good. I won't be alive to see it, but you know, you and I started in a generational low valuation. You and I were talking the other day I think the PE ratio was about eight. The dividend yield was about seven or eight. And you know, that's a valuation that has rarely been seen in our country other than, you know, in 1974, of course, it got to those kinds of valuation levels. And I suppose. In some ways during the depression, although during the depression, the funny, not funny “ha ha,” but the funny thing in the depression was there was no E. So, when the market bottomed in the summer of 1932, it wasn't a low PE, but it was a massively high dividend. Massively. Anyway. 

[00:39:29] Greg Denewiler: So, what would be your favorite book in regards to investing?

[00:39:37] Kent Hughes: Oh, kind of without a doubt stocks for the long run by Jeremy Siegel, the most recent edition. I believe it's the sixth edition. It's an easy read. I think if you read that book, I mean, I say this with no qualms, you'll probably know more than 98 or 99% of advisors. I mean, it's just, it's just chock full of great information. It's chock full of great history. And like I said, it's easy to read. Second book would be probably Random Walk Down Wall Street by Burt Malkiel. Its a kind of a precursor, if you will, to the efficient market hypothesis. 

So, so, just, I can elaborate on that Greg, you and I have had hours and hours and hours of discussions about the Efficient Market, and most listeners probably do know, but for those that don't know the Efficient Market Hypothesis basically says that securities prices reflect all publicly available information. It doesn't mean that they're right. You know, when we saw some of these meme stocks, and you all know the ones we're talking about, trading at incredibly crazy valuations and then they came down to earth, those prices weren’t right, but it did reflect possibly very large short positions out there that were held.So, that's my view on, Malkiel's random walk down wall street would be one. 

[00:41:08] Greg Denewiler: Well, then, um, I have to ask, uh, who's the favorite person you like to listen to? 

[00:41:17] Kent Hughes: Gosh, I hate to limit it to one. I'll list quite a few. You have to have Warren Buffett on there somewhere. Eugene Fama. I like listening to Jeremy Siegel, whom I had the pleasure of meeting. I like listening to, and I, he's an acquaintance, uh, of mine is Dr. Hendrik Bessembinder at Arizona State. I would like to point out his research. He's the one who wrote the great white paper entitled “Do Stocks Beat Treasury Bills?” It's a very provocative title, but his point was that half of the wealth as measured by the current market capitalization and all the cash dividends that have paid since 1926 have come from one third of 1% of the stocks that have traded. So, about 26,000 stocks have traded since 1926 and about 75 or 80 of those companies are responsible for half the current market value of the United States stock market. That plus including all the cash dividends that have been paid. And so a strong argument for buying the whole haystack and not just trying to find one needle. But Bessembinder would be on that list. I enjoy your podcast. I listen to it every time. I like your methodology of looking at these great companies and how you arrive at your different decisions. But I could go on and on. Scott Cederberg, Kenneth French, and I like listening to Cliff Asness, actually. He studied under Fama, he's very good.

[00:43:01] Greg Denewiler: I like Jeremy Siegel, I think he's great. Most people out there in the space of giving advice or writing books don't seem to be very accountable or they're not accountable at all, and that's a big problem that I have. But most of the names that you mentioned, I think do try to be, and that's really important.

[00:43:22] Kent Hughes: Yeah, most of the people I mentioned are academics. And that's who I really like to listen to. I'm looking at my bookshelf here and see one book that's way out of print — it's really old, but I liked was called The Triumph of the Optimist. That brings me to something maybe we talk about Greg, which is I'd like to get your view on the role of international investing, and then I'll share with you mine.

[00:43:53] Greg Denewiler: Well, one of the reasons why we don't, I don't talk about it much in this podcast, and I'm not saying this is right or wrong —actually I'm, I'm kind of considering whether maybe we should rethink this. One of the problems that we have in the international space, you know, the dividend payments are just not near as consistent. One year they can be significantly higher. The next year they can be lower. Because it's really more based on just what the current profitability of the business is. If they pay out 50% of their earnings and their earnings are up 30%, they'll bump up for one year. If the earnings decline the next year, they'll back it off.

This doesn't really have much to do with, are they great values or do they look like great opportunities? This comes more from the angle of what we really try to focus on is a growing income stream, and we want that to be as predictable as possible. I will also, kind of hedge this a little bit, but in the US it's more of a, we have a dividend policy and we're going to stick to it. And if we do any changes, the market takes that as a sign where internationally it's just a different way they operate. We haven't done hardly anything internationally, but I will say, and this is kind of part of the hedge. It is something because the yields are higher and valuations are really — I mean, you have to admit they're, they're cheaper over there. Now, should they be or not, that's all another discussion.

I mean, it will improve your yield. So, that in fact can compensate you for the less predictability because they quite likely are going to earn a greater income stream. And then you just look at the U S market has become such a dominant factor in global capitalization, that it's probably not going to hurt you to diversify somewhat from that standpoint. Looking at international exposure is definitely worth considering. I'm not going to say somebody shouldn't do it because it's worth looking at.

