Year end 2011 12 page final

Year End 2011

Volume 12 Issue 4

Helping You Navigate in an Uncertain Investment World

World Headquarters 128 South Fairway Drive

Belleville, Illinois 62223 Phone: (618) 397-1002

Mark J. Deschaine [email protected]

Marnie E. Deschaine [email protected]

Highland Office

1300 Mercantile Drive Highland, Illinois 62249

(618) 654-6262 Jason M. Loyd

[email protected] Matt T. Powers

[email protected]

Deschaine & Company, L.L.C. A REGISTERED INVESTMENT ADVISOR

1) Is there something statistically significant about earning 2.11% in 2011? Just asking.

F INANCIAL WRITERS, including yours truly, often invoke the metaphor of a roller coaster for the stock market. But

for the metaphor to be truly representative, a roller coaster starts and stops at exactly the same place. Stock markets rarely do. Then there’s 2011. In what is certainly to go down in history as one of the most statistically inter-esting years in memory, the Standard & Poor’s 500 finished 2011 about as close to where it started the year as statistically possible. When you consider that the index is made up of 500 sepa-rate (may we suggest disparate) companies, that’s saying something. For the record, the S&P finished 2010 at 1257.64 and then closed 2011 at 1257.60 which calculates to a loss of .00003%, or what’s known in the business as a “statistically insignificant out-come.” That’s before factoring in the $26 and change the collection of companies that make up the S&P 500 index will pay in dividends in 2011 for a total return of 2.11% for 2011.(1)

What’s missing from most analysis of the stock market’s 2011 performance is the obvi-ous fact, that without dividends, the S&P 500 would have technically posted a loss for the year. A statistically insignificant loss, to be sure, but a loss nonetheless. That fact is not lost on us, however, as we’ve argued for more than a decade now that without a myopic focus on dividends, and growing dividends at that, equity investors will be hard pressed to post positive returns over the long run. So far in the new millenni-um, we’ve been right. We don’t point that out simply to pat ourselves on the back for self-gratification, (ok, so maybe a little) but because

we believe the need to emphasize dividends in one’s equity investment strategy is alive and well and in need of immediate and ongoing consideration. In other words, we believe in-vestors need to continue to emphasize divi-

dends in selecting equities going forward and for some time to come. For without meaningful dividend income, we contend, eq-uity portfolios are likely to pro-duce less then acceptable results. That’s not to suggest that the ride for the S&P 500 was not without excitement in 2011. In early May the index was as high as 1370, or up 8.9% for the year,

before slumping all the way down to 1,074 in October, before rallying at year end to finish the year, at well, statistically even. Just to be clear, we’ve no particularly compelling expla-nation to offer to justify why the stock market moved in 2011, other than to suggest that’s what stock markets do from time to time. Of course, most investors abhor price vol-atility—to their wealth creating detriment, we like to point out. We also tend to remind read-ers often in these august pages that were it not for stock prices going down from time to time, we’d never be afforded the opportunity to ac-cumulate shares of the companies we like at reasonable, or even on occasion, bargain prices. It is truly one of the strange phenomena of investing that most investors never pick up on. The simple idea that when acquiring an asset it is best to pay the cheapest price possible. In fact, the cheaper the price, the less risk one as-sumes when acquiring an asset. Investing is really the concept of buying a Mercedes at Kia

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Year End 2011 Viewpoint Was 2011, a perfect metaphor for the last decade in the stock market?

Market Summary 2011 US MARKET INDEX 1.6%

GLOBAL EX-US -13.9

DEV MRKTS EX-US -11.4

EMERGING MRKTS -17.9

CORE BONDS 7.2 Source: Morningstar Q4 2011 Market Commentary

We would like to take this opportunity to thank our clients for making 2011 a record year for Deschaine & Company. Thank you!

Viewpoint is assembled, sorted, and prepared for mailing by SAVE. You can learn more about this vital, life-giving organization by visiting their website www.saveorg.org or contact-ing them at (618) 234-1992. Thank you S.A.VE. for your much needed assistance.

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VIEW FROM THE FRONT SEAT by Mark J. Deschaine

How We Grow Money

I ’LL BE THE FIRST ONE TO ADMIT I tend to get a little repetitive here in the pages of Viewpoint. But that’s pri-marily because the process of investing, when you boil it

down, is really pretty basic. So once you implement the basics, it’s pretty much wash, rinse, repeat. I also think it’s useful to review the basics periodically, just to remind ourselves what it is we’re trying to accomplish, because I strongly believe, from doing this for more than 30 years, that if you stick to the ba-sics, over time you’ll do just fine as an investor. And this is important—no mat-ter what the financial markets throw at you. As the feature article will corrobo-rate, 2011 was another year to confound and maybe confuse investors. Especially those poor equity investors thinking they could get good returns from inter-national investing. One of the biggest misconceptions of the last decade just might be that investors were earning good returns in foreign stock markets as investing outside the U.S. grew in populari-ty. As mediocre as the returns for U.S. stock markets were in 2011, as the table on page one shows; international equity markets, for the most part, took it on the chin in 2011. That’s also true for the last five years as the MSCI EAFE non-U.S. Stocks Index (say that three times quickly) is down an average of 5.0% a year, after being down more than 12% last year. Lay-ing to rest, at least for now, the notion that investors seeking to diversify their equity holdings outside of the U.S. can do so safely by investing in Europe, Asia, South America, etc.

Much the Same in 2012? Robert Price, co-chief investment officer at Bridgewater Asso-ciates, the largest hedge fund in the world, summed up the challenge facing investors in his year-end client letter as he cautions to expect at least another decade of slow economic growth and high unemployment—world-wide. Price describes the big-developed economies, (meaning primarily Europe, the U.S. and Japan) as “zombies.” Price suggests they’ll stay that way until they work through their mountains of debt. His ex-ample, Japan the last 20 years; virtually no real economic growth and a stock market that’s down from a high of 39,000 on the NIKKEI in 1989 to less than 8,400 as of year-end 2011. That’s a negative 6.7% annual return not including dividends. “What you have is a picture of broken economic systems that are operating on life support,” Mr. Price says. “We’re in a secular deleveraging that will probably take 15 to 20 years to work through, and we’re just four years in.” In Europe, “the debt crisis is a long way from over,” he said. The economic and financial morass will mean interest rates will essentially be locked at zero for years. In this bleak investment and economic environment, Mr. Price says stocks remain vulnerable to “air pockets” from shocks, such as bad news out of Europe, but for longer-term

investors looking out over the next decade, (that would be us) he says se-lective equities may be a good buy. I concur with Price’s interest rate, economic and stock market outlook. I highlight his comments not because they echo my own long-term outlook (well okay, partly for that reason) but

because Bridgewater has a long-term investment track record managing more than $125 billion in client assets that is second to none. Including their flagship Pure Alpha Strategy fund which was up more than 25% in 2011. The average similar fund was down 3.7% for the same period according to Hedge Fund Research. So when someone of Price’s investment acumen speaks, I listen.

