Dividends Are Dumb

Dividends Are Dumb

By Anand Chokkavelu, CFA
February 26, 2010

Question everything.

It's a good motto if you ever find yourself in a government-conspiracy movie. And it'll also serve you well any time money's involved.

The folks who question seemingly self-evident principles can make an absolute killing.

* Ask the Super Bowl bettors who took the so-called suckers' bet of the Giants over an 18-0 Patriots team.
* Ask hedge fund manager John Paulson, who made more than $10 million a day in 2007 ($3.7 billion total) because he figured out housing prices could actually fall.
* Or ask some guy named Craig who questioned the virtual monopoly that newspapers had on classifieds (yes, that's a craigslist reference).

So when I heard the argument recently that dividends are actually a bad thing, I was willing to listen.

In fact, it's a more compelling argument than you may think.

These dividends are just dumb
Why do we invest money in a company? Ultimately, it's because we think that company can grow our money by using that money to invest in its growth.

When a company turns around and gives us that money right back (creating a taxable event in the process), it defeats the purpose. If we want out, we can simply sell our shares. And do so on our own timetables.

Hence, anti-dividend people maintain that even the modest dividends that companies like Halliburton (NYSE: HAL), General Electric (NYSE: GE), and Microsoft (Nasdaq: MSFT) pay out are just plain dumb.

But hear them out. The case against dividends gets stronger given the reason folks buy dividend stocks in the first place.

Frequently, investors who buy shares of companies that pay large dividends are seeking safety and stability. Why? Because a company that commits to a regular dividend payment is signaling exactly that -- safety and stability.

So it's ironic that a dividend can act like debt -- an obligation that makes the bad times worse. Although paying dividends is optional (while missing debt payments leads to bankruptcy), a company that chooses to cut its dividend signals weakness, often leading to a further weakening of its stock price. That's a double whammy no investor wants to face.

Yet I still heart dividends
So why am I still bullish on dividend payers?

I'll leave aside the empirical evidence that dividend payers have handily outperformed non-payers historically. Instead, let's look at a company's life cycle.

Early in a company's history, it feeds on cash like a baby sucks down formula. Investors don't care, though, because the company needs that capital to fuel its growth. Soon enough, that company either fails or becomes bigger and stronger.

At some point, it starts producing more cash than it's consuming. It can then build a war chest to ensure its survival through good times and bad.

But then what? If there aren't any compelling internal opportunities, a company has four choices:

* Sit on the cash.
* Buy back shares.
* Make acquisitions.
* Pay dividends.

When you look at all four options carefully, dividends make a heck of a lot of sense.

Dividends stand alone
Sitting on cash is safe, but it’s a drag on a company's return on capital -- especially when interest rates are hugging 0%. Apple's (Nasdaq: AAPL) chosen this path, hoarding more than $20 billion. But few companies have the amazing innovation-driven growth that can hide this drag.

Buying back shares is almost like a dividend with no tax consequences. In fact, if a company can buy back its stock at low points, it can really juice returns to current shareholders. Unfortunately, most managements don't do a good job of timing. Even Goldman Sachs (NYSE: GS), the reputed master of the markets, made massive repurchases of its stock throughout the heady bubble years only to have to sell new stock to raise cash when its stock price was hammered. Classic "buy high, sell low" behavior.

Acquisitions are the scariest of all. You see, management is often judged on its ability to grow the business, specifically earnings per share. That's why they’ll buy back shares at inopportune times. And that's why they'll pursue ill-advised acquisitions and poorly conceived internal projects with such gusto. This growth at an unreasonable price helps management but hurts shareholders.

Which leads to the reason I love dividends. The issuance of a regular dividend instills management discipline by removing some capital from consideration. You can't waste what you can't touch.

Meanwhile, as shareholders, we get a nice income stream ... the classic stock play that yields like a bond.

With 10-year Treasury bonds currently yielding just 3.6%, dividend stocks are that much more attractive. Because of this, let me share three dividend plays that the dividend hounds at our Motley Fool Income Investor newsletter have identified and recommended.

Company/Description/Dividend Yield

Paychex (Nasdaq: PAYX)/America's largest payroll processor for small and medium-sized businesses/4.1%

Clorox (NYSE: CLX)/Maker of Clorox bleach, Glad trash bags, Kingsford charcoal, and Pine-Sol/3.3%

Philippine Long Distance Telephone/The Philippines' leading fixed and mobile telecom provider/4.9%


http://www.fool.com/investing/dividends-income/2010/02/26/dividends-are-dumb.aspx

How Rich Investors Stay Rich

How Rich Investors Stay Rich

By Motley Fool Staff
February 9, 2010 |

Ever wonder how rich folks trade?

