Q4 Commentary (2006)
Performance for the final quarter was spectacular for domestic equities. Despite the worries of a slowing economy and concerns over the health of the housing market, the S&P 500 appreciated by 6.7% and the portfolio’s return was reasonably competitive. It is during periods such as this, when valuations rise rapidly, that our more conservative style tends to lag. We are actually quite gratified by our performance this quarter.
If you consider the entire year, there was a clear bifurcation of returns. The first half was marked by a reasonably flat market and we gained good relative ground, while the second half was extremely strong and we captured nearly all of the gain. In essence, 2006 was a microcosm of what we endeavor to do—preserve principal during the difficult times and stay competitive during the better times.
Looking at our composite returns over the past one, three and five year periods ending December 31, 2006, we remain encouraged that we are delivering on this desired pattern of results.
Annualized Returns Ending 12/31/06 |
|||
|---|---|---|---|
1 Year |
3 Years |
5 Years |
|
| Coho Partners Taxable Composite * | +16.4% |
+10.3% |
+7.3% |
| Coho Partners Tax Exempt Composite * | +16.6% |
+10.3% |
+7.5% |
| S&P 500 | +15.8% |
+10.4% |
+6.2% |
| * composite results are shown NET of fees | |||
As we contemplate 2007 and beyond, it might be worthwhile considering where we were seven years ago, when the markets were peaking, and where we are today.
| 12/31/99 | 12/31/06 | Change | |
|---|---|---|---|
| S&P 500 | 1469 |
1418 |
-3.5% |
| NASDAQ | 4069 |
2415 |
-40.6% |
| DJII | 11,497 |
12,463 |
+8.4% |
| S&P 500 Earnings(Forward 4 Quarters) | $56.35 |
$88.50* |
+57% |
| S&P P/E | 26.1x |
16.0x |
|
| S&P 500 Dividends | $16.48 |
$24.19* |
+47% |
| S&P 500 Div. Yield | 1.1% |
!.7% |
|
| 10 Year Treasury Yield | 6.44% |
4.71% |
|
| * estimated |
The S&P 500 has produced a positive return for each of the past four years, with generous returns in 2003, 2004 and 2006. Nevertheless, only the Dow has returned to record levels, with the S&P 500 flirting with its historic high and the NASDAQ still meaningfully below its bubble peak. Valuations are much more reasonable today than they were at the onset of 2000, but this is not to say that the overall market is categorically attractive.
Looking back to the Coho Partners composite holdings as of December 31, 1999, we see that our overall P/E was 20.1x, a reasonable discount to the S&P 500 and we had a dividend yield of 2.0%, a meaningful premium to the market. These relative portfolio characteristics have remained stable over time. We have consistently managed the portfolio with a dividend yield higher than the S&P 500, a discount valuation as measured by P/E, superior balance sheet strength/quality as evidenced by above average returns on equity and low debt/capital, and a portfolio beta considerably less than one. Growth has in no way been compromised, as our earning’s growth has actually exceeded that of the market and importantly, while the S&P dividend gas grown 47% since the start of the millennium, the portfolio’s cumulative dividend growth has been 79%. All of these metrics have helped us to achieve our desired pattern of results of providing downside protection and upside participation.
In closing, our research effort remains focused on a unique and specific universe of companies that have predictable growth in earnings, dividends, cash flows and have demonstrated strong relative performance during difficult market environments. The majority of our effort is on demand defensive companies, which tend to be neglected or overlooked by the larger investment community. Since we truly invest for the long term, we are willing to be early on our investment if we believe that the long term operating strategies are sound and that the financial resources and strategies can support the plan. Given our conservative nature, if our timing is slightly off (i.e. too early), we should still preserve principal because ultimately the underlying fundamentals will manifest themselves. All the while, we should see annual dividend hikes, rising earnings, and generally growing cash balances, which are often directed to opportunistic share repurchase. Ultimately, this combination of factors will be realized and shareholder value will be created.
As we enter 2007, the S&P 500 has not experienced a 10% correction for quite some time (958 trading days to be exact), essentially matching the 3rd longest period without a meaningful pullback. We constantly worry about the “what ifs” and we believe that we are properly positioned for any market correction, but as we saw in 2006, should the market continue its upward trajectory, we expect to participate fully in any broad advance. We are not predicting any imminent correction, but we would be surprised if 2007 were as generous as 2006.
In the meantime, we hope you had a fun and relaxing holiday season and we wish you all the best in all of your new year endeavors. Please call us if you have any questions about our outlook or the portfolio.
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