[00:46:13] Kent Hughes: Yeah, it's a subject I obsess over. I so want to get it right even though it's so hard to get it right. Part of me is attracted to the idea. If you believe in the efficient market. And I'm going to be off by a little bit here, but the United States is probably 55, 58% of the world's stock market value. I'm pretty sure it's a record high, but let's just say between 55 and 60% of the world market capitalization is United States. And then of course the rest of the world's 40%. So, there's that view if you're agnostic, you would be 60% United States and 40% international. Our company is about 75% US, 25% international.

But they give us a lot of leeway. As long as we're doing what's suitable and proper and all that, they don't care if were 0% international. My son and I, who's part of my team, I give him a lot of credit. When he started nine years ago, he said, let's, let's reduce international down between 5 and 10%. And it was a good call because I think in the last 16 years, whether you use the S& P 500 or the total U. S. stock market index, it has beaten the EAFA I think 15 out of the last 16 years or something like that, Greg, but it's, it's a lot of dominance. However, in my career, I've had a couple of different times where if I didn't use the word international three times in a sentence, a client wouldn't listen to me. Between 1997 and 2007, that 11 year inclusive period, I don't think there were very many times the S&P 500 beat the EAFA. So, back then clients would say, oh yeah, Coca-cola’s International, you know and that’s back when the BRICS, Brazil, Russia, India, China was all the rage. 

So, I would recommend the listeners go to a podcast called Rational Reminder. And if you go to the October of 2022 episode, it was with Scott Cederberg. He's a professor of finance at the university of Arizona, and he studied over 35 countries I believe going back to the middle 1800s. He looked at thousands and thousands of monthly returns for both stocks for that country, bonds for that country, and bills. It's a long interview. It's close to an hour and a half. It was really fascinating to listen to.

[00:48:58] Greg Denewiler: I think international investing could potentially be a whole podcast in and of itself, but at this point now, I'd like to give you an opportunity to say whatever you think is relevant at this point. 

[00:49:17] Kent Hughes: All right. Well, I would say. For people listening that are individual investors, you do have the potential for one competitive advantage.

And one of the main things I learned in business school was comparative advantage. Some people say competitive advantage, and where an individual investor does possibly have it is you can be really patient. And this is where, again, Greg, I think you, I'm going to get back to the listeners, but where you have an advantage is you are patient. And that can give you competitive advantage. How the listeners can get it is you don't have to talk to an investment committee. You're not under the gun for quarterly performance or annual performance. You can just kind of do whatever you want and you can be as patient as you want. That's the positive of what you can bring to get advantage. The disadvantage that you possibly have that are listening is, it's what do you know about XYZ stock that everybody else in the world doesn't already know. Or put it another way, how is it you understand it better than the collective wisdom of the millions upon millions of people. Now, in your case, you're a CFA and you do have a skill set that exceeds the average. And so, that combined with your patience, Greg gives you an advantage. So, that would be one thing I would talk about. 

Another thing I would say is more to quote Warren Buffett. I may butcher this quotation, but you know, it’s something like clients understand that stocks go up and down, but they just don't believe it. I think what he meant by that was when the market's going up, it's only going to go up and when the market's going down, it's only going to go down. 

Another thing I would want to say before closing is I really follow sentiment very, very closely. As you know, Greg, you could argue, well, everybody has those sentiment figures and yet I talk to fellow advisors, strategists, and they don't follow it that closely. And I follow that like a hawk. Every Thursday night at 10:01 p.m. I get the readings from the American Association of Individual Investors. And right now, today's being taped July 24th. Last week, the American association of individual investors, 53% were bullish. Historically, it's 37%. And the question is, which has been asked by this organization since early 1987, over the next six months are you bullish, are you neutral, are you bearish? And the historical numbers are 37% say they're bullish, 32% say they're neutral, 31% say they're bearish. And we know from history that at market tops, that number is somewhere between 53 and 75. That's what that number has been preceding bear markets. So, we hit 53 the other day. I think it's only happened once where we had a cyclical decline of any magnitude from that number. And at market bottoms, like we saw in October of 2022, that reading was down around 20% were bullish on the market. So, I do watch that.

Merrill Lynch has a proprietary indicator called the bull bear ratio. It goes this way. It's extremely bullish when it's zero and it's extremely bearish at 10. So, It’s a screaming buy when 0.0. We had 13 consecutive weeks in a row in the fall of 2022 of 0.0. At market peaks that number is typically closer to eight. Right now it's at 6.5. So, it's not exact, not even a yellow signal, but it's just something to be a little bit cautious. 