I don't mean hedge funds and the like. I mean the real rich, people with inherited wealth who don't have to spend their days huddled over computers in order to earn a living. They can hire the best help and advice out there -- they must be cleaning up, right?

Pick up any issue of Barron's, and you'll see a few ads for trading "services" -- tutorials, tip services, gurus, etc. -- that promise spectacular results for those who apply themselves to learning the art of short-term trading. If those sorts of things are available to every Joe and Jane on the street with a few thousand bucks to spend, what do you think the really rich folks are doing?

I'll tell you what they're doing: Nothing.

The real secret of trading
Here's the real secret of trading: Most people who try it lose money. That was true a decade ago, when Brad Barber and Terrance Odean, business school professors at the University of California at Davis, published an important study showing that frequent trading was "hazardous to your wealth." If anything, it's even truer nowadays, with new technology giving professional traders an overwhelming advantage over individuals.

So why do ordinary investors do it? Barber and Odean concluded that overconfidence was a key factor -- people overestimated their ability to pick market-trouncing stocks. But I think there's another factor at work, one that comes to light when you compare the trading behavior of people who are building wealth with those of the folks who already have wealth: Simply put, some people are trying to wring more from the market than it has to offer.

Motivated by stories of outrageous returns, these folks aren't content with turning their $100,000 nest egg into a million over 20-plus years. They want to do it by next year. They look at how stocks like Apple (Nasdaq: AAPL) and Baidu (Nasdaq: BIDU) have done in the past five years and want to find the next big growth stories. And so they take the courses and subscribe to the trading tip lines. And usually, they end up underperforming their neighbor's index fund by several percent -- if they don't manage to lose all their money.

Meanwhile, over on Easy Street ...
By now, it should be clear that the "trading secret of the super-rich" is to trade as little as possible. Most rich folks are just buying and holding. And often, they're holding for decades. We know of one wealthy family whose stock portfolio consists entirely of just a short list of blue-chip stocks.

Most of their stocks were inherited from an ancestor who simply bought stock in the companies he admired and did business with a couple of generations ago. The dividends paid by these companies provide a great income stream, and as long as that income stream continues, the family won't have any incentive to sell. That's their complete stock investment strategy. In fact, it's entirely possible that the family's descendants will still hold the same stocks 50 years from now.

But what about us?
Sitting on Grandpa's dividend-paying stock portfolio is a fine approach if your goal is to preserve wealth and generate an income stream. And building your own is a pretty good approach if you want to build wealth, particularly if market volatility makes you nervous. How so? Instead of taking those dividends as income, reinvest them -- use them to buy more stock.

The practice of reinvesting dividends can turn boring performance into market-beating returns, partly because dividend-paying companies tend to be stable and mature. At first glance, that may appear to be a mixed blessing: good because they're much less volatile in choppy markets, bad because they're less likely to rocket to 10-bagger levels of return.

But even relatively safe dividend-payers can grow over time. Just take a look at these companies and their track records of making payouts:

Stock 20-Year Avg Annual Return Current Dividend Yield Consecutive Years of Higher Dividends

Coca-Cola (NYSE: KO) 11.5% 3.1% 47 years

ExxonMobil (NYSE: XOM) 12.1% 2.6% 27 years

Johnson & Johnson (NYSE: JNJ) 13.7% 3.1% 47 years

Intel (Nasdaq: INTC) 15.6% 3.3% 6 years

Stanley Works (NYSE: SWK) 10.8% 2.5% 42 years

Source: Yahoo! Finance.

When you combine top payouts with the power of dividend reinvestment, a well-chosen portfolio of dividend-paying stocks has a great chance of outperforming the market over the long haul.

In the meantime, if you're tempted to pore over your stock holdings every minute, do yourself a favor -- don't. You may be surprised how much better you do as a result.


http://www.fool.com/investing/dividends-income/2010/02/09/how-rich-investors-stay-rich.aspx

The 5 Rules Every Income Investor Has to Know

By Carla Pasternak Wednesday, February 10, 2010


http://www.investinganswers.com/lesson/5-rules-every-income-investor-has-know-1057