Dogs of the TSE

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Shakespeare
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Dogs of the TSE

Post by Shakespeare » 05 Jul 2005 22:05

This has come up a couple of times, and is worthy of its own thread.

The strategy is based on the "Dogs of the Dow" popularized by Michael O'Higgins. A small, select blue-chip index is used as the base. Each year, the ten highest yielders are selected and purchased in equal dollar amounts. The selection process is repeated once yearly, with deselected stocks sold and the funds allocated to new choices.

David Stanley has written a series of articles in Canadian Moneysaver on this strategy, which he calls "Beating the TSX". For this strategy to work, the base index must include a limited number of high-quality stocks; initial screening is in essence done by the index selection committee with the dividend yield serving as a second screen. Initially, the TSE35 served as the base index. However, that index is no longer available, so the Dow Jones Canadian Titans is used.

Although more sophisticated selection methods are used by some posters, this simple system has a good history of beating the TSX60 index most (but not all) years.

Norm's "Stingy Investor" site has a number of screens based on this and similar strategies, as well as several articles discussing the approach. The DJ40 dividend screen is here.
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Re: Dogs of the TSE

Post by jiHymas » 05 Jul 2005 23:07

Shakespeare wrote:For this strategy to work, the base index must include a limited number of high-quality stocks; initial screening is in essence done by the index selection committee with the dividend yield serving as a second screen. Initially, the TSE35 served as the base index. However, that index is no longer available, so the Dow Jones Canadian Titans is used.
According to Country Titans | Methodology Overview | Stock Selection
Dow Jones wrote: For each index, the top-ranked stocks in terms of size and liquidity are chosen from the corresponding selection list as components:

Stocks on the selection list are ranked first by size (float-adjusted market capitalization) and then by liquidity (12-month average daily trading volume).**
Stocks are sorted by final rank: an equally weighted combination of rank by size and rank by liquidity.
Stocks are selected top-down by final rank until the target component number is reached.
So this is not necessarily a "high quality" index and the "stock selection committee" is more like a clerk with a spreadsheet.

Remember Bre-x? A lot of people were most upset that it was included in one of the TSE indices way back when. I wasn't one of them, by the way - indices should be naive.

This strategy is very simple to implement, which brings its own problems. There's no risk control! The focus on dividend yield leads one to expect that the banks and utilities are going to be over-weighted:
Dogs of the Dow: these dogs can bite
Stingy Investor wrote: Another lesson I learned from my Dogs experience is that you can't just assume a big company is a safe company witness Laidlaw's bankruptcy. True to form, this year's Dogs of the TSX are a mixed bunch. They are (with symbol, price and yield): TransAlta (TA, $18.05, 5.5%), BCE (BCE, $28.92, 4.6%), TransCanada (TRP, $29.80, 3.9%), Bombardier (BBD.SV.B, $2.38, 3.8%), CIBC (CM, $72.23, 3.6%), Royal Bank (RY, $64.25,3.4%), National Bank (NA, $49.56, 3.4%), Bank of Nova Scotia (BNS, $40.70, 3.1%), Enbridge (ENB, $59.70, 3.1%) and Bank of Montreal (BMO, $57.76, 3%). The riskiest is perhaps Bombardier, which is trying to resuscitate its airplane business and isn't earning enough to cover its dividend.
It is not clear in just what sense the stocks are referred to as "a mixed bunch", but I certainly wouldn't call 40% Utilities, 50% Banks a very well diversified portfolio.

This is not necessarily a bad thing, but will certainly lead to higher volatility with respect to the index than a more complex approach might provide.

Another problem with the approach is that there is no provision for tax-effects - the automatic annual rebalancing might work against a taxable investor. But I'm kind of hung up on the lack of tax-effects in most quant strategies.
Stingy Investor wrote: David Stanley, University of Guelph professor emeritus, tracks the Dogs of the TSX and rebalances his portfolio each year on May 25. Stanley calculates that the Dogs have gained an average of 13% a year since 1987, trouncing the index by 3.6 percentage points a year.
I'm worried, too, about the meaning of the back-testing. 1987 was a funny year ... how does the total return comparison change when you move the end-points? And in such a simple system, with such a small number of examined trades, I'm concerned that 18 years isn't enough.

