Today we’re going to talk about dividends.
This is a very a popular topic right now and it’s heating up as more investors around the world search for places to pick up some yield. There won’t be much jargon today, I’m just going to tell you some stories about why I like stocks that pay dividends.
Love at first sight
I think I’ve told this story before but my first real job in this industry was at UBS PaineWebber. I interned with a couple of muni bond pros there and they showed me the ropes of retail finance. I got to use an empty corner office on the 30th floor of Century Park East and watched the sun rise every morning over a hazy downtown L.A.
I was hooked for life.
This was during the dot-com bubble and my first day of work was in March of 2000 — literally at the peak of the market. I was excited to have a cool job. But no single person at any point in history has ever been as excited about a single thing as Jim Cramer was about technology stocks. Back then, people took “Dow 36,000″ seriously. It was a new dawn. It was a gold rush.
Once I was hired and getting paid to follow this stuff every day, the market just went down and down and down. The gold rush was over. Jim Cramer was wrong. And this had a profound effect on my own psychology. My first professional experience in the market was not how much people could make as investors, but how much they could lose. Now you guys all know why I’m so messed up!
But it actually wasn’t so bad. In fact it was a good thing. In retrospect I’m not sure there was a better time or place to get started in this business. Framing every aspect of investing in terms of risk is hardwired into my psyche. I can’t not do it the way kids of the great depression couldn’t not pick a penny up off the sidewalk. The way polyester-suited bond guys from the 1970′s can’t not freak out about The Inflation.
The experience was a major lesson for a naive kid looking to survive in the business. Soon after that I would come to an even greater realization. In the years after the dot-com blowout we would have the accounting scandals. This was where some of the “Big 5″ accounting firms were revealed to have engaged in shady dealings, falsifying the financial positions of companies like Enron, Adelphia, and Global Crossing. The financial data that investors thought was audited and legit was nowhere near the truth.
This was huge. Huge.
It rocked me to my core.
As a student of accounting at UCLA, someone whose peers all dreamed about landing a job with a Big 5 Firm after graduation, I took it personally. These scandals were a violation of trust, another deep wound that would never heal.
Every quarter, every publicly traded company reports its financial results. And I have a really hard believing most of it. Sure reading a balance sheet and an income statement can be handy for this or that. If you have some investments to sell or have to manage a portfolio and need to plug something into your spreadsheets, it works. But this data is self-reported and it’s supposedly verified by auditors from Wall Street, a culture that has violated public trust so frequently and so egregiously the only rational response is laughter.
Sarbanes-Oxley was supposed to fix this, to repair our trust in what these big businesses tell us. And for a while, it did. But then came Lehman Brothers and the infamous Repo 105 stuff. We thought we knew where AIG stood, but the reality was a bigger nightmare than we ever might have fathomed — they had a AAA rating! Then there was the rampant fraud in the mortgage industry to say nothing of all the debt securities they backed. A lot of people mistakenly thought we were supposed to be protected from all this stuff and that we could take all this information from these companies at face value.
This time, my response was laughter. ”Now there’s the financial industry I remember.” In case you are wondering, Dodd-Frank isn’t going to save us either.
Before you write me off as a damaged-goods conspiracy theorist, know that it isn’t all bad. In fact, most of this data is actually pretty good and can be trusted. The overwhelming majority of companies are honest. But there does exist an alignment of incentives for CFO’s to goose shareholder value any way they can, so long as it’s within the letter of the law. (Don’t even get me started on FASB.)
Ultimately, one thing helped me make peace with the realities of this untrustworthy world. The things that companies tell me are fine, but what’s infinitely more important are the things that a company does. Actions really do speak louder than words.
It was a simple thing that brought me peace of mind… “show me the money.”
Brother, you got to yell that shit!
SHOW ME THE MONEY!!!
This was what got me excited about fundamental analysis once again. And how do publicly traded companies show you the money?
They pay you dividends.
Show! Me! The! Money!
Who’s your motherfucker, Jerry?
A company that pays significant dividends — especially companies that raise their dividends year after year — is signalling to you that their financial condition is strong. Their business is making money and they are generating enough cash flow to support those dividend payouts. If they feel confident that they’ll grow and generate more cash in the future, they’ll raise that dividend. Cash is King, remember?
Another thing about companies that show you real dividends is that their earnings have to be predictable and stable. Businesses that wildly swing from profits to losses can’t afford to reliably pay out dividends, or can’t without borrowing to finance them.
Dividends can also be a good leading indicator. When a company is sinking, the dividend is usually the first thing to go. This is why dividend cuts are such a huge deal and reviled by shareholders. When a company cuts its dividend it’s like a gigantic blinking red light that says “UH OH!” The cockroach theory applies. Watching a company cut its dividend is like seeing a cockroach crawl out of the wall and scuttle across the floor. It’s not a pretty sight, but what’s worse is knowing that where you see one cockroach there are many more lurking behind the wall.
Remember when Citigroup famously slashed its dividend in early 2008? Their stock took a beating after that announcement but on that day you still could have sold out for $27 a share. Crazy. Now we know that they had a pretty serious cockroach infestation.
If you are going to adopt one hard and fast rule when it comes to dividends, it’s to buy these companies with the intention of holding them forever but to immediately divorce yourself from them if they ever cut that dividend. Yes, owning a portfolio of dividend stocks is a lot like a marriage; the true benefits accrue over the long haul and sometimes you need a little faith to get through the day-to-day movement of the market. But if a company fools around with that dividend, that cornerstone of trust in our relationship, I consider it an act of infidelity.
Respond with haste and decisiveness.
L.A. cinephiles know that Neil McCauley was a straight up bad ass. A sensitive bad ass, but few in the modern crime canon were as disciplined as he. And you know what Neil McCauley would say. He would say, “don’t let yourself get attached to anything you are not willing to walk out on in 30 seconds flat if you feel the heat around the corner.”
Those are words of wisdom when it comes to designing and managing an investment portfolio. And they are doubly relevant when it comes to dividend stocks. If you feel the heat coming around the corner, if you see them monkeying with that dividend, then you sell ‘em and move on.
One last thing
Dividends have been out of fashion for a long time. Basically as long as I’ve been in the industry. In 1999 somebody called up Jim Cramer and asked him about Johnson & Johnson’s 4% dividend yield. He cackled maniacally and said put all of your money in Pets.com!!
*Maybe he didn’t actually say that, but whatever. The point is still the same: dividends haven’t been cool for a while. Now they are cool and now you understand why. Investors of all shapes and sizes around the world are starving for investments with good yields that they can count on.
It’s a new dawn!
Venture forth, grasshopper
OK. It’s entirely possible that after reading this article you are really fired up about dividend stocks. I will admit, I got a little fired up while writing this.
So maybe now you want to go read our Seeking Alpha article on a neat dividend strategy. But only phase two of that strategy is relevant now. The little market correction is now underway. So now just hang out in cash as the market runs its course and then go shopping. I like to do my buying on dips for tactical reasons, but if you are a long term investor, things like this don’t matter quite so much.
It’s good stuff. Talk to your financial advisor about it. He probably likes dividends too and probably has some more good ideas about how to pick up some yield you can count on.