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Is Your Dividend Income Protected by a Moat?

Posted: Fri Feb 04, 2005 4:12 pm
by peteyperson
If there was any strategy that might be considered a push-button exercise in investing, selecting a stock for a long, attractive dividend record ought to be it. Combine decades of consistent payments, predictable dividend increases and a decent yield, and what could be left worry about?
The trouble is that this investment case isn't yet complete. While the dividend adds an impressively sharp tool to the investor's toolbox, it isn't enough to buy a stock based on its dividend history alone. It's still critical to obtain one more characteristic of a well-chosen investment: an economic moat.

http://news.morningstar.com/doc/article ... tion=Comm1

Petey

Posted: Fri Feb 04, 2005 6:14 pm
by JWR1945
I am hesitant when I read the word moat. I remember that everything that was in a Motley Fool Risk Maker or Risk Breaker portfolio had an overwhelming moat when recommended. Those moats had a habit of disappearing overnight.

Still, the quality of dividends is critically important. We should always look into other value indicators and financial strength.

The writer is right: a long history of dividends is not enough. There must be the earnings power to pay for them well into the future.

Have fun.

John R.

Posted: Sat Feb 05, 2005 2:01 am
by hocus2004
Here's a link to a post from the Motley Fool's Dividend Growth Investing board:

http://boards.fool.com/Message.asp?mid= ... t=postdate

emiller8988: "When you look at people who go to church... those who tithe a regular amount do not have near the financial problems as those who do not. The more optimistic among the holy flock point to this as indication for divine blessing. The more earthly explanation is sadly less celestial. People who are able and willing to part with a small portion of their earnings are better money managers in the first place and more carefully marshall their finances. "

I think that this guy makes a cool argument. He is saying that the fact that a company pays a dividend is a sign that it knows how to manage its money. Intuitively, you would think that a company that pays a dividend would have less cash available for growth of the business. He is saying that just the opposite may be so. Companies that know how to manage their money well just end up with more money, leaving them with more to invest in the business even after they cover the dividend payment.

I am not saying that I buy into this 100 percent. But I think this is an interesting way to think about the dividends question.

Posted: Sat Feb 05, 2005 4:06 am
by unclemick
Seems like every generation rediscovers what it already knows. Bogle often goes back to Bachelor's 1900 paper. Ben Graham thought the market valued dividend dollars more than earnings dollar.

Petey put some interesting links up recently - divining the charts - you might come to see the changing trends Thornburg Investments sees.

Posted: Sat Feb 05, 2005 4:23 am
by peteyperson
Excellent quote.

I somewhat agree and somewhat disagree. It does depend on what stage the company is in with regard to growth opportunties. Good management can retain free cash flow and use it productively for growth rather than pay some of it back to shareholders who then pay tax on it each year. This reduces their net real return over time. The same quality managers may later decide between share buybacks (again a more tax-efficient use of funds), retiring debt which will increase future free cash flow & increase the security of the balance sheet, or pay funds out as a dividend. The last option, the dividend, is the least preferable.

It is true that it does add an additional layer of corporate responsibility when a company is paying out a high dividend, possibly selecting more carefully between a range of expansion opportunities rather than investing in all of them when a more careful analysis would have shown some to substandard and a poor use of investors' capital. However whether a high dividend stock investing strategy gets ahead of the S&P 500 after taxes are taken into account is in question. also the majority of higher dividend payers have their faster growth days behind them and so it is more likely that their earnings growh rates will not match the average 5% growth in the S&P 500 and the net additional return from the higher dividend may not overcome this to come out ahead. For those FIRE investors seeking higher income but similar returns to the S&P, this not be of much concern though. ;)

As to the other assertion that the market values companies that pay dividends more than those that don't, that would be a) illogical and b) Warren Buffett invests predominantly in companies that do not pay a dividend wherever possible for the reasons I cited above. His results haven't suffered for this preference and in fact have benefitted with higher compounded returns. Clearly a dividend is useful in FIRE planning but I don't think for most people who select some individual stocks that that will comprise a large part of their diversified portfolio and so it is pretty immaterial to portfolio income levels overall. Adequate allocations to real assets boost the portfolio yield sufficiently anyway. The market over reasonable timeframes revalues companies based on their rising earnings. I would not be surprised to discover that over the shorter-term, companies benefit from more market action due to being dividend payers. With a diversified portfolio however, I'm focused on long-term returns and not short-term ones.

Petey
hocus2004 wrote:Here's a link to a post from the Motley Fool's Dividend Growth Investing board:

http://boards.fool.com/Message.asp?mid= ... t=postdate

emiller8988: "When you look at people who go to church... those who tithe a regular amount do not have near the financial problems as those who do not. The more optimistic among the holy flock point to this as indication for divine blessing. The more earthly explanation is sadly less celestial. People who are able and willing to part with a small portion of their earnings are better money managers in the first place and more carefully marshall their finances. "

I think that this guy makes a cool argument. He is saying that the fact that a company pays a dividend is a sign that it knows how to manage its money. Intuitively, you would think that a company that pays a dividend would have less cash available for growth of the business. He is saying that just the opposite may be so. Companies that know how to manage their money well just end up with more money, leaving them with more to invest in the business even after they cover the dividend payment.

I am not saying that I buy into this 100 percent. But I think this is an interesting way to think about the dividends question.

Posted: Sat Feb 05, 2005 4:55 am
by JWR1945
When academics first addressed dividends, they assumed without looking into the evidence that dividends were harmful, that they took money away from growth.

Only later was it discovered that the opposite is true. As a rule, but not always applicable to specific companies and in specific situations, dividends are a surplus brought about by sound management. After management funds everything that makes sense for internal growth, it sends what is left over to shareholders. Superior management does not squander money on inferior projects.

It is not always true that dividends are the product of sound management. At times, as the Morningstar article indicates, inferior management uses dividend policy as a bluff. We can all think of cynical reasons as to why they might do so.

Have fun.

John R.

Posted: Sat Feb 05, 2005 5:53 am
by peteyperson
Actually after funding what growth makes sense, it then makes the most sense to repay all company debt and then to repurchase company shares if they are trading at what the management believe is either a fair value or a discount. Both of these are still preferable to taxable dividends on a total return basis. Indeed this is what TimberWest did last year when it had excess cash from the timber harvest in excess of the cash needed to pay the fixed stapled unit dividend distribution. This in turn boosted the share price as the company. The value of the company would have been boosted with the cash on the books, but this makes them a safer investment and a more profitable one in the future. This then becomes a happy self-repeating cycle of improvements. The market price moved up.

I do feel that this kind of prudent management action isn't the norm.

Petey
JWR1945 wrote:When academics first addressed dividends, they assumed without looking into the evidence that dividends were harmful, that they took money away from growth.

Only later was it discovered that the opposite is true. As a rule, but not always applicable to specific companies and in specific situations, dividends are a surplus brought about by sound management. After management funds everything that makes sense for internal growth, it sends what is left over to shareholders. Superior management does not squander money on inferior projects.

It is not always true that dividends are the product of sound management. At times, as the Morningstar article indicates, inferior management uses dividend policy as a bluff. We can all think of cynical reasons as to why they might do so.

Have fun.

John R.