A Brief Look Back at 2011 In the highly competitive world of money managers with less then $125 billion under management, the Deschaine & Com-pany Equity Income Portfolio was up a total of 10.62% in 2011, compared to the S&P 500 index which was up 2.11%. That marks the seventh year out of the last 11 where the EIP beat the market as measured by the S&P 500 from a total re-turn standpoint, (which includes cash returns) while the port-folio’s equity holdings managed to beat the S&P eight out of the last eleven years. Cumulatively, over the history of the strategy, its managed to handily beat the overall stock market up 8.9% annually compounded compared to the S&P up 1.5%. As proud as I am of those results, what I’m most proud of is the fact that the EIP’s dividend income grew more than 15% in 2011 and has grown by just short of 13% annually (12.95% to be exact) since we began the strategy in 2000.(2) That was our primary investment objective when we began the disci-pline in 2000: grow dividend income at double digit annual rates. The bottom line: had you started in 2000 with a portfo-lio generating $25,000 in annual dividend income and had been able to reinvest all of your dividend income over the last 11 years, a portfolio of EIP stocks would now be producing over $95,000 in annual income. Not to mention—but I’ll men-tion it anyway—the EIP has more than doubled in market val-ue over the same period. On one hand, the capital appreciation of the portfolio continues to surprise me since I didn’t really expect any given the relatively bleak outlook for the stock market in 2000. But on the other hand, if the companies in the portfolio continue to increase their dividends at double digit rates, we should expect their market values to increase over time, which is precisely what’s been happening. It’s at this point in the proceedings where I’m compelled to tell you that past investment results are not indicative of


Year End 2011 Viewpoint

2) The growth rate in dividend income assumes full dividend reinvestment. Without dividend reinvestment the dividend income grew at about 9% per year since inception. I haven’t had time to calculate the EIP’s dividend growth without dividend reinvestment for 2011. Hey, I’ve been busy, like writing this article and such.

Equity Income Portfolio Score Card

2011 3-Year 5-Year Incept*

Equity Returns 11.8% 17.6% 4.5% 12.3%

Total Return 10.6% 12.8% 3.2% 8.9%

S&P 500 2.1% 14.1% - 0.3% 1.5%

Total return includes cash. *Annualized returns since Dec 31, 2000

future results nor are they in any way shape or form, guaranteed. However, if there’s any aspect of equity investing that we as investors can rely on to any degree of certainty it’s most likely divi-dends and dividend growth. You see, once a company commits to paying a dividend, they’re extremely reluctant to cut (or eliminate it). That’s because they usually only increase it when they’re reasonably certain they can continue to pay it at the new higher rate go-ing forward. It’s the closest thing to a sure thing in investing there is, short of the interest payment on a U.S. government bond. And lately, I’m not even sure that’s true. Periodically, at least annually, I feel compelled to tell you how we managed to achieve our in-come growth objective over the history of the strategy and how we expect to do so going forward. It’s really a pretty straight-forward six-part mathematical formula. (See “How We Grow Money,” nearby.) Our Equity Income Portfolio’s divi-dend focused investment strategy con-sists of six components.(3) They are:

One: Compounding from High Dividend Yields In a world of increasingly volatile stock pric-es and zero short-term interest rates,(4)

as of year-end 2011 we can construct a diversified, high-quality dividend port-folio with a current dividend yield from 5.5% to 6.5%. If we’re then able to rein-vest all the dividends at a dividend yield of 6% over the coming decade, then our portfolio will grow 79% over ten years just from cumulative dividends. Throw in an additional 2% in new money to your portfolio each year and your portfolio doubles over the next decade from those two variables alone. And again, at the risk of boring you to tears, I’ve not factored in dividend growth, capital appreciation or the stock market grinding down in price to the bottom of the current long-term bear market allowing us to reinvest our divi-dends at dividend yields in excess of the current 6.0% we’re looking at today. Thus, doubling the EIP portfolio over the next decade is virtually assured—all

through simple compounding. I say virtual-ly, because, I’m not allowed to say guar-anteed. And I don’t say, guaranteed, be-cause, I can’t, well, guarantee it. In addition, healthy double digit annual income growth is also assured.(5)

If for no other reason than reinvesting dividends buys more shares powering more dividend income. Again, let me point out that the Equity Income Port-folio’s dividend income grew an average of 13% a year over the last 11 years. I see no reason for that to change over

the coming decade. If anything, it’s like-ly to only get better as prices ease.

Two: Compounding from Dividend Growth After dividend yield, dividend growth is the most important variable to the outcome of our investment strategy over the next decade. Despite the dour outlook for economic growth both domestically and worldwide, we’re optimistic about the prospects for dividend increases from the companies in the EIP over the next ten years. For a number of reasons in-cluding: they’ve got lots of cash on their balance sheets, they’re generating lots of extra cash because they’re running lean and mean after the economic slowdown, (at the expense of the unemployed, of course), and the fact that dividends are and will be increasingly in demand from investors with each passing year of poor capital returns by stocks. McDonald’s (MCD) stock (See page 8) had another stellar year in 2011, up 35%. I predict MCD’s amazing share-holder performance over the last nine years will not go unnoticed by investors or corporate boards. As a result, the pressures to emulate MCD’s corporate performance by returning more cash to shareholders primarily by raising divi-dends (and the obligatory share buy-

backs it seems) will do more to grow dividend payouts in the future as any-thing else I can point to. To which I can only say, “show us the money.”

Three: Compounding from Dividend Reinvestment Once we establish a portfolio and get it invested, our job is to maximize the portfolio’s total return by efficiently and effectively reinvesting dividend income (and any new contributions to the port-folio) in the highest yielding stocks available to us at the time. Note the in-

verse of high yield is “low price.” One of the great things about investing in the stock market is there’s always a company (or two) that, for whatever reason, is sell-ing at a price that makes them an attractive addition to our portfo-lio. Or, as is usually the case, makes them an attractive stock to increase our already existing posi-tion. One of the most egregious mistakes investors make (us too) over the short run is we over-pay

for a stocks. It’s not because we’re stu-pid, it’s just the nature of investing. It’s just plain easier to buy stocks when prices are, shall I say, “healthy” then it is when they’ve just tanked 30%. So if we find we’ve over-paid for a stock (which is one reason why we rarely buy a full position of a stock in the first go-around) we have the opportunity to rec-tify the situation with each passing quarter with our dividends. I thinks this is one of the fundamental strengths of our high-yield, dividend growth equity strategy. Over the coming decade, I expect we’ll add as much as 1.0% a year in addi-tional annual return by timing dividend reinvestment when stocks yields are most attractive. With discipline, I think the goal is actually quite conservative, but then I always prefer to error on the conservative side when forecasting such return variables. One final note about the process of dividend reinvestment. Believe it or not, every time we buy a stock it’s with the expectation that we’ll be able to buy it 50% cheaper at some point in the future. If that seems extreme to you, punch up the price chart of just about any stock

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Deschaine & Company, L.L.C. Page 3

3) For details of our investment process and philosophy you can always contact us and we’ll be happy to send you a detailed booklet of our investment research and selection process or meet with you to discuss it at your convenience. 4) I’m still amazed every time I write that, the zero interest rate part, that is. 5) I see zero chance of significant dividend cuts or eliminations from quality dividend paying stocks over the next decade barring some major economic calamity.

How We Grow Money

Part 1: Compounding from High Dividend Yields

Part 2: Compounding from Dividend Growth

Part 3: Compounding from Dividend Reinvestment

Part 4: Capture higher yields as stock prices decline

Part 5: Add additional funds to the portfolio

Part 6: Minimize fees, commissions and taxes

Page 4 Year End 20101Viewpoint

and see for yourself. Johnson & Johnson (ticker JNJ) for example traded for $71 in August 2008 and $48 in March 2009. A difference in price of 32% in just eight months. And JNJ is certainly one of the less volatile companies you can buy. Our job is to try to buy JNJ closer to $47 a share (yield of 4.9%) and less so when it’s trading at $71, (yield of 3.2%). By doing so we’re locking in an additional 1.7% in annual yield in the process.