None of my objections should be taken as an outright rejection of the strategy, though! Ever since I became a quant, I've been amazed at just how little thought is required to outperform the market, given a reasonably lengthy time horizon and 'Yield-Tilting' has been recognized as a successful strategy for a long time.

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Post by Shakespeare » 05 Jul 2005 23:18

So this is not necessarily a "high quality" index and the "stock selection committee" is more like a clerk with a spreadsheet.
Nonetheless, those screens combined with the necessary presence of a dividend will eliminate a surprising amount of crap. (Bre-X never paid a dividend.)
the focus on dividend yield leads one to expect that the banks and utilities are going to be over-weighted
There's no doubt this simple strategy has some embedded risks, although it has performed very well in the past. I would not use it for all of my Canadian holdings, for example. However, it shows that a complex approach is not necessary to capture much of the value premium. (But how much risk is really in the Big 5 banks - which likely would not be allowed to fail?)
there is no provision for tax-effects - the automatic annual rebalancing might work against a taxable investor
I'm pretty sure the claimed outperformance (3.6%) would overwhelm the tax drag.

I think a more careful selection and buy-and-hold will likely outperform. But the approach can be a useful, simple screen.

Added: Even P/B in the three-factor model is a simple way to boost returns. You don't appear to need complex factors to capture the value premium; O'Shaunessy also tried things like P/S and P/E, with generally similar results. That suggests to me that the underlying problem with cap-weighting is both simple and universal; I believe that it is behavioural.
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Post by DenisD » 06 Jul 2005 00:42

David Stanley has written a series of articles in Canadian Moneysaver on this strategy
And the latest in the series is in the July/Aug issue. Just looked through it at a magazine store. It trounced the DJ40 again.

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Post by Westford » 06 Jul 2005 12:25

The cautions that Norm proivdes at "Stingy Investor" about this strategy are noteworthy. My question and concern is that when we simply pick the stocks with the highest yield, we are not really looking at any one stock's history of high and low yield range are we? So in essence what might be a high yield in the screen may not really be a high for the stock? Is that correct? If so, then the security might not really be cheap.

My other concern is that usually a yield is high for a reason (I do not intend to resurrect the EMH vs irrational market behaviour here)--i.e., there is a perception that the company will not do too well/is not doing too well in terms of growth or earnings, etc. (I have placed "perception" in bold because the drop in price may be a short term overreaction of the irrational market). But then the question is how do we know whether the price will rebound, whether the company will turn its revenues, earnings, etc. around? How often does a stock keep sinking or remain essentially stagnant for years (even if we assume that the company does not cut its dividend)?

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Post by Shakespeare » 06 Jul 2005 12:38

Although the concerns by stock pickers are valid, the return evidence (as well as the wider work by O'Shaughnessy and Fama/French) seems to suggest that much of the value advantage can be captured by quite simple strategies such as P/D [which this is equivalent to], P/E, P/S, or P/B. So, is the extra advantage from stock picking really worth the extra work? :twisted:

(I think a greater concern in the Canadian market is that all value or stock-picking strategies increase concentration in what is already a thin market.)
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Post by Westford » 06 Jul 2005 12:55

Shakespeare wrote:So, is the extra advantage from stock picking really worth the extra work? :twisted:
No it isn't. But then I am by nature quite lazy. :lol:

Some questions: how important is it to dump the deselected stocks at the end of the year? If the last year's high yielding stock is doing well (i.e., no longer in the top 10), why get rid of it unless it is approaching a low yield where it is expensive? Would it not be wiser to hang on to it, thus avoiding capital gains and allowing reinvestment of the dividends?

