Dividend Growth & March Madness
Subtle improvement is ignored by crowds looking for dominance. Then, it’s undervalued when first noticed. When that small change in direction begins accelerating, the stage is set for the most shocking upside.
Be ready to pivot. Of all investing and life lessons I’m lucky to learn, an un-crowded pivot offers the most profound consequences for years to come, and it’s the most fun.
Fun is a wildly underrated key to any good game plan. I have so much fun as a Portfolio Manager, that I never want to stop learning about all sorts of stuff I never knew or was completely wrong about. I shared one of those deep dives down a rabbit hole of curiosity with a friend recently, while we were flying to a basketball game together. We always love talking hoops and stocks. I explained how I had no choice but to change my mind and was pivoting one position after a recent Stock Tournament that we run each month. When the math changes, so does our playbook.
My friend had a much better story than mine that night. I want to share it here. Because of all the pivots I’m in awe of, this one cuts down the nets. And, because I will offer a backup plan for us mathletes who are better at spreadsheet pivot tables than jump shots. We can all invest better, to go have more fun.
He told me about a volunteer basketball coach that he joined to help young kids. My friend is a real estate developer (right), and the guy in charge was an attorney named Griff (left), here with one of their original teams.
Repeatable & Consistent Process
Every month we hold Saturday Stock Tournaments at our offices. When the stock market is closed and each team’s ticker stops moving, we measure them against each other. We use several different brackets throughout the year. Their qualifying rounds ask different questions of the market, rather than us form an opinion on the market. No matter what your own investment process is, I will humbly submit that curiosity consistently beats conviction.
A growth stock can become undervalued by the crowds quickly. A value stock may exhibit its first signs of growth in years. Companies do not usually change in a week, but the stock market quoting its price certainly can.
So, we make stocks constantly compete against each other for our deep dives. Over three decades, we have tested then improved a repeatable selection process for dividend growth stocks, which is no different than any other tournament (and just as fun for nerdy mathletes). Each round eliminates more teams. It began as a fun way to look at the markets, that forced me to continue learning. What it took me years to realize is that the real value was that I never stopped. Now, I have all of this incredibly deep data and a blood-stained diary to bounce anything off of. When I started building it, I would have never believed how much simple but relentless consistency would outlast any big ideas.
2004
My buddy explained a key to developing their young basketball program. “Our team was in an AAU tournament and our biggest game ever was against the Houston Hoops, the top program in the city. They looked like a college team because their players were all about to be on one, including a top kid in the country. They were all huge, and we only had one big guy. We knew that we had to be at our best to stay within 15 points. But our kids were the most excited they’d ever been to get this big chance. Our big guy was also the best athlete on our team. His only problem was that he was late to practice a few times recently. The week before the big game, Griff made it clear to him the importance of not skipping any step or being late.
The day of the game, the entire team is there early...with one big exception. We were headed into the gym, when he finally arrives just before the game started. Everyone’s natural response is ‘GOOD, he’s here!” Not Griff, who explained he could either turn around and go home, or watch in the stands, and he was no longer a member of the team. Griff was more interested in sending the right message about consistency to the rest of the team for all their futures, than that game’s outcome.
A week later our big guy showed up to practice (on time) and begged Griff to rejoin the team if he would never be late again. He kept his promise and went on to become a college All-American. He developed into such a good athlete in two sports that he was drafted in the NFL and played for several seasons. I can’t help but think Griff had something to do with his character and accountability.”
I learned from many others who I tracked down that basketball was always second to Griff, after trying to improve kids’ futures. A man of deep faith, he wanted to build a program for kids who needed the most help. He was a highly successful attorney living in a beautiful house in a prestigious neighborhood, but he moved into one of the poorest parts of Houston to help change lives and be right in the middle of it.
There was study hall and dinner provided for the kids every night. They had to take a math quiz before they could play basketball. A bus took each of them home safely after practice. Many of the boys didn’t have a father. Griff said, “I remember trying to do a lesson…I just casually asked, ‘How many of you have a father that you live with?’ One kid raised his hand out of the 17, and that was the pastor’s son…That helped me see that my calling was not to help these guys have a better left-hand or a stronger jump shot, but it really was to invest in them, to love them.”