Four: Capture Higher Yields as Stock Prices Decline As I’ve said many times, I expect the bear market to take another ten years to run it’s course.(6) As a result, I anticipate flat to negative capital returns from stocks as the stock market grinds down the last third of it’s price-earning adjust-ment from 14 (the year-end PE on the S&P 500 Index) to 7 time earnings (the typical bear market bottom PE). If I had to guess how the stock mar-ket might perform over the next ten years, I’d point to the last ten years and suggest that it’ll perform an awful lot like that. But as I’ve also said repeatedly over the last ten years, that’s actually really good news for dividend investors. At least for investors looking to build their wealth and grow their dividend income by accumulating as many shares as possible by reinvesting dividends and cash flow over the next ten years. Table One “How We Grow Money” below shows how a $100,000 initial in-vestment and an additional $10,000 in-

vested each year might grow over the next 40 years under a dividend growth and reinvestment strategy. While I real-ize most of us probably don’t have 40 years to watch our money compound, we all have a lot more time then we re-alize, and besides, our kids and grand-kids have decades longer than 40 years, so it’s still relevant. So if we’re not go-ing to do it for ourselves, how about doing it for our kids and grandkids? (Shameless plug, why not send a copy of this to your kids, or grandkids, or better yet add them to our mailing list and get them start-ed on learning how to build their wealth and income though dividend growth and reinvestment.? This illustrious publication is free and we’re always happy to put folks on our mailing list, no charge or obligation.) The table assumes a dividend yield of 5% and an annual dividend growth rate of 10%. Both are below the long-term historical annual returns for the EIP strategy since it’s inception in 2000. Believe it or not, I also assumed stocks go up 10% a year over the next 40 years, including the next ten years. Huh? You ask. How can I assume stocks appreciate 10% a year over the next 40 years if I think the stock market isn’t going to go up over the next decade? For a couple of reasons: First, eventually the bear market will end and the next bull market will com-mence and when it does, stock prices will grow at double digit annual rates for an extended period of time, just like they did from 1982 to 2000. As I’ll show you in a moment, to assume they go up 10% year is actually a conservative as-

sumption. Second: if the stocks in a portfolio grow their dividend by 10% a year over the next decade, then eventually the underlying value (i.e. their stock prices) should follow. And third: if I assume prices remain flat (or go down) over a 40 year period, then the cumulative numbers in year 40 just get ridiculous. For example, if I assume stock prices stay flat over 40 years yet also assume dividends grow 10% a year and you dili-gently reinvest all dividend income, a $100,000 investment and $10,000 a year in new savings grows to $1,100,963,648,891 in 40 years. That’s as in one TRILLION, one hundred billion. (For those of you skep-tics out there I’m always happy to send you my excel spread sheet and you can check my math for yourself.) As you can see from the table be-low, $100,000 and $10,000 a year in-vested at 5% with a dividend that grows at 10% will grow to more than $46 mil-lion and produce more than $2 million in annual dividend income in year 40. That works out to a compounded annual growth rate of 16.53%. The arithmetic behind the trillion number is the assumption that we would be able to reinvest a divided that’s grow-ing at 10% a year into a stock with a stock price that remains flat for 40 years. While that’s not a particularly realistic assumption, what I’m trying to demonstrate is the fundamental power behind the arithmetic. In other words,

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Table One: How We Grow Money: 5% Dividend Yield, 10% annual Dividend Growth, all dividends reinvested

One time $100,000 investment, annual investments of $10,000 and all dividends reinvested

Period

Estimated Annual

Dividend

Assumed Year End

Share Price

Estimated Annual

Dividend Income

Income Growth Factor

Estimated Year End

Market Value

Market Value

Growth Rate

Factor

Annual Market Value

Growth Rate

Estimated Annual Income

Income Growth Factor

Income Annual Growth

Rate

Estimated Year End Market Value

Market Value

Growth Factor

Annual Market Value

Growth Rate

5 $ 1.46 $ 32.21 $ 8,745 1.75 $ 201,135 2.01 15.00% $ 12,762 2.55 19.45% $ 280,767 2.15 16.53%

10 $ 2.36 $ 51.87 $ 17,589 3.52 $ 404,555 4.05 15.00% $ 28,873 5.77 16.92% $ 635,211 4.86 16.53%

15 $ 3.80 $ 83.54 $ 35,379 7.08 $ 813,706 8.14 15.00% $ 61,278 12.26 15.90% $ 1,348,124 10.32 16.53%

20 $ 4.18 $ 91.90 $ 71,159 14.23 $ 966,235 16.37 15.00% $ 185,363 25.29 15.43% $ 2,782,048 21.29 16.53%

25 $ 9.85 $ 216.69 $ 143,126 28.63 $ 3,291,895 32.92 15.00% $ 257,554 51.51 15.21% $ 5,666,181 43.36 16.53%

30 $ 15.86 $ 348.99 $ 287,877 57.58 $ 6,621,177 66.21 15.00% $ 521,236 104.25 15.10% $ 11,467,203 87.75 16.53%

35 $ 25.55 $ 562.05 $ 579,024 115.80 $ 13,317,552 133.18 15.00% $ 1,051,597 210.32 15.05% $ 23,135,129 177.03 16.53%

40 $ 41.14 $ 905.19 $ 1,164,624 232.92 $ 26,786,354 267.86 15.00% $ 2,118,341 423.67 15.03% $ 46,603,497 356.62 16.53%

One time $100,000 Investment and all income reinvested

6) I told you I tend to repeat myself.

Page 5 Deschaine & Company, L.L.C.

we can quibble about the particulars of the assumptions but it doesn’t change the underlying arithmetic behind them. Regularly reinvesting a growing income stream into a cheap asset is the secret behind growing wealth and income. Most investors never get the con-cept of buying stocks cheap because it’s so counter intuitive to everything that has been drummed into their under-standing of stock investing over the last 30 years. Over that time they’ve been led to believe that the path to great wealth is to seek out and buy stocks like Apple and hang on. The problem with that strategy, known as growth stock investing is twofold: one, few investors ever find the next Apple, and two, if they do, they rarely hang on long enough to reap the benefits of com-pounding.(7) Because most investors never get the concept of buying stocks cheap is the reason I pound on it repeat-edly in the pages of Viewpoint.

Five: Add Additional Funds—save more money I touched on adding new money to the investing equation at various points so far, but it can’t be overstated. Saving money has never been more important than it is in today’s challenging econo-my and investment environment. Even a little incremental savings can have a huge impact on the long-term outcome of your investment plan. Just look at the difference adding an additional $10,000 a year does over 40 years in the table on page four. Particularly if stock prices are declining. Every new dollar of savings will buy more assets and more income, magnifying the compounding effect. I think it’ll be critically important to save more over the next decade be-cause I suspect that many investors will be inclined to throw in the towel on the whole notion of saving and investing after a couple of more of years of poor stock market performance (like the last 11 years?) and just spend their money. How do I know this? Because they often do so at the tail end of a long-term bear market. Needless to say, that’ll be pre-cisely the time when savings and invest-ing is most financially rewarding, be-cause that’s when you’ll get the most bang for every new dividend and invest-

ing dollar. Trust me when I tell you that it won’t be easy to buy stocks after another decade of relentlessly declining stock prices, but that’s when it will be the most rewarding. My suggestion—hold onto your hat, and save, invest and reinvest.

Six: Minimize fees, commissions and taxes This is akin to saving more money in that every dollar we to save in fees, commissions and taxes over the next decade is one more dollar available to us to compound in our portfolios. Need I say more?