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Post by Shakespeare » 06 Jul 2005 13:07

how important is it to dump the deselected stocks at the end of the year?
I'm going to guess on that, but I suspect if the company is fundamentally sound there is no need to dump it. I followed the list mentally for a number of years on Norm's site when it was the TSE35. Basically, certain stocks drift in and out of the Top 10 list - the Big 5 banks, for example, are not all usually present - while others like TRP or (on the TSE35) TA just sat there. When a solid company like DFS suddenly moved up, it was usually a buying opportunity. One advantage of using a small index as a base is that there are really only around 15 stocks that regularly show up; it doesn't take long to recognize if they are cheap. That's one reason it's easy for an experienced value investor to make extra money on the Canadian market: if you stick to large caps, the market is efficient enough that you can trade on the behavioural effects.

In a registered account, of course, there are no capital gains effects, so the Dogs strategy would not need to account for them.
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Post by jiHymas » 06 Jul 2005 13:10

Westford wrote:My other concern is that usually a yield is high for a reason (I do not intend to resurrect the EMH vs irrational market behaviour here)--i.e., there is a perception that the company will not do too well/is not doing too well in terms of growth or earnings, etc. (I have placed "perception" in bold because the drop in price may be a short term overreaction of the irrational market).
Sometimes they have high yield for a rational reason, which this model does not attempt to discover. To decrease your chances of such unpleasantness, you will have to use a more complex trading rule.

The most general knock against this type of stock is that they are boring. You will never be the centre of attention at parties because your banks & utilities portfolio outperformed the index by 3% pa over the past 10 years.

Look at the returns distribution for another type of security: lottery tickets. People are prepared to accept probable poor returns in exchange for a tiny chance of a million-bagger.

It's quite neat, actually: the stocks you don't have to agonize over so much are, to a large degree, the same stocks that will outperform.
Westford wrote: how important is it to dump the deselected stocks at the end of the year? If the last year's high yielding stock is doing well (i.e., no longer in the top 10), why get rid of it unless it is approaching a low yield where it is expensive? Would it not be wiser to hang on to it, thus avoiding capital gains and allowing reinvestment of the dividends?
This is how models get improved. Congratulations! You are now a "quant"!

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Post by Westford » 06 Jul 2005 13:18

Thanks, Shakes, I am going to mull all of this over.

Experienced investor I am not. At present I am 100% indexed , but want to move slowly into exploring individual stocks, and this strategy seems relatively simple enough so that perhaps even I may be able to manage it.

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Post by Westford » 06 Jul 2005 13:22

jiHymas wrote:To decrease your chances of such unpleasantness, you will have to use a more complex trading rule.
Yes, that is what I am still trying to figure out how to do... :?

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Post by Shakespeare » 06 Jul 2005 13:52

You can get information on how to perform more sophisticated screens at Canadian Shareowner.
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Post by DenisD » 06 Jul 2005 16:28

This is how models get improved. Congratulations! You are now a "quant"!
One of the advantages of a simple, time tested model is less temptation to "improve" it. But that temptation is always there. One thing I did when I was buying the Dogs was limit my exposure to each sector. For example, I might buy up to a maximum of 3 banks in the 10 stocks.

Who knows if it increased returns. I never compared my returns with the unchanged model returns. Once you change things, you have to take more on faith.

Now I have a more "advanced" screen. :)

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Post by gouthro » 07 Jul 2005 10:21

Hello everyone,

I'm happy to see this thread on 'Beating the TSX' as I am considering a similar approach. I am certainly no expert in investing and so, it is with a little fear and trepidation that I make this post, considering that there are people here who really do know what they are doing. But, I thought I would post it anyway as it may help others who are looking at this approach. A little more grist for the mill, perhaps. It least it will show where some of the main Canadian sites to find information on this kind of approach are. And also, so that those of you who are more experienced might correct any erroneous thinking or knowledge.

