Good morning,

The past few days have brought fear back into the stock market. Omicron, Senator Manchin or Inflation - All reasons given to explain why we’re back in a fearful place in the markets. This brings to mind the following 3 quotes:

1. Wisdom is knowing what you don’t know (Socrates)
2. True wisdom is knowing what you don’t know (Confucius)
3. Because as we know, there are known knowns; there are things we know we know... But there are also unknown unknowns—the ones we don't know we don't know. (Donald Rumsfeld)

The first two of these quotes are by giants of history and the last one is by… well never mind (this is an RBC letter after all). You have to admit that it seems that a lot of people share the ownership of quotes about ‘not knowing’.

While I don’t know what the next week or the next quarter has in store for us, I simply would like to remind everyone that in the investment world, the most dangerous citation is: This time it’s different.

Clearly, from April 2020 to the end of August 2021, things have been fairly smooth for financial markets. Since then, it’s been a little harder and in the past few days just plain harder. Right now, the various greed/fear indices are all pointing towards fear. If you look at financial news, you can see that investors are nervous. Frankly, news in general is not much better with Omicron, inflation and the various outcomes of the economic slowdown (don’t even get me started on the Montreal Canadiens season so far…).

So why am I so cheerful? Trust me, it’s not related to Christmas! For some reason, I like the décor, I like the music and I even like the food, but I was never really fond of the atmosphere and the fake happiness surrounding it (No, I’m not the Grinch, although Rita likes to think so…). So my present mood is not related to Christmas!

My present mood is actually related to facts. Not fads (I’m looking at you uncorrelated asset class!), but facts.

Since 1927, equity returns have been on average 10.1% per annum. How we get to that number is the interesting part. Earning, in the long run a proxy for free cash flow, has provided 4.9% of that number. Dividend has provided another 3.8%, so clearly a key source of return. And valuation, so the P/E change, has provided the missing 1.4% to get to our overall number of 10.1% for equities. So 86% of historical return are attributed to earnings and dividends.

That’s why, if your portfolio is mostly high P/E stocks that don’t pay a dividend, you might be in for a rude awakening. However, in our Global 35 and in our Global Income portfolios, this is not the case.

You might be tempted by a shorter time horizon. You’re not wrong in thinking that the author of this memo is old-fashioned and things have changed since the late 20’s. But please keep in mind that my previous example started just before the Great Depression, so clearly I’m not trying to cherry-pick my data.

Now, let’s take the MSCI World index since 1994 and thus include the tech run-up of the 1990s. From May 1994 to December 2019, dividend growers have been the best performing category of stocks, well ahead of dividend cutters, those who pay no dividend and those with stable dividends. The numbers per annum are respectively 10.2% vs 5.5%, 6.5% and 7.2%. Long-time readers of my memos and participants in our various conferences would know this, because I’ve been harping on this theme for the better part of 20 years.

What is interesting is that since January 2020, basically since Covid, the annual return numbers are as follows: dividend cutters at 8.9%, stable dividend payers at 10.2%, dividend growers at 12% and those who don’t pay a dividend at 28.3%. Great performance from the likes of Netflix, Alphabet, Peloton, Shopify, Tesla and others. But keep in mind that growth stocks tend to be more sensitive to changes in the discount rate used to value cash flows anticipated in the distant future and, with interest rates rising, the discount rate is changing.

So what should you do? In plain English, diversify your risk. Without a small number of super winners, like Alphabet, Microsoft, Visa and Apple, we wouldn’t have provided the returns that we have in the past 20 months in your portfolios. Nevertheless, you didn’t hire us with a time frame of 20 months in mind. That’s where TD Bank, Honeywell, Richelieu Hardware, Fortis and Allied REIT all come into play. We build portfolios for the long run. Stocks we like are bought with a 5 to 10-year horizon. Remember that we’ll have had two Presidential elections by 2031 (a 10 year time frame). It’s really not about the next quarter or next year.

This long runway plays into the compounding power of dividends and especially growing dividends. Take the following example that I’ve chosen because it’s easy to follow and understand.

It is based on a real company that we might one day add to our Global Income portfolio. They’re not growing quickly, they lagged the TSX badly in 2021 and they are very small. Still, they’re a great example. Assuming you bought 1100 shares of this company for $4,774 in early 2021(4.23/share). Over the next year, you would have received 11 dividend payments reinvested in the stock, as is our investment process, which would have bought you an extra 33 shares (see following table).The end result is that 11 months and a few days later, you would own 1133 shares, with one more dividend to receive and reinvest this year. 33 extra shares doesn’t seem like much, but compounded over time it adds up rather quickly. Which brings me back to the title of this memo: Wait a minute or actually just be patient. Investing should be about as thrilling as watching paint dry. Therefore time is your friend, especially if you own a collection of growing business that are diversified by sector and characteristics.

Is it sexy? Is it exciting? No, it isn’t, but then again it isn’t supposed to be. Speculating is sexy and exciting. Speculators look at their portfolios daily and hope they’ve gone up in value. Why? They mostly don’t have a clue when the value will go up but are happy when it does. There lies the trap for these times. If you don’t know why a stock has gone up in value, how can you possibly know why it’s going down in value? Sure, they’ll know the tagline (typically mumbo-jumbo marketing speak), but do they really know the ins and outs of a company? Why the falling price of their shares may not change the long-term outlook of the company and makes it even more attractive to purchase? They most likely don’t know or care to know.

We like to think the other way around.

For example, take CP Rail. Don’t you think that the purchase of the Kansas City Southern Railway is a great long-term catalyst for the company? They paid less than a competitor offered for the same company. They became the only rail company to reach the 3 NAFTA countries and they’re managed by a great management team who didn’t panic when they got punched in the face, they stayed cool and stuck to their game plan. Yet, the stock is down 8% from its high in June and barely up 4.25% since January 1^st of the year. The price today clearly doesn’t reflect the long runway in front of CP Rail. Also, when you take into consideration trends like on-shoring of production, rising protectionism and higher inflation, their set-up is even better.

In parting, take the long-term view and position yourself to determine your fate by planning for it. That’s the secret. Investing is patience and planning.

As usual, thank you for your trust and Happy Holidays.