The Paradox of Dividend Investing When you get right down to it, the only really “unknown” component to our high-yield, dividend growth equa-tion, is what the stock market does over the next decade. But as I’ve pointed since the beginning of the EIP strategy in 2000, a declining stock market actually helps us reach our income growth objective. I call it the “Paradox of Dividend Investing.” With each successive decline in stock prices (assuming dividend payments remain intact and we actually have the guts to invest excess cash and divi-dends in the face of a declining stock market) the faster we’ll build wealth and future dividend income because we’re able to buy that many more shares. The only time, as dividend investors, should want stock prices to go up, I suppose, is when we want to sell. But since my personal investment objective to build my wealth and divi-dend income until I’m called to the great beyond, I’m not rooting for stock prices to ever go up. (8) But because price volatility poses such a vexing psychological challenge to most investors, they rarely take advantage of cheap stock prices. Which is why I believe the average investor doesn’t achieve anywhere near the returns from stocks as they could. If 2011 and the last decade demonstrates anything, it’s that inves-tors should use the stock market for what it really is—a market place to buy shares of your favorite company when they periodically go on sale. That’s really what investing is all about. That’s what we try to do here at D&C. Efficiently reinvest our dividends

at the highest yield (safe dividends) available to us in the market at any point in time. Either by adding to exist-ing stocks within our portfolio trading at attractive yields or by identifying new stocks that have recently hit an attractive dividend yield target. Of course, the EIP is just the equity

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7) Because such companies are rare and really hard to find. Isn’t it interesting how we’re talking about Apple, when just a few short years ago it would have been Google, Cisco Systems, Microsoft or Wal-Mart. All great companies, but which exemplifies the difficulty in “growth stock investing.” Eventually, the growth stops and when it does, the stock usually gets hammered often wiping out much of the long-term gain. 8) I guess you could say I’m on record as saying I hate rising stock prices.

Hypothetical Reader Question Why haven’t I ever seen the arithmetic of $100,000 initial investment and $10,000 in-vested annually at 5% dividend yield and 10% dividend growth rate grow to a trillion dollars? The number seems absurd? ANSWER: For a number of reasons. ONE: Investors rarely calculated returns over 40 years when the real power of com-pounding kicks in. They just don’t think that way. TWO: They assume simple compounding, not the power of compounding that can oc-cur from “double compounding” from rein-vesting a growing income stream. THREE: They bring compounding to a screeching halt because, at some point, they start spending the money or they have the temerity to get old and sick, or worse die. FOUR: Most important to the equation, they assume rising asset prices and usually buy at high prices never realizing the benefits of cheap stock prices. Keep in mind, getting to a trillion dollars requires assuming flat stock prices over 40 years, a scenario that is not going to occur in real life. Flat stock prices over the next ten years, however, is a very distinct possibility, just as we’ve seen since 1998, which is why we need to take full advantage of cheap stock prices during the current bear market to build our share positions, wealth and dividend income. Finally, the power of compounding is the reason the estate tax is such a devastat-ing tax. It robs families and estates the pow-er to compound just at the time of maximum benefit. If the government was truly inter-ested in creating wealth and prosperity it would eliminate the estate tax immediately. To whack 55% off the top of an estate simp-ly because someone has the misfortune to die is completely counter to the very con-cept of creating wealth and long-term pros-perity. Remember, the money’s already been taxed and in the case of dividends, some-times twice previously. Just thought you might be wondering.

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prices. Funny, (funny as in ironic, not funny as in ha ha,) that most folks get it when applying the concept to just about anything else they buy. Nevertheless, when it involves buying a few shares of a great business like Johnson & John-son, the whole notion of paying a cheap price is completely lost on them. All we can tell you is, the longer we’re in this business, the more we appreciate the periodic stock market selloff. Although the year wasn’t particu-larly volatile, by statistical standards, consider that the S&P 500’s quarterly returns for 2011 were as follows: 1st quarter: up 5.92%, 2nd quarter: up 0.10% (again, without dividends, returns would have been negative,) 3rd quarter: down 13.87%, and 4th quarter: up 8.31%. Giv-en that data set, when would’ve been the best time to consider buying stocks? May we suggest after stocks had been marked down 13.87% in the third quar-ter? We’re just saying. Of course, the S&P 500 is but one of hundreds of stock market indexes. The Dow Jones Industrials for example was up a relatively robust 8.38% for the year compared to 2.11% for the S&P. The dividend yield for the Dow: 2.82%. All but one stock in the Dow (or 97%) pays a dividend compared to 77.9% or 104 stocks in the S&P 500. The yield on the S&P 500 index minus the zero dividend stocks is 2.57%.

Gold was up 10% for the year but finished well off its highs reached in August. We mention it, because we think investors ought to have some of their investable assets in gold related assets. (say 10%) Such as gold EFTs and gold mining stock ETFs, as well as some physical gold (coins) just in case the world really does end later this year as the now infamous Mayan Calendar implies. We also mention it because gold is the inflation adjustment we make to the stock market each year to put the current long-term bear market into his-torical perspective. (See chart below.)

The Bear Market Marches On Or Where are we in the Current Bear Market Cycle? The chart below is our annual stock market update showing the Dow Jones Industrial Average going back to 1900 adjusted for inflation. Veteran View-point readers have seen this chart peri-odically since 2001. The beauty of the chart is it’s simplicity. It’s the year end Dow divided by the corresponding year end price of an ounce of gold. Most im-portant is what it tells us, which is that the long-term bear market is right on track. That is, until the Dow Jones in-dex to the price of gold ratio dips below five, the stock market will continue to trend down. Equally important is the fact that we’re still probably several

years away from a bottom. (See D?) Another way to look at the current bear market cycle is by price-earning ratio and dividend yield. As you can see from each of the three bull market peaks the average PE ratio is about 32 times earnings, with a record high of 38 times earnings in 2000, while the correspond-ing dividend yield is about 3.0% with the statistical anomaly for dividend yields being the 2000 market peak (a new record low) dividend yield of 1.1%. On the flip side, the average PE ratio and dividend yield at the bottom of each of the three previous major bear market bottoms is 7 times earnings and 6.0% respectively. (See A, B, C,) The market’s current PE ratio: 14, current dividend yield: 2.2%. We’ll continue to monitor the price to gold index ratio and show it to you each year as a gauge of where we are in the current bear mar-ket cycle. Bottom Line: the current bear market has a few more years to run.

Are Dividends Too Popular? In a world of zero interest rates and another mediocre year for stocks, divi-dend are garnering more investor and press attention. As a result, we’re in-creasingly asked if the dividend “craze” has run it’s course. Or if it’s too late to consider dividends a part of one’s in-vestment strategy. It’s hard to argue that dividend stocks haven’t become too

popular when they

(Continued from page 1)



The Dow Jones Industrials divided by the $ Price of Gold Valuing the Stock Market in “Inflation Adjusted” Dollars: 1900 — 2010

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2000 Stock Market Peak PE: 38 Yield: 1.1%



Average PE ratio at bear market bottom: A, B, C: 7 times earnings. Average dividend yield: 6% Year End 2011 PE: 14x Year End 2011 Yield: 2.21%


appear in major features in the New York Times and Barron’s within a week of one another. Yet we’re not worried for this reason. It seems, every article extolling the virtues of dividend stocks is also replete with caveats to the risks of dividend investing. Which is a good thing. It’s only when we start to see articles that extoll the virtues of divi-dends without the usual obligatory homage to risk that we’d become con-cerned. Finally, dividend investing, unlike the Internet and Tech bubble of the late 1990s is built on a foundation of basic eighth grade arithmetic. As long as we can continue to find stocks with a 4-5% dividend yield that can grow their divi-dend at 8-10% a year, we’ll do fine. It’s not built on some pie in the sky, earn-ings or revenue growth expectation.