I have also followed David Stanley's portfolios in the Moneysaver magazine. It is appealing approach because you seem to be able to make a descent return without spending all your time keeping on top of stocks. You don't have the possibility of making that 'little bit more' as if you fiddle with it. But, a return like Stanley's would be good enough for me.

I have, though, had some of the concerns mentionned in this thread. Mainly concerns about diversification and the possibility of a higher return. I know that I said earlier that I liked the ease of 'The Beating the TSX' approach. But, if there was another approach that offered the possibility of a little higher return and greater diversification without too much more trouble, it might be welcome.

I have been looking at various possibilities. One is the Canadian Shareowner, which offers a gradual approach of dollar cost averaging. http://www.investments.shareowner.com/i ... ation.html The advantages here are that you can get an almost instant diversification and the possibility of building up a diversified portfolio for quite a low fee. While Stanley concentrates on largely Drip stocks, Canadian Shareowner provides access to smaller and faster growing companies, which could give a higher return. At first I hadn't liked the idea of dollar cost averaging, thinking instead that I could buy these securities when they are relatively low priced. Someone mentionned, however, that when securities have a low price there is usually a reason for it and you may be afraid to buy because of that reason. True enough.

But, then i realised that this may be more true for smaller and higher growth stocks. These are not the kind that Stanley pursues. I could stick to these large cap, relatively stable companies and possibly buy them at a discount. Another reason for buying a bigger amount all at one time and of the larger companies is that this kind of process seems to depend upon the compounding affect of dividends. This is greatly enhanced by buying a large amount at the beginning and letting the compounding dividends do their work. In my mind this would be an argument against dollar cost averging in regular drips, as well.

The nagging question of diversification and quality of companies still remains, however. Staneley's portfolio this year consists of five banks, a couple of utility companies and an insurance company.

In the June issure of Canadian Money Saver, Norm Rotherery offered another version of a drip portfolio, which might provide better diversification and better quality growth without too much more work:

''A portfolio of seven stocks does not provide adequate
diversification but this problem can be overcome by
moving beyond SPP eligible stocks. In my view, it is
more important to select good long-term stocks than
to stick with poor stocks just because they have share
purchase plans.''

Yet, Norm appears to like this kind of thing. I can imagine that David Stanley might say,'Well, I've done pretty well so far without much trouble. It is not worth it to me to change.' The beauty of all of this, of course, is that there is no one 'best way'. It depends a lot upon one's temperment and outlook. I think I would be more inclined to go with Norm Rothery's approcah.

Then there is the question of when to buy. Both Stanley and Rotherey buy at a given time. They believe that the fact that it is a high dividend approach guarantees buying at low prices. But, if you look at this list of relative high and low dividend ratios produced by Mike Higgs, http://www.dividend-growth.org/DivRepor ... 053105.pdf you will see that in May, when these portfolios were bought, many of these stocks weren't bargain-priced relative to their own ratios between high and low dividends.

What to do? Enter Thomas Connoly, who prints a newsletter and operates a website called 'Dividend Growth'. http://www.dividendgrowth.ca/pages/old_site/about.html Connoly says that investing in Blue Chip Canadian stocks is not too risky, as they usually vary only a few dollars per year. Rather than using a traditional 'Dogs' approach, Connoly seems to wait for his stocks to exhibit a high dividend and to have had a dividend increase in the last year. The seeming disadvantage to this approach in relation to Stanley's is that, if you were to build up your portfolio over several months and even years, you would have even less diversification, at least for a time, than even Stanley has.

What is the conclusion to all of this? I will buy blue chip stocks from a discount broker. That is sure. I will try to pick and choose between Rotherey and Stanley in order to get a more diversified and yet simple strategy. Although I am not sure I will follow the 'Dogs' approach. I may, like Connoly, wait for a better buying point and build up over time. But, I will buy a few, not all, of Stanley and Rothery's picks right away. I will also supplement this with a drip portfolio. I make make large contributions to the drip when I think they are down and dollar cost averaging certain ones.

thanks Joe

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Post by Shakespeare » 07 Jul 2005 10:39

Thank you for your post, Joe, which outlines the options fairly well.

