Dividends, Yes. Yields, Not So Much

February 17, 2012

What can a common thief tell us about investing?

 

Dividends are great in and of themselves. (See our recent post on dividend yields.) Dividing them by another quantity, such as the price of the underlying stock, is a distraction at best and misleading at worst.

The S&P 500 came up with an easily calculable set of presumably desirable stocks called the “Dividend Aristocrats”. It works like this: a talent agent gets a phone call from a guy who says, “I have this amazing act. It’s me, my wife, our daughter and our son…”

Alright, it really works like this. The S&P defines a dividend aristocrat as any company with a $3 billion market capitalization, at least $5 million of which changes hands on an average day. And the company must have increased dividends every year for the last quarter century.

This is venturing dangerously into technical analysis territory (i.e., looking at charts instead of fundamentals.) Furthermore, it gives no leeway. A stock that pays a 25¢ dividend one year, then pays a 25¢ dividend the next, even when the consumer price index has risen <1%, doesn’t qualify.

Worse yet, the dividend aristocrats method looks a little too closely at past performance. Yes, what a stock did is important. What a stock did 25 years ago, back when it had a different management team and board of directors, is less important. Whatever the company is and whatever it does, its place in the economy did not remain unchanged. Since 1987, paper manufacturing got a lot less important, and internet search a lot more, but even the industries in the middle moved in some direction. And that movement could well have compounded every year. Fully half the companies on the Dow of 25 years ago are no longer there. (14 of them were replaced, including a couple that went bankrupt, and the 15th, Texaco, merged with Dow stalwart Chevron.)

Please understand that you need to look at more than indicators before committing to a security. Remember, a stock price is nothing more than an opinion. A consensus opinion, really, or a combination of opinions distilled into one number, but one formed by opinions nonetheless. That means that a stock price is as fickle as your teenage niece’s musical tastes.

Wait. I thought this post was about dividends, not stock prices. 

It’s about dividend yields. We’re saying that the denominator of a fraction is just as important as the numerator.

More to the point, the two are only tenuously related. Sports analogy coming up.

Cam Newton led the NFL in yards per rushing attempt this season at 5.6 (among all players with at least 7½ carries a game.) That makes him the most valuable running back in the league, doesn’t it? If he were a free agent, any team that signs him and makes him their primary running back would be guaranteed a Super Bowl victory, right?

Yeah, except he rushed for only 706 yards. (Primarily because he’s a quarterback, not a running back.) We’ll take Maurice Jones-Drew’s additional 900 yards, thanks.

The very phrase “dividend yield” implies that the dividend is somehow connected to the stock price. It isn’t. The dividend is connected to whatever the management team wants to pay out. More to the point, the managers have to set the dividend low enough that it doesn’t eat up too much of the company’s profits, but high enough to attract investors and keep them happy. (Keep in mind that the managers and directors themselves own plenty of the stock themselves.)

CME Group is the parent company of the Chicago Mercantile Exchange, and also owns at least a piece of several other exchanges. (What, you thought stock exchanges were public utilities, like the water company?) CME Group also owns the Dow Jones indices. We’re not sure how you can own numbers, but CME Group manages to and with a market cap of $19 billion, they don’t need to answer to us. CME Group paid dividends totaling $8.92 per share last year. The company will not be folding nor becoming irrelevant anytime soon.

The raw number – $8.92 – is more meaningful and more attractive than the dividend yield. That’s because CME Group trades at about $285. Yes, it costs a lot to own a standard lot of CME. That’s the point. 100 shares will cost you most of America’s per capita salary, and give you an annual payment of $892.

Are high dividend yields better than low ones?

Don’t answer yet. Let’s rephrase it slightly.

If you’re a CMG Group shareholder, do you want a high dividend yield or a low one?

You want a low one. For the dividend yield to lower, the dividend itself would have to lower. Or, what’s far more likely, the stock would have to appreciate. Chase dividend yields, and you start chasing perversions. Who cares what the dividend is doing relative to stock price? Lots of people do, but they shouldn’t. A stock like CME, trading at only 10½ times earnings, with positive cash flow, 60% off its 2007 peak, with net income increasing every year, is a bargain. And on no one’s list of dividend yield champions.

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The Sexy World of Dividend Yield Stocks

February 1, 2012

 

Fine, but who's the woman in the back? Is she the Belgian au pair whom Dad will eventually have an affair with?

 

Time to debate the merits of another 2012 investing buzzword. It seems half our personal finance blogger contemporaries are incorporating stocks with high dividend yields into their portfolios. So what’s a dividend yield stock and should I care? Should I be interested? Should I take my money out of T-bills and start investing in dividend yield stocks immediately?