How Dividends Could Save the Day By Paul J. Lim New York Times, December 31, 2011 When the global economy slowed last year, investors looking for reasons to be bullish could at least point to one posi-tive sign: the continued strength of cor-porate profits. Even as the pace of economic growth in the United States fell to 1.7 percent in 2011 from 3 percent in 2010, profits among companies in the Stand-ard & Poor’s 500-stock index climbed by an estimated 15.8 percent. Revenue, meanwhile, surged by a surprisingly strong 10 percent. Yet as investors usher in a new year, their faith in the profit outlook is starting to wane-and for good reason. Corporate earnings are projected to rise only around 4 percent through June, and 8 percent for the full year, accord-ing to estimates by S.&P Capital IQ. That’s down from earlier projections of 13 percent growth for 2012. The recent adjustments to the pre-dictions were to be expected, said Chris-tine Short, senior manager at S.&P. Capital IQ. “There’s a cloud of uncer-tainty engulfing Europe,” She said, “and analysts don’t know how to position their forecasts.” There are other reasons to be con-cerned, said John Butters, senior earn-ings analyst at FactSet, a financial re-

search firm. “When you look at 2012, the two sectors that are expected to drive growth are financials and technol-ogy,” he said. Mr. Butters said the modest 2012 growth projection for the overall S.&P. was dependent on financial sector earn-ings climbing by around 25 percent this year. Last year, banks, brokers and in-surers collectively saw their profits rise just 6 percent. The forecast also depends on tech sector profits expanding by around 10 percent this year. “The question is, do people have a lot of confidence that financial compa-nies will perform so well?” he asked. As for technology, Mr. Butters pointed out that one tech leader, Oracle, recently reported worse-than-expected revenue growth, which could be a harbinger of the challenges faced by the broader tech sector as well as the general economy. Technology revenue growth, for instance, is expected to slow to 7 per-cent this year from 12 percent in 2011. Similarly, sales growth for the entire S.&P. 500 is expected to slow to around 4 percent in 2012, a sign that the global economic slowdown is starting to seep into corporate results. Global gross do-mestic product growth is expected to slip to 2.7 percent this year, from 3 per-cent in 2011, according to HIS Global Insight. So if investors can’t rely on strong earnings growth or a rapidly expanding economy, what’s left to keep the bulls hopeful? One possible answer may be divi-dend growth, market observers say. “In an environment where economies around the world are slowing, growth is starting to get scarce, “ said Thomas Huber, a portfolio manager at T. Rowe Price, “ and interest rates are so low, it makes sense to focus on companies that can grow their dividends over time.” Unlike corporate profits, which rebounded to record levels last year, overall dividends paid by domestic com-panies have yet to recover fully to the highs reached before the global financial crisis. Yet that could change early this year. S&.P. 500 dividends are expected to grow by nearly 11 percent in 2012, said Howard Silverblatt, senior index analyst at Standard & Poor’s. “The divi-dend story is good and should continue to be good, “ he said.

Yes, there is always the possibility that companies could reverse course and cut their payouts to shareholders. “But if companies cut, forget dividends – that’s a sign that the economy is really shot, “ he said. Mr. Silverblatt says one reason for continued growth in dividends is that companies are sitting on record amounts of cash. And “companies have been pounding their chests about the importance of dividends, yet the divi-dend payout ratio is a little under 30 percent,” he said, referring to the per-centage of earnings that corporations are passing along to shareholders as dividends. Historically, the payout ratio has hovered around 50 percent for S.&P 500 companies. Low interest rates are another rea-son that investors are likely to focus on dividend growth. Since 1962, the divi-dend yield of the S.&P. 500 has aver-aged about 40 percent of the yield on 10-year Treasury notes. Today, however, the S.&P. is paying more, dividend-wise, than 10-year Treasuries. In such an environment, market strategists say, investors tend to lean toward dividend-paying stocks. And if corporate profit growth slows as ex-pected that interest will only grow.

A Toast to 2011 Last Year was a Great One for Dividends Barron’s January 5, 2011 Dividends had a great year in 2011. Among the reasons why: robust corpo-rate profits and strong cash flow; payout rates, which historically average 52%, remain near their lows at under 30%; and yields are staying relatively high compared with those on alternative in-vestments. Thus, Standard & Poor’s announced Wednesday that dividend increases reached $50.2 billion last year. That’s an 89.2% surge over 2010’s $26.5 billion. S&P counted 1,953 dividend in-creases, in 2011, up 13% from 1,729 the preceding year. While only 101 of the approximately 7,000 publicly companies that report their payout activity to S&P cut or omitted dividends, down 30% from 145 in 2010. Fourth-quarter dividend enhance-



Page 8

ments, however, didn’t mirror the year as a whole. They slipped about 7%, to 649 from 696. Not to worry. Howard Silverblatt, S&P’s senior index analyst, explains that the drop was a re-sult of a sharp 44% ad-vance in positive actions in 2010’s fourth quarter, “as the market entered a recovery period.” Silverblatt predicts that, in 2012, “dividend increases will continue across the board for all sectors with another double digit gain in ac-tual cash payments. “The latter climbed more than 16% in 2010, and the forward indicated dividend rate is up 18%. If you’re a long-term investor

with the ability to live through the cur-rent and expected economic turmoil, a balanced dividend– oriented stock selec-tion should be part of your portfolio,” says Silverblatt.

U.S. bank and thrift divi-dend activity in 2011 was strong. SNL Financial recorded 123 payout hikes or initiations, 8% above 2010’s 78 and more than triple 2009’’s 39. What’s more, dividend decreases fell by about half, to 16 from 31, while cuts plummeted to just seven from 25. State Street and PacWest Ban-corp had the biggest boosts (each to 18 cents a share from a penny). The 65 stocks in the

Dow Jones Averages saw plenty of posi-tive dividend action in 2011. Looking

first at just the year’s final quarter for the 30 industrials, Barron’s statistics director, Peter Miller, counts eight boosts: by AT&T, Boeing, Chevron, Disney, General Electric, Home Depot, Merck and Pfizer. All told, 2011 was a strong year for dividend investors and dividend growth. We look for those trends to continue in 2012 and beyond.

McDonald’s Update Another Great Year for Shareholders We highlighted McDonald’s in last year’s year-end Viewpoint because of the outstanding job management’s done in creating wealth for shareholders since 2002. The good times continued in 2011 as MCD’s stock was up more than 35% compared to the S&P 500 up 2.11%. As we noted last year, McDonald’s has been dishing out dividends as effi-ciently as their hamburgers. Moreover, they have raised their dividend every




McDonald’s Share Buybacks 2002‐2011

Period $ Amount Out/Shares Per share

2011 $3,535 1,054 $3.35

2010 2,699 1,066 2.53

2009 2,797 1,092 2.56

2008 3,919 1,127 3.48

2007 3,943 1,188 3.32

2006 2,959 1,234 2.40

2005 1,202 1,260 0.95

2004 621 1,260 0.49

2003 391 1,270 0.31

2002 670 1,273 0.53

Total $22,736 $19.92

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McDonald’s Corp Performance 2002-2011 2002 2011 % Change Ann GR

Revenues $15,406 $24,075 56.3% 5.1%

Operating Income 2,113 7,473 253.7% 15.1%

Earnings Per Share 0.70 4.64 562.9% 23.4%

Dividends 0.24 2.80 1,091.5% 31.4%

Year End PE Ratio 20.9 19.7

Source: Morningstar

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McDonald’s Market Performance March 2002 to December 2011

MCD S&P 500

Relative Performance

Capital Appreciation 660% 54% 606%

Dividend Return 95% 29% 65%

Total Return 756% 84% 672%

McDonald’s Quarterly Dividend 1976 to 2011

McDonald’s Stock Price 1970 to 2011

Does dividend growth lead to . . .

superior stock price performance?

