Wells Fargo and the perverse power of incentives

Wells Fargo (WFC) is mired in a scandal of its own making that revolves around the perverse power of incentives. The U.S. bank’s problems reminded me of a famous lecture that Charlie Munger gave in 1995 on the psychology of human misjudgement. Mr. Munger’s speech is well worth listening to. You can do so on YouTube or read a transcript online. Mr. Munger points out that the impact of incentives is often underestimated. He says, “I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.” I suspect that the latest Wells Fargo scandal came as another surprise to the 92 year old. While I won’t go into all the gory details, CNN reported that the bank recently fired more than 5,000 employees for allegedly opening a slew of phoney customer accounts in an effort to meet aggressive sales targets. Subsequent reports have been even more damning because, it is alleged, that some employees alerted management to the problems via an internal “ethics hotline” only to be fired shortly thereafter. If true, the behaviour reflects very poorly on the bank and its managers. It also demonstrates some of the problems that can occur when incentive systems run amok. (In this case it seems likely that several factors combined to amplify the problems at the bank.) Incentives can also cause havoc in many other fields. For instance, The Atlantic reported this week on a study that “shows how the incentives of modern academia naturally select for weaker and less reliable results.” Gulp! Naturally, the media and politics are prone to similar issues. But I doubt that even Mr. Munger, being merely human, would be able to provide a full explanation for this year’s presidential race.

Safer Canadian Dogs

Investors following the Dogs of the Dow strategy want to buy the 10 highest yielding stocks in the Dow Jones Industrial Average (DJIA), hold them for a year, and then move into the new list of top yielders. The Dogs of the TSX works the same way but swaps the DJIA for the S&P/TSX 60, which contains 60 of the largest stocks in Canada. My safer variant of the Dogs of the TSX tracks the 10 stocks in the index with the highest dividend yields provided they also pass a series of safety tests, such as having positive earnings. The idea is to weed out companies that might cut their dividends in the near term. Just be warned, it’s a task that’s easier said than done. Here’s the updated Safer Dogs of the TSX, representing the top yielders as of September 15. The list is a good starting point for those who want to put some money to work this week. Just keep in mind, the idea is to hold the stocks for at least a year after purchase – barring some calamity.

Name	Price	P/B	P/E	Earnings Yield	Dividend Yield
Power Corp (POW)	$27.42	1.04	11.2	8.93%	4.89%
CIBC (CM)	$101.64	1.86	9.84	10.16%	4.76%
National Bank (NA)	$47.31	1.67	13.59	7.36%	4.65%
Shaw (SJR.B)	$26.09	2.12	9.45	10.58%	4.54%
BCE (BCE)	$60.48	4.22	19.14	5.22%	4.51%
Emera (EMA)	$46.91	1.98	14.46	6.91%	4.46%
TELUS (T)	$42.13	3.09	17.63	5.67%	4.37%
Bank of Nova Scotia (BNS)	$70.06	1.66	12.31	8.12%	4.22%
Royal Bank (RY)	$81.36	1.93	11.83	8.46%	4.08%
Bank of Montreal (BMO)	$85.63	1.47	12.69	7.88%	4.02%

Source: Bloomberg, September 15, 2016 Notes Price: Closing price per share P/B: Price to Book Value Ratio P/E: Price to Earnings Ratio Earnings Yield: Earnings divided by Price, expressed as a percentage Dividend Yield: Expected-Annual-Dividend divided by Price, expressed as a percentage As always, do your due diligence before buying any stock, including those featured here. Make sure its situation hasn’t changed in some important way, read the latest press releases and regulatory filings and take special care with stocks that trade infrequently. Remember, stocks can be risky. So, be careful out there. (Norm may own shares of some, or all, of the stocks mentioned here.)