Saturday, March 20, 2021

Equity Risk Premium Strategy

Barbarian Capital posted a superb chart on Twitter, showing the average dividend yield on the big three tobacco companies (PM, MO, and BTI; weighted by their market capitalizations) minus the yield on the ten year treasury.

This is just the dividend yield. The payout ratio for PM and MO is about 75%, so the earnings yield is even higher. You can see the "vaping panic" that took place starting at the end of 2018. But Altria's gross profit and operating income keep rising:


This looks like revenue growth for a utility, not a distressed company. And the bond market agrees. In February, Altria issued 30 year debt that is trading at a 4.6% yield. The U.S. 30 year bond is now yielding 2.45%. Altria's 6.8% dividend yield is 220 bps above its 30 year debt. And the cigarette business is a real asset (inflation protected), and the debt is not.

I am interested in combining the sector rotation growth strategy with an equity risk premium strategy, where we look for companies (i) in an industries that have been through an under-investment cycle and (ii) with equity yields significantly higher than their debt yields.

We have hit on some promising ideas that combine (i & ii) so far in tobacco, pipelines, mineral ownership, and telecom/utilities:

Another interesting example of equity risk premium is banks. Via government insured deposits, they can borrow for almost the same rates as the government. (They can borrow unsecured and un-guaranteed for 4%.)

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