Page 9

year since they started paying them in 1976. They raised the dividend ante again in 2011 from $0.61 a quarter to $0.70 or $2.80 annually or a 14.75% increase. That’s just part of the share-holder cash payback in 2011. As the table on page 8 shows, MCD bought back stock to the equivalent of $3.35 a share in 2011. While we are not big fans of share buybacks, we certainly prefer them to the standard misuses of shareholder money such as overpriced acquisitions or unprofitable growth. The two tests of buybacks are: one, does management actually care about the price they pay for stock when buying and two, does the buyback program actually reduce the number of shares outstanding. In the first case, we estimate that MCD paid an average of about $79 a share for their purchases over the last nine years so as of the year end 2011 price of $100, MCD’s buybacks look reasonably efficient. On the second score, they’ve managed to reduce the number of shares outstanding by about 17% which is a good thing for us re-maining shareholders. Note however, dividend growth and share buybacks are just the end result of a management that is properly focused on the right thing—profitable growth. It’s one thing if a com-pany can grow rapidly, it’s another when the growth slows, then manage-ment should switch to focusing on in-

creasing profitability and returning part of the profits to shareholders and only grow the business if they can do so while maintaining or increasing profits at the same time. A neat trick if they can pull it off, like McDon-ald’s has managed to do so well since 2002. (See the table of MCD’s cor-porate performance 2002-2011 on page 8) Reve-nues up 5.1%, but operat-ing income is up 15%, earnings per share up: 23% and dividends up: 31%! The net result to shareholders, total return up 756% since March 2002 compared to 84% for the S&P. Note that at the same time MCD’s stock prices was going from $16.08 at year end 2002 to $101.74 at year end 2011, it’s PE ratio went from 20 to 19. Can you say, “long-term, bear market?” Our only complaint? We didn’t buy more MCD when the stock was cheaper. At the same time, we may regret it, but for now we plan on holding off buying more MCD until the stock again yields over 3.0% or more. But that’s the disci-plined investor in us.

Interest Rate Outlook 10-Year Treasury Note Expected Return How about less than zero? As of year-end 2011, the 10-year Treas-ury Note was yielding 2.03%; a new all-time low going back to April 1954 (See Interest rate chart at top of page). That

begs the question, “What are 10-year Treasury Note buyers thinking?” We’ll start by assuming an investor buying a $100,000 worth of notes at 2.03% has enough income to fall into the

25% tax bracket. Next, we further assume infla-tion will average 3.0% over the life of the note. Under those two assump-tions an investor foolish enough to buy a 10-year note at a yield to maturi-ty of 2.03% are locking in a loss to the tune of 1.5% to 2.0% a year net of tax-es and inflation, (depending on the actual

inflation rate.) Since inflation has aver-aged a minimum of 3.0 and 3.5% a year going back fifty years, we can reasona-bly assume inflation will average at least 3% over the next ten years—if not more. Further, our loss estimate assumes an investor holds the 10-year note to maturity. It doesn’t factor in the poten-tial loss of principal should an investor be forced to sell all or a portion of the note prior to maturity—after interest rates rise. Investors should take their cue from the financial markets, because the mar-kets tend to convey everything you need to know, particularly at the extremes. But investors rarely do pay attention to financial markets that is, which is why they often end up on the short end of



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10-Year Treasury Yield 3-Month Treasury Bill Yield

S&P 500 Dividend Yield Inflation


Is this the Real Interest Rate Outlook?

Given the global current debt situa-tion and the Federal Reserve com-mitted to keeping rates low, it could be awhile, years even, before inter-est rates move higher. We admit we don’t have a clue as to when that will happen. We just know that, sooner or later, interest rates will have to go up, and when they do, the potential capital losses on long-term bonds will be substantial.

Interest Rate Update Year End 2011

the stick when it comes to investing. Right now the current yield on the 10-year Treasury Note is telling investors, (no make that SCREAMING at them) that Treasury Notes are a bad deal, yet in investors continue to buy them in record amounts despite the calculation of a guaranteed loss on the investment. The obvious question is why? The only reason we can think of is safety. In a world overflowing with uncertainty, investors buying the 10-year Treasury Note, must be making the mental calcu-lation that it’s better to lose a little money than a lot. The only thing wrong with that line of thinking is they’re set-ting themselves up for the possibility they could lose a lot more than 2-3% a year after taxes and inflation when interest rates rise. Of course the current price (i.e. the record low current yield) of the 10-year Treasury Note is also being driven by demand from the big bond fund investors like PIMCO. As investors pour money into bond funds in search of yield, and in today’s interest rate environment, any positive yield, fund managers like Bill Gross, co-founder of PIMCO, the world’s largest bond manager with over $1 trillion in assets, have to put the cash somewhere, and a 10-year Treasury Note is as good a place as any right now. As bond fund managers buy the 10-year treasury note it drives its price higher and its yield lower. We suspect current buyers of the 10-year Treasury would argue that losing less by locking in 2.03% in a 10-year treasury is better than losing more by parking money in a money market fund at a paltry yield of say 0.01%. And that’s true, assuming interest rates don’t go up. If they do, money market funds will make more money while the 10-year Treasury investor could loses their shirt, in a manner of speaking.

It Could be Worse Investors buying a 10-year Treasury Note at today’s yield to maturity are guaranteeing a annual loss even if they hold it until maturity. However, if they invested in a mutual bond fund with a maturity longer than 10 years and inter-

est rates rise, they could be looking at loses of anywhere from 20 to 40% de-pending on the quality and duration of the particular bond fund. Most im-portant, because a bond fund never ma-tures—it’s made up of hundreds of bonds of various maturities—it’s quite possible the fund may never get back to par so the potential for a permanent loss of capital is very real. Unlike a money market fund where the principal is protected, (99% of the time, that is) and the yield it pays us will rise as interest rates rise. What many investors fail to learn is that financial markets convey infor-mation. Just as the stock market was signaling obscured valuations and high risks for stocks in 1999 and 2000, the bond market is signaling to bond inves-tors that any investment in a bond long-

er than say ten years maturity is a risky bet. Heed the warning and stay away from long-term bonds and low-quality, especially long-term bond funds. Of course, we don’t know when interest rates will begin to rise and with the Fed committed to keeping rates low for now, it could be awhile, years even, before interest rates move significantly higher. We just know that sooner or later rates have to go up, and when they do the potential losses on bonds is significant.(9)

