As we seek out early signs of spring, the Day Hagan Logix Tactical Dividend (DHLTD) strategy has delivered strong performance, returning +8.33%* over the first two months of the year. DHLTD performance came while holding a defensive cash position in the context of our risk management protocol. While the markets have been strong year to date (Russell 1000 Value +11.23%; all returns are gross of fees and total return), our valuation process currently shows cash as a prudent hedge to protect downside. However, it is worth noting our process also shows the industries and equities that are part of our current portfolio construction as having price targets significantly above current levels (49% upside at the end of February). In addition, while attractive dividend yield is just a byproduct of our methodology, our current yield, inclusive of portfolio cash, is around 3%, which can provide a notable boost to total return in potentially volatile markets moving forward. Historically, our portfolio yield has been roughly 20% above our benchmark. With a track record going back to 2002, the strategy has been “battle-tested” through a variety of market environments, and yield has consistently worked to our advantage in terms of long-term benchmark outperformance with modest risk metrics.
Our valuation approach seeks attractive entry points for portfolio positions with sales at our measure of fair market value. What that means in practical terms is that we generally buy industries and underlying equities when most investors don’t like them. In other words, a lot of negative sentiment and noise surround them. We have found over our 17-year history (using a consistent process) that this is the best way for us to optimize the upside-downside capture equation in the name of generating portfolio alpha. Our portfolio position sales during the month of February, which served to modestly increase our cash position after a meaningful, opportunistic cash reduction at the end of December, provide a good illustration of our buy/sell process.
We purchased Cisco Systems (CSCO) in September of 2017. Prior to the purchase, a sampling of sell-side equity research comments included “Cisco is structurally challenged,” “We recommend remaining on the sidelines… as cloud headwind is likely to remain significant over the coming years,” “Cisco’s strategic importance has deteriorated significantly,” “We don’t see an obvious end in sight to the switching and routing doldrums,” “Cisco is fairly valued at current trading levels [~$32]”. Whew! To the point in our earlier paragraph, a lot of negative sentiment and noise clearly surrounded CSCO at our point of purchase. We are used to this kind of adversity in our holdings. We aren’t saying the issues around a name like CSCO should be ignored or dismissed but rather that we viewed our entry point as attractive, even if it required near-term patience. We sold CSCO after holding it for just shy of 17 months at about $48/share for a total return of over 48%.
Our sale of Monro, Inc. (MNRO) in February followed a different trajectory than CSCO, but ultimately with similar success. Early on, MNRO required some patience. In the months after our entry point, the stock dropped around 10%. While this was frustrating, we do not believe precise market timing is consistently possible. Our prerogative is finding an objectively attractive stock price, based on our comprehensive process, that will deliver upside over time. With our thesis around MNRO intact, negative noise around, for example, the likelihood of a potential deal with Amazon did not change our belief around longer-term value. While holding periods are ultimately different for different portfolio stocks, MNRO value was realized over a relatively short period of time. MNRO generated a return of over 40% for the approximately 14 months it was held in the DHLTD portfolio.
Speaking of patience, Medical Distributors is our best-performing industry grouping year to date, and we are pleased to see the broader markets finally recognizing significant untapped value. We own the “Big 3” distributors: Amerisource Bergen (ABC), Cardinal Health (CAH), and McKesson (MCK), which collectively dominate industry market share. To give a sense of the size and scope of these players, MCK generated $208 billion in fiscal year 2018 revenues, with ABC and CAH generating $160 billion and $137 billion in revenues respectively. MCK delivers 1/3 of all prescription medicine in North America, CAH is in nearly 85% of U.S. hospitals and 26,000 pharmacies, and ABC does 50,000 daily deliveries to healthcare institutions. The Big 3 increasingly serve the entire drug supply chain in some capacity, inclusive of health systems, pharmacies, physician offices, manufacturers, insurers and patients. Their massive reach provides significant barriers to entry in a highly complex and regulated industry with long-term, entrenched relationships.
There has been plenty of noise for some time around the Medical Distributors for a variety of reasons. Some of these issues, while we generally believe them to be overstated, are real, and we don’t suggest they won’t have an impact. However, even taking those issues into account, based on our valuation and screening process, we believe the medical distributor stocks we own have significant upside at current levels. As an example, CAH is up ~23% year to date, but our dynamic price target is over 45% higher than its price at the end of February. With improved visibility into drug pricing (branded drug pricing consistent with expectations, generic drug pricing deflation moderating), continued growth in higher-margin specialty pharmaceuticals, and indications of an evolving contract paradigm with pharmaceutical companies that protect distributor economics, we believe market sentiment on the industry is finally evolving in a positive direction.
We welcome the opportunity to further engage with you on the DHLTD strategy and why it is unique. Please don’t hesitate to contact us at any point with questions or to schedule a conversation.
We wish you a happy start to spring.
Robert Herman, MBA
Donald L. Hagan, CFA
Jeffrey Palmer, CIPM
Arthur S. Day
Steve Zimmerman, MBA
Print Copy of Article: Day Hagan Logix Tactical Dividend Strategy Update March 2019 (PDF)
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The Russell 1000 Value Index measures the performance of the large-cap value segment of the U.S. equity universe. It includes those Russell 1000 companies with lower price-to-book ratios and lower expected growth values. Indexes are unmanaged, fully invested, and cannot be invested in directly. The S&P 500® Index is a broad-based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general.
Alpha is a statistical measure that calculates an active manager’s return in excess of a benchmark index or a “risk-free” investment.
Disclosure: *Note that individuals’ percentage gains relative to those mentioned in this report may differ slightly due to portfolio size and other factors. The data and analysis contained herein are provided "as is" and without warranty of any kind, either express or implied. Day Hagan Logix (DH Logix), any of its affiliates or employees, or any third-party data provider, shall not have any liability for any loss sustained by anyone who has relied on the information contained in any DH Logix literature or marketing materials. All opinions expressed herein are subject to change without notice, and you should always obtain current information and perform due diligence before investing. DH Logix, accounts that DH Logix or its affiliated companies manage, or their respective shareholders, directors, officers and/or employees, may have long or short positions in the securities discussed herein and may purchase or sell such securities without notice. DH Logix uses and has historically used various methods to evaluate investments which, at times, produce contradictory recommendations with respect to the same securities. The performance of DH Logix’s past recommendations and model results are not a guarantee of future results. The securities mentioned in this document may not be eligible for sale in some states or countries, nor be suitable for all types of investors; their value and income they produce may fluctuate and/or be adversely affected by exchange rates, interest rates or other factors.
There is no guarantee that any investment strategy will achieve its objectives, generate dividends or avoid losses.