Most blue-chip stocks pay dividends. Yes, you get money just for doing the company the favor of purchasing its stock. If that sounds unduly generous, you’re forgetting that purchasing the stock doesn’t just make you an investor. It makes you an owner of the company. You’re the person in charge, however minimal your particular influence is. En masse, the owners can demand payment – a reward for the company’s success, if you will. Single proprietors and partners enjoy their companies’ profits, so why shouldn’t the person who owns one millionth of Google? Sure, it might make more sense to invest the profits back in the company, but as an investor, that’s not necessarily your concern. Putting money back in the company might, or might not, result in an increased stock price down the road. Paying a dividend will benefit you immediately (or at the end of the quarter, or whenever the company calculates it.)

Dividend yield is just a company’s annual dividend divided by its stock price. A company that pays a quarterly 50¢ dividend and whose stock is trading at $10 has a dividend yield of 20%.

If you think it’s insane to give 20% of the company’s value back to the owners, you’re right. At that rate, assuming static growth, within 5 years the company would evaporate from largesse. As a rule, 3% is considered high.

CPI Corp (NYSE: CPY) (it stands for Consumer Programs Incorporated) is the company that Sears farms out its infamous Portrait Studios to. Walmart, too. If there’s a picture somewhere of you and your siblings smiling awkwardly on a carpeted white stool in front of an anodyne gray background, then there’s a good chance your family has done business with CPI.

You’re not going to believe this, but those department store studios aren’t as successful as they were in the 1980s. Frankly, they were always kind of a holdover from the days of daguerreotypes, back when cameras were luxury items. Today, when any iPhone can capture pictures indistinguishable from the ones Sears Portrait Studio takes with an Olympus E-1, CPI is about to go the way of Borders Books & Music and Solyndra. Which is reflected in the stock price, which fell from $30.48 in December of 2010 to $1.59 today. The company’s market cap is $11.2 million. Just put it out of its misery already.

Yet it still pays a quarterly dividend of 25¢, which means a dividend yield of 63%. Which is like a baseball player with a batting average of .833. Unsustainable. No other company currently has a dividend yield of higher than 20% (That’s American Capital Agency, a real estate investment trust.)

Dividends are a drug, hard for investors to wean themselves off once they’ve become accustomed to a certain dose. A history of quarterly 25¢ payments means that if CPI lowers its dividend, it’ll prompt those few investors who are still around to jump ship and sink the stock price once and for all. The New York Stock Exchange threatened CPI with delisting, unless the price somehow sextuples.
The rationale for buying high dividend yield stocks is that you’ll presumably receive lots of cash per dollar spent on the stock itself. However, it’s easy to forget that just because you can divide one quantity into another, doesn’t mean you should. Look at the opposite situation: if the stock you buy turns out to have a low dividend yield, that means it has a high price, and how is that bad?

Seeing as dividends are cash, that means they derive from cash flow. Which brings us to the least heralded of the major financial statements, the cash flow statement.

Check out total cash flow from operating activities. CPI brought in $39,067,000 via that method last year. And paid out 17% of it as dividends. That’s hardly excessive. Coca-Cola pays out 43%. But it reminds us how stock price – an arbitrary number that represents nothing more than a collective opinion among buyers and sellers in the marketplace – has little to do with the concrete accounting entry that a dividend payment is.

A history of regular dividends is a welcome thing. A history of high dividends relative to stock price means nothing. It can’t mean anything, because a truly high dividend yield can’t last for any length of time.

Update: CPI got sued last week. Class action. The plaintiffs argue that the company was doing worse than management was letting on. CPI had to change the terms under which it borrows money, which means no more dividend, which means its dividend yield has fallen 63 percentage points. Isn’t this fun? 

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Stock quotes, demystified

November 1, 2009

Math is hard. Poverty is harder.

Q: Dear Control Your Cash, how do I read a stock quote?

A: Considering that you’re just a literary construct and not an actual person, it doesn’t really matter.

Q: Thanks. You know how to make a girl feel special.

Tickers and charts are easy to understand if you know what you’re doing. Take stock ABC, for instance.

That’s not an idiom. Take stock ABC. That’s the ticker symbol for AmerisourceBergen, a drug wholesaler based out of suburban Philadelphia. ABC trades on the New York Stock Exchange, which is what the “NYSE” represents on this page.

The first line tells you what price a share of ABC last traded at (as of 1:49 p.m. ET today), and how much ABC gained or lost from the previous trading day (last Friday).