Buyback Update Corporate buy backs are running at the highest level since 2007, (see chart above) according to Standard and Poor’s. Total share buybacks are ex-pected to reach $540 billion for the year. Many companies effectively are taking themselves private. Data for the third quarter of 2011 shows that buybacks involving companies in the S&P 500 totaled $132 billion, up from $80 billion in 2010’s third quarter, $109 billion in this year’s second quarter and the high-

est level since the $142 billion in 2007’s fourth quarter, according to Howard Silverblatt, Standard & Poor’s senior index analyst. The S&P 500 companies are repur-chasing stock at a 5% annual rate. The S&P’s “total yield”—dividends plus buy-backs—exceeded 7% in 2011. The argument in favor of share buybacks goes like this: When a compa-ny buys and then retires outstanding shares, it drives up earnings per share (fewer shares divided into the same dol-lar amount of net income) and in theory, should boost the share price. Buying back stock gives the remaining share-holders a larger cut of the profits, and hints to those thinking of buying shares that the company’s executives—the in-siders in the know—think their stock is

undervalued. Then again, buybacks don’t always follow the mutually bene-ficial course. Some companies stretch buybacks out for years, reducing the chances they’ll reach completion. Companies often overpay for their own stock, ren-dering them ineffective and costly destroying shareholder wealth along the way. Many buyback programs have more to do with countering

the dilution that accompanies issuing executive stock options than with re-warding shareholders. Finally, share buybacks are a blatant manipulation of the balance sheet, plain and simple. Management should be focused on the profitable growth of the business and not artificially trying to boost the stock price. Topping the list of buybacks is ExxonMobil (XOM) with $22 billion in 2011. Over the last ten years, Exxon has retired more than two billion shares spending $80 billion. Cutting outstand-ing shares to less than five billion from seven billion in 2001. Since 2000, XOM has raised its dividend from $0.88 to $1.88 per share and its stock is up in total return 140% compared to the S&P up 6%. We’ll concede it’s hard to argue against buybacks when a stock is up 23 times the market, yet we would suggest the results speak more to the power of a XOM business then it does to buybacks.


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9) But you’ve heard our interest rate warning for several quarters now. We’ll just remind you each quarter anyway. Sooner or later we’re bound to be right and when we are, we hope we’ve saved you some money.

Deschaine & Company, L.L.C.

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Quarterly Share Buybacks Source: Standard & Poor’s


Equity Income Portfolio Update 2011 Annual Review

T HE EQUITY INCOME PORTFOLIO is an actively managed hypothet-

ical portfolio of all the actual buys and sells we do in client portfolios. The cur-rent holdings for the portfolio as of De-cember 31, 2011 are shown to the left. We launched the EIP (and View-point) on December 31, 2000 to docu-ment the high-yield dividend growth strategy we’ve employed since that time. Since each individual client portfolio is managed to meet their individual goals and objectives we wanted a way to track and demonstrate our research and secu-rity selection process and the strategy’s overall effectiveness.

What We’ve Learned in 11 Years Like all things in life, our high-yield, dividend growth strategy continues to grow and evolve. In other words, we’d like to think we learn from our mistakes. One mistake we like to own up to is to not underestimate the power of com-pounding. By that we mean to have faith and employ the basis strategy of buying great companies that have the ability to grow their dividend and religiously re-investing the dividend, come what may. It’s a winning strategy. For example, the Equity Income portfolio’s annual total return is up 8.9% since inception on December 31, 2000. That compares to the S&P 500 index which is up 1.5%. By any measure, excellent results. How-ever, the total return includes cash hold-ings which have averaged about 20% over the life of the portfolio. We’ve rec-ommended holding cash as protection against a volatile stock market. A pru-dent strategy in these uncertain times for most clients, but a costly one none-theless as the equity only portion of the EIP earned 12.3% compounded since 2000 (compared to 8.9% for the total portfolio.) The difference over the last 11 years? About $635,000 on a million portfolio or almost 25% less return. Therefore, the EIP will hold less cash going forward (year end cash about 13%) and we’ll focus on stock selection and dividend reinvestment. As always, we’ll keep you posted here in the pages of Viewpoint.

Equity Income Portfolio Year End 2011 Update

Name Ticker Industry Recent Close

Dividend Yield

Year End PE Ratio

2011 Total

Return

Abbott Laboratories ABT Drug Manufacturers 55.71 3.45 19.31 22.90 Alliance Bernstein Global High Inc AWF Bond Fund 14.29 8.42 NA 2.34 Altria Group Inc. MO Tobacco 28.90 5.47 17.70 26.16 Aqua America Inc WTR Utilities-Water 21.42 2.94 20.88 -5.49 Arthur J. Gallagher & Co. AJG Insurance Brokers 32.85 4.02 24.69 18.11 AstraZeneca PLC ADR AZN Drug Manufacturers 47.52 5.68 6.38 5.68 AT&T Inc T Telecom Services 30.25 5.72 15.36 12.49 Atlantic Power Corporation AT Utilities-Independent 14.53 7.68 29.90 1.99 BGC Partners, Inc. A BGCP Capital Markets 6.26 10.38 30.58 -23.22 Black Hills Corporation BKH Utilities-Diversified 33.08 4.41 23.09 11.71 Bristol-Myers Squibb Company BMY Drug Manufacturers 33.72 3.94 18.02 35.64 CenturyLink Inc CTL Telecom Services 36.96 7.85 24.51 -9.96 Chevron Corp CVX Oil & Gas Integrated 106.72 2.90 7.89 18.29 Clorox Company CLX Household & Personal Products 68.93 3.34 32.79 11.33 Coca-Cola Co KO Beverages 67.35 2.79 12.87 9.66 Colgate-Palmolive Company CL Household & Personal Products 89.73 2.53 18.55 17.48 Compass Diversified Holdings CODI Industrial Holdings 14.26 9.96 91.74 -13.27 ConocoPhillips COP Oil & Gas Integrated 70.80 3.73 9.35 8.45 Consolidated Edison, Inc. ED Utilities-Diversified 59.34 4.04 16.50 23.90 CPFL Energy SA ADR CPL Utilities-Diversified 28.35 5.14 17.18 14.15 Dominion Resources Inc D Utilities-Diversified 50.80 3.88 20.24 22.78 Eli Lilly and Company LLY Drug Manufacturers 40.03 4.90 9.92 20.28 Energy Transfer Partners, L.P. ETP Oil & Gas Midstream 47.88 7.47 13.42 -4.39 Eni SpA ADR E Oil & Gas Integrated 42.27 4.85 9.41 -9.15 EV Energy Partner LP EVEP Oil & Gas E&P 69.90 4.35 27.70 67.45 Federated Investors, Inc. B FII Asset Management 17.48 5.49 9.50 -31.07 Fifth Street Finance Corporation FSC Credit Services 10.07 12.60 20.37 -9.58 Frontier Communications Corp FTR Telecom Services 5.09 14.73 32.15 -37.81 General Mills, Inc. GIS Packaged Foods 40.77 2.93 17.18 17.22 Genuine Parts Company GPC Industrial Distribution 62.90 2.86 17.61 26.49 Gladstone Investment Corporation GAIN Asset Management 7.56 7.34 4.61 1.95 GlaxoSmithKline PLC ADR GSK Drug Manufacturers 44.56 4.95 22.68 19.36 HCP Inc HCP REIT-Healthcare Facilities 41.56 4.62 26.32 20.01 Health Care REIT, Inc. HCN REIT-Healthcare Facilities 55.70 5.09 61.35 24.41 HJ Heinz Company HNZ Packaged Foods 53.04 3.56 18.21 12.95 Integrys Energy Group Inc TEG Utilities-Diversified 52.15 5.22 16.16 14.38 Johnson & Johnson JNJ Drug Manufacturers 65.12 3.46 15.97 7.71 Kimberly-Clark Corporation KMB Household & Personal Products 73.65 3.80 17.57 20.13 Kraft Foods Inc KFT Packaged Foods 38.13 3.04 20.41 25.37 Leggett & Platt, Inc. LEG Home Furnishings & Fixtures 22.76 4.83 19.46 3.97 Linn Energy LLC LINE Oil & Gas E&P 36.26 7.45 16.34 0.83 Lockheed Martin Corporation LMT Aerospace & Defense 81.64 3.98 9.99 13.95 Main Street Capital Corporation MAIN Asset Management 21.60 7.27 8.56 27.87 McDonald's Corporation MCD Restaurants 100.55 2.52 19.69 39.18 Mercury General Corporation MCY Insurance-Property & Casualty 43.83 5.50 28.41 7.61 Microchip Technology, Inc. MCHP Semiconductors 36.17 3.83 17.89 0.49 Microsoft Corporation MSFT Software 28.26 2.41 9.44 2.24 Middlesex Water Company MSEX Utilities-Water 18.46 3.97 21.10 1.87 MLP & Strategic Equity Fund MTP Oil & Gas Mutual Fund 16.80 5.58 19.65 8.02