Operating Advantage
Most dividend fund shareholders would be shocked by how many of their top holdings’ impressive yields are being paid out by businesses unable to grow their top line sales.
I’d suggest asking about any large yield on any investment – “To what do I owe this great act of generosity?” You may find many red flags. The company may be issuing debt or more shares. They may be recording sales from one-time events. They may be cutting back on important investments or research and development for future sales. Those dividends will not grow and may not even be sustainable.
We want to look at the most basic Xs and Os of a business, first. One primary example of many metrics we measure is operating revenues. This is a simple way to begin measuring a business that investors often overlook. When my daughter ran a lemonade stand recently, we talked about lemonade sales filling that shoe box with cash. When she smiled and explained her little brother brought a piece of candy and accidentally left it on the table, that she then sold, that was a one-time event. The operating business was lemonade. Our focus is entirely on operating revenues, eliminating all the corporate candy that can be reported as sales.
2004-2016
My friend explained that Griff had a different lens for the game he was operating with. “I thought I was a good coach and really knew basketball. But, after only a few practices I realized Griff was watching something completely different than the rest of us. It is easy for me to watch a game and know who the ball should be passed to, or who has a mismatch. But when Griff blew the whistle, it was never only the one thing I saw. It was always five things. After calling them over he went through each of their exact spots on the floor, and every different advantage they had against the opposition. He coached a way to improve the spacing, a better cut, or an angle of attack for each of them at the same time.”
Attacking Moats
Relying on traditions of success for any team, in basketball or business, can get you beat. Competition clarifies exactly where you are now. We re-score every stock in our universe every month, because when the inputs change so will the outputs. We trust math, so that our beliefs never bias us against, or for, any outcome. Math leaves no room for opinions, including our own.
A wide moat is a most cherished description from stock analysts to compliment a company’s tradition of unchallenged success. Frankly, they are easy to identify and can also mean investors are too lazy to do new work. Or their heels may be dug in after so many years that it would feel like a gigantic waste of time if they questioned their own work. Confirmation bias is a big part of all our lives but investing with it can get you beat. While nobody is looking, any big moat can begin eroding, barely noticeable at first. Re-measuring those levels, in our experience, offers the best opportunity for stock research in some wonderfully un-crowded spots. What we find much more interesting than the size of a moat is its direction.
2016-2018
After pouring his free time into coaching young kids for many years after work, Griff got a call from an old friend who had just been named head coach at University of Maryland, Baltimore County (UMBC). Ryan Odom was taking over a program off seven consecutive seasons losing 20 or more games. He had a crazy job offer for his good buddy available - director of program development. Griff had it made in every way after making partner in the law firm making close to seven figures, and a loving wife with the deepest of roots in Houston. He was offered a basketball job, to move across the country for $32,000 a year salary.
His wife knew his real dream. Griff gives her all the credit for nudging him to take the job, “She is a passionate follower of Christ, fearless, and adventuresome. She said, ‘Let’s go for it, and if we find out that’s not where God is leading us, we’ll pivot.”
Two years later, Griff was helping his buddy try to break an 0-16 streak against Vermont to win their Conference Tournament. UMBC hit a three at the buzzer to win it and qualify for the NCAA Tournament.
Their reward was a historic mismatch. UMBC was the # 16 seed in their region, and none of those had ever advanced in tournament history. They were playing the # 1 seed Virginia, and top overall tournament seed. UMBC was considered the worst team in the entire field, by far. Quantitative ace, Ken Pomeroy, ranked them 188th in the nation, before heading into the Tournament of 64 teams. Virginia was ranked # 1. Nate Silver’s deep analytical war chest gave UMBC less than a 2% chance of winning. UMBC had just lost by 40 points to Albany. Now, they were facing the biggest mismatch ever in round one.
Accelerating any sized advantage
We are most interested in early signs of a change in direction. We will use operating profit margin as an example here, as just one of many ways to measure an advantage. A giant profit margin is easy to see and will eventually attract crowds of competition. Often, it also attracts the largest crowds of investors bidding up shares to perhaps over-valued prices. If asked, those purchases will be defended with explanations like “They are dominant…they have a wide moat.”