I, personally, prefer to stick tolarge-cap blue chips because the risk of complete failure is relatively low and, should such a failure occur, it usually takes many years because a large-cap stock has many resources. This gives time to re-evaluate the stock and, if necessary, sell it.

If you do that, and pick stocks from the various sites you mention, you will, over time, acquire a solid family of blue chips that will offer you a growing source of income.

For further thoughts on what a diversified family of blue chips might look like, see here.
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Post by gouthro » 07 Jul 2005 11:35

Shakespeare,
thanks for the encouragement. I read your site earlier but hadn't digested the part that you indicated. I have added it to my file. Thanks for posting it.
Joe

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Post by yielder » 07 Jul 2005 11:38

Welcome aboard Joe,

Stanley, Connolly, myself, Shakespeare, Rothery, scomac & others here and at TWB2 are all doing variations of the same thing - buying blue chip type stocks when they are a bargain, ie, out of favour for whatever reason. Some focus, in different ways, on yield while others consider it along with other factors such as P/B, P/E, balance sheet quality, etc. Some of us appear to buy mechanically while some of us use these ratios to trigger more research before buying in order to confirm that the bad news that makes these stocks cheap is nothing more than near sighted focus on temporary poor earnings.

If you buy when stocks become cheap, you can't control the makeup of the portfolio. You may find that for a while you are not diversified. There is a certain amount of risk in that but it's relatively minimal considering the kinds of companies that you are buying. Over time though, you should end up owning just about all the quality blue chip stocks in Canada assuming that only a few will give you reason to sell.
But, if you look at this list of relative high and low dividend ratios produced by Mike Higgs, http://www.dividend-growth.org/DivRepor ... 053105.pdf you will see that in May, when these portfolios were bought, many of these stocks weren't bargain-priced relative to their own ratios between high and low dividends.
These stocks were not bought in May. Most were bought in early 2003 before the market turned. They were cheap then. I'll go back through my files and dig out the yield at the time of purchase or sale.

Code: Select all


                       Purchase Date

IGM Financial   	      2002-12-31
Tesma International   	2003-01-31
Thomson Corporation   	2003-01-31
Magna International   	2003-01-31
Enerflex Systems   	   2003-01-31
Canadian Western Bk   	2003-01-31
BCE Inc.   	           2003-01-31
AGF Management           2003-01-31
ATCO Ltd.   	          2003-01-31
Saputo Inc.              2003-02-28
Loblaw Companies         2003-03-31
Empire Company   	     2003-04-08
Rothmans Inc.   	      2003-04-30
Leon's Furniture   	   2003-04-30
Cara Operations   	    2003-04-30
Dofasco Inc.     	     2003-06-23
Metro Inc.   	         2003-08-06
George Weston Ltd.       2004-05-31
Caribbean Utils Ltd   	2004-10-29   
  

A few have been sold or taken private

Code: Select all


                          Sale Date
    
Cara Operations   	    2003-08-29 (taken private)
Dofasco Inc.        	  2004-07-30
Tesma International   	2004-10-29 (taken private)
Rothmans Inc.   	      2005-02-28
It's not surprising that there have been very few purchases and that they occur before the market turned bullish in March of 2003. I suspect that had the portfolio started a year earlier that there would have been more purchases. Certainly, TD would have been in the portfolio sometime during the fall of 2002.

This is the nature of this kind of investing.

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Post by Shakespeare » 07 Jul 2005 11:44

all doing variations of the same thing - buying blue chip type stocks when they are a bargain, ie, out of favour for whatever reason
And I suspect that all of us outperform by roughly similar amounts.