Paychex, Inc. PAYX Outsourcing Services 31.20 4.01 20.28 0.43

PepsiCo Inc PEP Beverages 64.65 3.13 16.64 -0.16 Philip Morris International, Inc. PM Tobacco 75.90 3.72 16.53 38.91 Pinnacle West Capital PNW Utilities-Regulated Electric 47.65 4.41 16.16 19.82 Pitney Bowes Inc PBI Business Equipment 19.32 7.66 10.08 -13.08 Plum Creek Timber Co Inc PCL REIT-Industrial 38.82 4.33 31.06 1.10 Procter & Gamble Co PG Household & Personal Products 66.26 3.10 16.95 4.25 Progress Energy, Inc. PGN Utilities-Regulated Electric 54.30 3.90 21.23 26.13 Prospect Capital Corporation PSEC Asset Management 10.07 12.07 6.64 -3.30 Realty Income Corporation O REIT - Retail 35.82 4.85 29.07 11.41 Reynolds American Inc RAI Tobacco 41.62 5.17 18.21 34.22 Southern Company SO Utilities-Regulated Electric 45.19 4.14 18.38 22.24 Suburban Propane Partners SPH Utilities-Regulated Electric 45.85 7.44 14.79 -14.46 UIL Holdings Corporation UIL Utilities-Regulated Electric 34.18 5.06 20.28 20.74 Unilever PLC ADR UL Packaged Foods 31.60 3.93 16.89 8.78 Vector Group, Ltd. VGR Tobacco 17.59 8.88 17.57 16.58 Vectren Corp VVC Utilities-Regulated Electric 29.10 4.76 17.57 15.82 Verizon Communications Inc VZ Telecom Services 39.02 5.06 16.13 15.61 Wal-Mart Stores Inc WMT Discount Stores 59.85 2.44 13.44 11.86

Wayside Technology Group, Inc. WSTG Computer Distribution 11.96 5.35 11.12 7.97


part of the typical client portfolio. Each client portfolio is managed to meet their individual needs, goals and objectives and will have an asset mix that is appro-priate for their needs, investment objec-tives and risk tolerances. If you don’t have the time or incli-nation to sweat the details of high-yield, dividend growth investing consider hiring us to do it for you. For a modest 1% annual fee we’ll be happy to handle it for you. I’m pretty confident that we’ll be able to earn our fee by capturing at least an additional 1% in yield over the life of your portfolio over you doing it yourself. Not to mention the time and aggravation you’ll save by having us do it for you. Sure, you can pay less by investing in an index fund or an equity ETF, but you’ll get what you pay for, passive management of your money in a market environment calling for a more appro-priate strategy. The Vanguard S&P 500 index fund (VIFNX) for example, is up 1.37% compared to the Equity Income portfolio, which is up 8.9% annually since December 31, 2000. But that’s just part of the story. As of year-end, the VFINX is yielding 2.1% compared to the Equity Income Portfolio, which has a current yield of 5.5% and is yielding 6.5% on our cost. And as I mentioned earlier, the portfolio’s dividend income has grown 13% a year, or almost four-

fold, since 2000. In addition, a high-yield, dividend growth strategy is a low turnover strategy which works to keep commissions (at less than $10 a trade anyway) and taxes as low as possible. Since 2000 the EIP’s annual turnover is less than 20%. Compare that to the typi-cal mutual fund with turnover exceed-ing 200% and you start to see the bene-fits of an individually managed portfolio compared to most mutual funds. If your current equity portfolio con-sists of equity mutual funds, why not let us show you how we can replicate the same holdings, with a focus on high yield, dividend growth stocks, at a frac-tion of the cost, turnover and taxes. We often have folks bring us their mutual funds which we then throw into our Morningstar fund analyzer which spits out a report showing that their many supposedly “diverse” mutual funds hold the same stocks and that many of the stocks are ones we use to build an effi-cient, individual, high-yield, dividend yield portfolio at less than half the an-nual cost. A review will cost you noth-ing but your time and curiosity. There you have it. My annual re-view of what exactly it is we’re trying to do here at Deschaine and Company in the management of client equity ac-counts. Thank heavens it’s not rocket science because, at my age, I simply don’t have the energy to perform such a mentally challenging task as rocket sci-ence, I’m sure requires.

I’d like to take this opportunity to thank all of the many folks who have entrusted us with their hard earned as-sets as 2011 was another record year for the firm. At the same time, I’d like to also take this opportunity to reaffirm our commitment to our primary firm objective, which is to manage our clients assets well. While we enjoy the benefits of the growth of the firm over the last few years and believe it’s in our clients interest that we grow, it’s not our top priority. The prudent and safe manage-ment of your assets are. Marnie and I started Deschaine & Company to man-age our money, our family and friends money, and anyone who entrusted us with their assets as if they were our own. That means focusing on quality assets and keeping a keen eye on fees, commissions and taxes. The objective has not and will not change regardless of the firm’s growth. As we grow, I in-tend to add staff primarily in the invest-ment management and research side of the business, in order to continue to provide clients with investment man-agement that meets their long-term investment objectives. So again, while we thank you for your support and con-fidence, know that we get up every morning committed to earning it through the prudent and safe manage-ment of your assets. May 2012 bring health, happiness and prosperity to you and yours. As always, thanks for reading. MJD

(Front Seat Column Continued from page 5)

PUBLISHER: MARK J. DESCHAINE EDITOR: JOHN H. DESCHAINE CONTRIBUTING EDITOR: TOM O’HARA STAFF CONTRIBUTORS: MATT POWERS, JASON LOYD COPY EDITOR: MARNIE E. DESCHAINE TECHNICAL ADVISOR: Joseph M. Deschaine. VIEWPOINT is a comple-mentary publication of Deschaine & Company, L.L.C. a registered investment advisor in Belleville, Illinois. This information has been prepared from sources deemed reliable, but its accuracy is not guaranteed. It should not be assumed that any securities discussed will be profitable or will equal past performance, or is it an offer to buy or sell any security mentioned. Deschaine & Company and/or one or more of its clients, employees, family or friends may have a position in the securities discussed herein. © 2011. All rights reserved. Reproduction of this publication is strictly forbidden without written consent from Deschaine & Company. This issue was published on January 25, 2012. If you would like to receive a complementary copy each quarterly, simply send us your address and the preferred method of delivery: snail-mail or email, to: 128 South Fairway Drive, Belleville, IL 62223. Or email us at [email protected] and we would be happy to add you to one of our mailing or email list.

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