How Lazard's Philipp Hofflin uses 150 years of data to find the best ASX income stocks

One of the biggest challenges investors face today is figuring out what is real, what is noise, and where things sit in a historical context.

We’re all busy and while we all love investing, unless we do it as our profession, it’s only one of the many parts of our lives. Subsequently, we’re often consuming information only at the headline level and – take it from someone in the business of writing appealing headlines – that can be dangerous.

No one could accuse Lazard Asset Management’s Dr Philipp Hofflin of operating at the headline level. He has spent nearly 30 years in markets and has interrogated data spanning the last 150-200 years.

If ever there was someone capable of providing the appropriate context for value and income investing today, Dr Hofflin is our man. We recently sat down as part of Livewire’s 2024 Income Series. Below is a summary of the key points, but I strongly suggest watching the video for the full experience.

The state of the market

In my opening gambit, I put it to Hofflin that the 12-month forward yield of the ASX 200 is now below 4%, while the average since 2005 has been around 4.7%. I should have known better.

The market isn’t that expensive and dividend yields are only slightly below long-term averages when considering the full, 150-year history, according to Hofflin (see, context matters).

If we end up getting a recession, historical evidence tells us that dividend income will be lower by about one-third, says Hofflin, and that it takes about 5-6 years to get from peak, to trough, and then back to the peak in such a scenario.

“So there's no doubt downturns hurt. At the same time, they're not the end of the world. You always get back to your peak, and you keep on going after that, and you get increases.

“In fact, in the very long run - again 150 years in Australia - dividends have grown by 5% per annum, which is a very nice number", says Hofflin. 

What makes for a great income stock?

Lazard looks for three key factors when considering income stocks with a sustainable dividend for the portfolio. They are;

1. A sustainable payout ratio – You don’t want a company that pays out an unsustainably high level of dividends, because every company needs some money to grow and if they’re paying it out, they’re running down the assets.
2. An appropriate level of gearing – Is the company too geared? If it is, that’s not sustainable.
3. Earnings sustainability – Can the level of earnings be maintained in future periods?

There is one more hurdle that a stock must clear, however.

“We will not buy a stock if it doesn't have capital upside” says Hofflin, adding that “Just because the dividend is nice, it doesn't mean that you want to lose money on capital. 

We do not want to trade those two off”.

Overweight/underweight

As of 30 June, the Lazard Defensive Australian Equity Fund held some significant sector overweights and underweights, and I was keen to get Hofflin’s thoughts on the positioning.

Significantly underweight financials

At a headline level the portfolio is underweight financials but “it's composed of a big overweight in insurers and an underweight in the major banks”, says Hofflin.

The reason for this? 

Over the last year, earnings estimates for banks fell 8%, according to Hofflin, “so more than a hundred per cent of the price gains were, in fact, just multiple”. 

For insurers, they were plus 15%, “so a fair whack of the price gains were, in fact, backed by higher earnings”, says Hofflin.

Underweight materials

Whilst cyclical and traditionally not the best dividend stocks, the big miners have paid some hefty dividends in recent years and are expected to again this year. 

The Lazard portfolio is significantly underweight and Hofflin explains that this is to balance the overweight in energy. He also adds that it is always important to be in strong companies with very strong balance sheets and very low costs, “because you need to be able to survive the difficult times to be there for other times when they get better”.

Of the companies that Lazard does hold in the space, Hofflin mentions Rio Tinto (ASX: RIO), Whitehaven (ASX: WHC), Nickel Industries (ASX: NIC), and IGO Limited (ASX: IGO).

Overweight energy and consumer stocks

According to Hofflin, the overweight in energy is all about valuations and he cites Woodside Energy (ASX: WDS) as the poster child for the opportunity. Below is his thesis;

"Woodside trades on a 15% cashflow yield. Now, we have much more conservative prices. We’re value investors. We like to have a margin of safety. But even on that it's a 10% cashflow yield. That's a very good starting point.

The full dividend is about 6% fully franked. So it's 8% gross. That's not bad either. It has a phenomenal balance sheet. Cost of production is $15 a barrel or equivalent - so incredibly low. They always make money in a cash sense and they are, of course, in exactly the right place for the Asian gas opportunity”

By far the largest attainable decarbonisation opportunity on the planet is substituting gas instead of coal in Asia and in China in particular", says Hofflin. 

As for consumer stocks, Hofflin likes the “bread and butter” names like Coles (ASX: COL) and Metcash (ASX: MTS), but he also likes Collins Foods (ASX: CKF) and, more recently, Domino’s Pizza (ASX: DMP) – which has become appealing after the share price fell circa 75%.

“Fast food or quick service restaurants are very defensive economically”, says Hofflin.

“If you go back to the US and you look at the large fast food operators there through the GFC, which was a crunch of a consumer recession, you can't see it because what happens for those players is people trade down because they're the cheap alternatives”.

View from the Top

As for Hofflin’s View from the Top? Well, you’ll just have to watch the video. But it’s safe to say it’s not to be missed. 

Managed Fund

Lazard Defensive Australian Equity Fund

Australian Shares

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