Even the biggest moats can spring a leak. We would rather ask questions of math than vested interests. By making stocks compete against each other, nobody’s lead is ever assumed safe. Every stock in our portfolio has a sell stop discipline. Competition from the next up on the bench, trying to break onto our portfolio’s roster, is the biggest upside of that discipline.
Our favorite bracket busters are the stocks where any sized operating advantage begins to expand, and growth rates begin to accelerate. Signs of improvement in the business are often not reflected on the stock market scoreboard yet. Those opportunities to consider buying, combined with the ability to sell when the data changes, is why I don’t believe active management is a choice or a style of investing – it’s a requirement.
March Madness 2018
UMBC Head Coach Ryan Odom admitted, “I was worried whether our team would even get to 30 points the way Virginia played defense.”
So, they decided to spread them out and open up the game board. “Our goal was to move the ball faster than they could rotate,” explained Odom.
Virginia had the slowest pace of any team, so the fewest number of possessions. That’s not good math for the demonstrably better team. The more opportunities to separate themselves the better off they would have been. Slower pace increases the variance. That hadn’t mattered yet for Virginia, because they were just so dominant. They accidentally did their lucky opponent a favor by making the game shorter, giving away some of their talent edge with every second of patience. Chances for surprises were increased in a shortened game, with fewer shots taken.
UMBC was able to take the lead. Then, they did the unthinkable. When an underdog is ahead late, the natural instinct to protect that shocking lead is an even stronger incentive to slow down. UMBC’s hardest step to take was the next one – they not only didn’t slow down, but they accelerated the pace and their lead.
Momentum from a growing change is real. Virginia had the best defense in the country that year, holding opponents to 53 points per game. UMBC scored 53 in the second half alone to beat one of the biggest moats in basketball history.
Stakeholder Yield
How do you measure intangibles like relationships, belief systems, and humility in the stock market? A high-quality dividend, share buybacks and debt elimination offer historically good clues. We call this Stakeholder Yield, and a round in one of our our Saturday Stock Tournaments that eliminates a lot of teams.
Here is one fun example of a Saturday Stock Tournament we just ran. If we use the S&P 1500 (small, mid & large cap indexes) as this bracket’s field, only 133 teams are left after a highly competitive level of Stakeholder Yield is used.
If we advance only those growing their dividend at a healthy pace, using less than half their available free cash flow, only 32 teams are left.
After measuring all of our operating advantage metrics we are left with a sweet 16 of stocks.
If we advance only those with an accelerating advantage of growth rates and margins, we are down to a final four of stock tickers.
2018-2022
Griff got another phone call. Four days after UMBC’s historic tournament run ended, he was named head coach of Longwood. This Division I program’s arena seats 1,500 people in Farmville, Virginia, a town with a population of about 8,000.
Griff took over a Longwood program off a 7-26 season, finishing in last place. The school had never sniffed the NCAA Tournament. A couple years ago he had to buy a ticket and sit in the stands if he wanted to watch a college basketball game. Now he was a head coach looking across the court at opponents like Tubby Smith. Griff said, “Gotta be one of the great coaching matchups of all time. Tubby with 606 wins and a national title, me with a law degree.” Griff beat Tubby both times that first year.
Griff installed his system. His consistent process as a leader, lifting up kids to be better than they thought they could be off the court, never changed. His operating advantage as a coach on the court continued to improve. He wanted to attack moats loaded with the biggest dragons to slay. And, whenever he finds an edge – accelerate the advantage.
He immediately improved Longwood to winning as many games as they lost over the next three seasons. In 2022, the unthinkable happened again. Griff led them to a 26-6 season and their first NCAA Tournament.
I was lucky to visit with Ryan Odom, who had that crazy idea of offering Griff a 96% pay cut and a new job. He was so excited to sing Griff’s praises he reached out to me only hours before his own biggest game of the season. Ryan explained, “When I hired Griff, I knew that I was going to be getting several things…
1- Tell me the truth and challenge me to be excellent.
2- Willing to sacrifice his own comfort to positively impact others.
3- A true partner who’d organize, implement, and act on our vision.
4- Always give his best effort regardless of the role/results.
Lastly, God gave us two amazing years together. The wins were great but the time together doing what we both love was what it was all about for me.”
Keep a curious pivot foot, it’s capable of yielding remarkably better results.