So, I like to also, look at the fund manager survey that Merrill Lynch puts out and it looks at how much cash is on the sidelines as a percentage. Anything above 5% is a strong buyer signal. Anything below four is worrisome and that number right last couple of weeks has been right around 4.1%. It kind of gives a sell signal, if you will, at the low four. Now, do I do much about it? No, we just might be, if it's below five, we point out to people, “Hey.” I mean, October 22, I think that number was 5.6% cash. So, institutions as a group, they get it wrong. That's what I'm trying to say. It's a contrary indicator. And why do they get it wrong? If it could be career risks, these men and women are making great incomes. They don't want to stick their neck out and go against the grain. It could just be group think, career risk, whatever it is, but it's been a very valuable indicator for me in my career.

[00:54:37] Greg Denewiler: My response would be something that maybe you really wouldn't expect to hear. Probably the biggest thing that I got from the CFA program was just a realization that it's good enough just to steer down the middle of the road. And in fact, how hard it is to outperform and how much risk you have to take to do that. Well, in the world of investing Kent knows, and I know it's just not easy. So, if you're looking for a broker relationship, give Ken a call. He's in Phoenix, Arizona with Merrill Lynch. Of course, if you're looking for dividend growth, call us at Denewiler Capital Management. And Kent, I really do appreciate your time today. You know, hopefully the listeners get something out of this. You've got two people with 40 plus years of experience. So, hopefully we learned something in 80 years. Thanks again, Kent.

[00:55:36] Kent Hughes: Thanks for having me, Greg.

[00:55:43] Greg Denewiler: Now, before we conclude, we did want to follow up on our last episode. We did mention that we were going to talk to Snap on. So, here's just some of the questions I was able to ask. And actually I thought the person at Snap-on's Investor Relations Department was really good at discussing them with me.

Before I even go there, I will tell you. We do not have a position in Snap-on yet because it hasn't hit our buy target, but we continue to look at it and it's definitely something that we want to own. 

I did ask about revenue growth and basically it's going to be probably more of the same. They're in the roughly 5% range, but one thing that does make it a little bit more attractive, margins have been improving. So, one question is, well, okay, how much can you continue to do that? They still feel that they can get some margin expansion because they are continuing to move into higher priced products. This comes through their diagnostic stuff and some of the tools do continue to get more complex. 

In regards to the franchise business, this was actually kind of interesting. The franchisee actually has a 25% recourse for bad loans. So, that definitely gives them a vested interest in monitoring their accounts receivable and how they make financial decisions and how they track payments. It's a boots on the ground concept, I'll call it. It is the company actually having a good sense of where these hundreds of thousands of loans are at and how to monitor them. 

As far as the software business, it's not significant. It doesn't appear that they have the impression that it's going to be ever, at least in the near term, it's going to be a single item where they would show that as a significant revenue piece of the business. But it is something that they continue to work on and they realize that it is a recurring revenue model. 

From the CEO standpoint, this is sort of a big one because CEOs create the culture of the business, and in this case, they've got a CEO that at some point in the relatively near future, he's going to retire because I believe he's 78 years old. Well, the response there is, it's something that they are well aware of. They have a succession plan in place. Of course, it's not unusual, or I would say it would be unusual if they actually told you who it was, because they're not going to tell you. But it does appear that it is internal. 

Capital allocation — this gets a lot of companies into trouble. This is kind of an obvious response. They see no need to pay debt down because actually they aren't a positive spread on it right now because their debt costs are much lower than what their current cash earns. So, from that standpoint, they're not afraid to let the cash grow. 

And this was, I thought, a fascinating answer. I did ask, well, I know you can't tell me, but when you've got a cash flow return of up around 8, 9% based on your market cap value, are you a takeover target? Her response is it's not the first time it's come up, but they don't really view themselves as a real takeover target. Their model is somewhat complex. They have the franchisee piece of the business, then they have the finance part of the business. They're in sort of a unique market segment. According to her, it's something that another firm or especially a private equity firm would have a harder time managing. From a standpoint of insiders, they only own about 3% of the company. That in and of itself doesn't really impact whether somebody can buy it or not, but she doesn't really think it's a strong or a very good takeover target.

I will say, it's actually, I think good news because we don't want to make a quick 50%. We want something that we can own for 10 years or more and really compound that cashflow. So, that's just a quick overview of Snap on, but I will stress we don't own it yet. It is on our list to acquire it, to make it a position because it is a company that we think is going to really check the box for long term dividend growth.

In closing, I hope you got something out of 80 years of experience in the investment management world. One point I hope is the biggest takeaway is that one thing that seems to never change is mindset. So, don't underestimate the power of discipline, being patient. And just sticking to a strategy that works for you.

If you enjoyed today's podcast, please leave us a review and subscribe. If you would like more information regarding dividend growth or our investment strategy, please visit growmydollar.com. There you will find previous episodes and also, our monthly newsletter. If you have any questions or anything to add to today's episode, please email Ethan@growmydollar.com.

Past performance does not guarantee future results. Every investor should consider whether an investment strategy is right for them and all the risk involved. Stocks, including dividend stocks, are volatile and can lose money. Denewiler Capital Management may or may not have positions in the publicly traded companies mentioned herein.