The TSE seems to be relatively easy to outperform by a large-cap-value approach, however formulated.
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Post by gouthro » 07 Jul 2005 11:52

Quote:
But, if you look at this list of relative high and low dividend ratios produced by Mike Higgs, http://www.dividend-growth.org/DivRepor ... 053105.pdf you will see that in May, when these portfolios were bought, many of these stocks weren't bargain-priced relative to their own ratios between high and low dividends.


These stocks were not bought in May. Most were bought in early 2003 before the market turned. They were cheap then. I'll go back through my files and dig out the yield at the time of purchase or sale.
Hello Mike,
Again, thanks for the encouragement. I don't know what happened on that post. But, I was looking at your dividend list that you send out each month. I had hoped to post the list for May of 2005 in order to show that the stocks in Stanley's buylist were not necessarily cheap, even though there was a high dividend.
Joe

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Post by Shakespeare » 07 Jul 2005 11:57

"Cheap" is a relative matter.

I don't think much is "cheap" at these valuations. Nevertheless, for very good companies held for a long time, the entry point doesn't matter that much.
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Post by NormR » 07 Jul 2005 12:56

Humm, a good thread and I've lots of comments but very little time this week. :(

So, here's a few brief comments ...

The value segment has done very well recently, try to avoid being swayed by good past performance figures.

The dividend oriented folk tend to fall into two camps. Straight high yield and high dividend growth.

It is my guess that high yield stocks will provide a long-term return 'bonus' of between -1% and 3%, depending on the period, over the index. Mind you, it is just a wild guess.

I tend to favour other value metrics (P/E, P/B, P/S, P/CF) and view dividends as a good bonus. But I'm happy to write articles on all sorts of value oriented approaches :)

Also, in my own portfolio, I'm more of an 'all cap' guy and will go where the bargains are. As a result, I tend take a more entrepreneurial approach. Nonetheless, I usually take a more defensive approach when dealing with a wider audience.

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Post by Shakespeare » 08 Jul 2005 11:08

Here is a graph obtained from David Stanley comparing "Beating the TSE" returns to index returns from 1987 to 2004:

Image

The 1999 underperformance reflects the Nortel overvaluation.
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Post by NormR » 08 Jul 2005 12:01

As per usual, my guess (-1% to 3%) appears to be wrong. Ah well, I was talking even longer term :wink:

David sent me his numbers and I looked at the results over rolling 5 and 10 year periods.

For rolling 5 year periods, the Dogs beat the TSX by...

Min -3.57%
Avg 2.59%
Max 8.58%

For rolling 10 year periods, the Dogs beat the TSX by...

Min -0.06%
Avg 2.57%
Max 5.91%

This should give some idea of the variability of performance versus changes in entry and exit dates. Go value!

:D

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Post by Norbert Schlenker » 08 Jul 2005 23:49

NormR wrote:For rolling 5 year periods, the Dogs beat the TSX by...

Min -3.57%
I don't have the numbers. I'm just eyeballing Shake's chart above. 1995-1999 inclusive looks worse than -3.57% to me. I also note that the entire 2000 and half the 2001 outperformance are erased if one uses the TSX capped composite. (I'll be fair: The 1999 underperformance is overstated by a few % on that same basis.)
Go value! :D
It's admittedly pretty impressive. Will it hold up through the next fashion change? :wink:
Nothing can protect people who want to buy the Brooklyn Bridge.

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Post by yielder » 09 Jul 2005 00:06

NormR wrote: The dividend oriented folk tend to fall into two camps. Straight high yield and high dividend growth.
Excellent point. I try to hold both, eg, I'll own EMA along side L. I'll even own stocks that don't pay a dividend but have all the characteristics that I look for in a dividend stock, eg. ATD.SV.B

There are a few that have reasonable yields and high growth - GWO, IGM.

I'm an all cap guy as well but I'm also a bird-in-the-hand guy as well. I will rarely buy a stock that doesn't have a record of paying sustainable dividends.

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