, , , , , , , ,

Continued from here.

OK, so what’s wrong with a focus on income/dividends?

– Erm, everything..? I wrote about this recently – a focus on a single investment attribute’s always dangerous, but dividend yield certainly seems the v worst of the bunch to me. Sure, it all starts out innocently enough… You have a little toke on a 4% yield occasionally – feels good! But all too soon, it’s not enough – you end up calling your broker every single day, snorting up 6% yields left and right. But it’s OK, it’s low risk, you still know what you’re doing – not like those other losers… So how come I came across you the other day, twitching on a park bench, scanning the dividend column in the FT, muttering ‘All I need is just one more 9 per-center…‘?

– A ‘good‘ dividend yield can’t save a bad share. I wonder how much money’s been lost by people saying ‘…but hey, it’s got a great dividend…‘? All higher yields mostly seem to offer in a portfolio is a gradual migration into mature and/or declining businesses. And what does that offer in terms of upside?! Even worse, it leaves nowhere to hide when the dividend’s compromised – your income drops, and the share price crashes…

– I looked at Supervalu Inc. (SVU:US) recently, a (perpetual) falling knife too many (value) investors felt compelled to try catch. Many highlighted the sweet 6.6% dividend yield – not so sweet now, with the company recently announcing a suspension of their dividend. See the chart? No, that’s not a 2-for-1 stock split, the stock actually dumped 49% on their news… Reminds me of Avon Products (AVP:US) – the only trace of lipstick left here is a 6.0% yield. But the dividend’s consumed the last 5 years of free cash-flow (ignoring M&A and share repurchase, so net debt’s actually tripled), and now they’ve a new CEO & CFO on board. So how much longer can that dividend last? And even if the dividend survives, by some idiotic miracle, how will that improve AVP’s prospects? Appears investors may lose out either way…

– And the people who fall in love with dividends are generally the very folks who can’t afford those kind of losses. They’re also the people who often seem the most vulnerable (we never hear about low P/E investors being targeted & shafted!). ‘Cos every scumbag (criminal, or simply civil) loves an investor who’s just looking for a steady return..! Let’s just stick to the legal stuff (but the FINRA site‘s fun to read…not that they ever get near the real baddies): Take another look at listed US REIT/MLPs (don’t dare look at the unlisted stuff, you’d throw up!) – how many fund some/all of their dividends out of loans/capital/share issuance? Do that with enough scale & deceit, and you’re more than ready for a Ponzi scheme..! 

– Far too often, a high dividend’s presented as low risk & sustainable. In reality, it means share dilution, increased leverage, a return of capital, or simply an impairment of the company’s growth prospects – or all of the above! And shareholders buy into this crap. Sometimes they keep buying more…

OK, we’ve covered the taxation issue, and (various forms of) exploitation, but still many investors just can’t get enough dividends. What other possible reasons can there be? Let’s rip right through these:

Many investors want/need an income:   Really? If you’re gainfully (self-)employed/not retired, what on earth are you doing with the dividends? Spending them, or paying tax & buying equities with the net proceeds?! Sigh, I just can’t help you, mate… But if you really do need spending cash, why the obsession with dividends – perhaps you just like a good shellacking from the tax-man? As I’ve pointed out, he much prefers 20 quid of income than capital gains. Whereas nobody else cares – ask the vicars, ask the tarts…money is money! So if you need some cash, a judicious sale now & again from your portfolio is far more attractive.

Many investors don’t want to eat into their shares/principal:   Again, really?! Are you one of those people who does their monthly budgeting via eight different piggy banks? This is a psychological crutch, or a delusion – I’m not sure which! And it’s so ludicrous, it’s probably quite prevalent… In terms of return (forget taxes for a minute), who really cares whether it comes from dividends or capital growth? It’s your money either way – dividends are not ‘free money‘, or a license to spend them blindly. You should be a) either trying to maximize the compounding of your portfolio, or b) trying to determine an appropriate portfolio withdrawal rate based on actual/estimated total returns.

– We already covered a), while if it’s b), dividends are irrelevant to that decision process. At a minimum, ideally, you want to maintain your portfolio in real terms – this means your withdrawal rate cannot exceed any actual/estimated portfolio return in excess of inflation. So, if you expect/are getting hosed with losses, should you be blindly spending your dividends? No, of course not! And if you’re doing well, you’re just selling off some excess principal. The silliest notion is clinging to X number of shares – look to the (rising) monetary value of your holdings instead.

A (rising) dividend signals management confidence:   What is this, some strange kind of kabuki theatre? Or Kremlin watching? I prefer to pay as little attention as possible to what management says or signals, anyway… Most people learn this eventually in the corporate world – look at what your leaders/HR do, not what they say, sometimes they’re two v different things..! But many somehow neglect to apply this lesson in their investing. There’s far too much corporate spin coming from most management teams – far safer to just focus on the actual results they deliver over time.

– If you still insist on interpreting a company’s prospects via the prism of its dividend, you just might be misleading yourself, or you’ve been forced into it by a management who can’t/won’t communicate clearly with you, the shareholder. Neither bodes well…

Cash dividends (now) are better than future reinvestment gains:   We don’t need to argue about this one – this may v well be true! So why are you investing in this company anyway?! You’re essentially saying this is a mature/low growth company and/or it’s in an industry with poor growth prospects. Surely you can find a better investment? You also seem to be suggesting you don’t trust management so much… Which leads to:

Low/zero dividends encourage management to waste capital:   Again, I don’t necessarily disagree – all too often, management will piss your money away the minute you turn your back. Because every mediocre junior/middle manager quickly realizes empire-building, however petty, is the key to advancement & success. Consider how much they’ve mutated if they ever manage to make it to the top: Mini-Genghis Khans riding into battle with a f**king Blackberry & a hole punch. So if that’s what’s worrying you, again I ask, why are you investing in this company anyway?! There are better companies, and management, out there…

OK, so dividends kinda suck…but what’s the alternative? We’ll take a look in our next dividend post.