That covers everything down to the Previous Close line in the first column. Open means what price ABC first traded at today. That gives you an idea of what direction ABC’s price was heading in earlier, but it’s not as important at what ABC closed at.

Bid and Ask are a little more complicated. For large, heavily traded companies, Bid and Ask usually don’t apply. But for companies whose stock trades sporadically, they’re important. That’ll require us to look at a different company for a while; DEF.

DEF is Claymore/Sabrient Defensive Equity exchange-traded fund (more on these later), which is operated by Claymore, a Chicago financial firm. DEF trades on NYSEArca, a smaller, online-only exchange that features the stocks of small companies.

You’ll notice it’s been a few hours since someone bought DEF. For a decently sized company, that’d be all but impossible. Shares of DEF last traded at 20.77 (these numbers will obviously have changed by the time you read this.) But since then, no one’s been willing to buy it for that much, nor has anyone who owns it been willing to sell it for that little. Buyers are offering 20.77 for more shares, but there are none left at that price. Because no one’s willing to sell it for less than 20.79. The broker who bid 20.77 a share for DEF was willing to buy a lot consisting of 3500 shares at that price. The broker who was asking 20.79 a share for DEF was offering a lot of 2500 shares.

Alright, back to ABC. The 1-year target estimate is what some analyst thinks the price will be a year from now. Treat this with the skepticism it deserves.

Day’s range and 52-week range are self-explanatory. Volume is the number of shares that were traded today. But you can’t multiply Volume by Last Trade to get the dollar value of the number of shares traded today, because not all the shares traded at 24.60. (Of course not, they fluctuated between the numbers listed in Day’s Range.)

The (3m) after Average Volume means 3 months.

Market Capitalization is essentially what the company is worth. There are several ways to value a company, the most obvious one being what someone would be willing to pay for it. But since there’s probably no one who wants to buy every last share of ABC, the best we can do is multiply the price of a share by the number of outstanding shares. Makes sense, right? The chart tells us that ABC is thus worth $7.2 billion.

Which means we now have an idea of how many outstanding shares of ABC there are, which would be 293 million (give or take a tenth of a percent or so, thanks to rounding.) Not that that’s important in and of itself, but it does tell us that about .42% of ABC’s outstanding shares have changed hands today. Which means that 99.58% of ABC’s outstanding shares stayed right where they were. (When the hotties on Fox Business say that “trading was heavy today”, it’s relative. Trading is always pretty light.)

The next two items should be reversed. Let’s start with EPS, which is earnings per share. It’s how much money the company made (according to its annual income statement), divided by the number of outstanding shares. A little multiplication shows that ABC made about $486 million last year, which is excellent, especially considering ABC’s market capitalization. (ttm) means trailing 12 months; in other words, looking at the company’s earnings over the past year.

P/E is price/earnings ratio, which is a indirect measure of what investors think a company’s stock will be worth. It’s the stock price divided by EPS.

ABC investors are willing to pay $14.79 for every dollar of income the company generates annually. In other words, it would take about 14.79 years for the stock to earn enough to pay for itself.

Which isn’t bad. Say you have another investment, like a $100,000 house that you rent out. If it took you 14.79 years to collect enough rent to pay for the house, that’d be an annual rate of return of 6.76%.

P/E ratio is important enough that it warrants its own post, but for now just know that a high number (usually >17 or so) means that the stock is either overvalued, or investors think it’s going to earn a lot more in the future. A number from 0-10 means that the company stock is a bargain, or the company’s going to start earning less. (A negative number means the company’s losing money.) ABC’s P/E ratio just happens to be right around what’s normally considered fair value. P/E ratios depend hugely on what industry a company is in. For instance, a healthy electric utility will usually have a lower P/E than will a barely profitable tech company. Governments regulate utilities heavily, and while they’re profitable, they cost a ton to start up and their profits are usually limited if steady.

That leaves Dividend and Yield. Successful, consistently profitable companies pay shareholders a dividend – sometimes annually, sometimes quarterly, sometimes even monthly. It’s a piece of the profits earmarked just for this purpose. If that sounds unduly generous, keep in mind that the shareholders own the company: it’s their money. They authorize the board of directors to hire executives who’ll authorize dividends, and those directors and executives hold shares themselves.

To keep things uniform, dividends are expressed annually. So if a company happens to pay a quarterly dividend, the number listed here is 4 times that. Yield is the dividend divided by the share price.

Q: Wow, Control Your Cash. You’re really smart. Did I mention that I’m tall, blonde, statuesque and lonely?

A: Very funny.

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