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Book Review: The Art of Short Selling

Description

The Art of Short Selling, by Kathryn Staley, is by no means about short selling. If I had to sum it up in a few words, I would say the book is focused on hardcore fundamental analysis. It points all readers in the direction of discovering and analysing fundamental problems with a company. The book clearly states that one should never short a good company with temporary issues or just because a company seems overpriced.

There is no mention of technical analysis, trends or volume. The true method of short selling described is based on an extremely detailed fundamental analysis, which is why I immediately purchased the book. The book describes everything that enterprising investors should do.

I watched a video of Kathryn Staley talk about short selling and what it involved and was blown away by how little I was doing in comparison. Did you know that she shorted the same company on and off for ten years! Now that's confidence, conviction and an understanding of the company. Something that everyone, especially me, can benefit from.

The Art of Short Selling does not teach you how to short stocks. What it does try to show is what to look for in the industry, business, management and financial statements to detect a company that is on the verge of a fundamental breakdown.

Make Up of the Book

The book immediately starts off by stating that fundamental short sellers look for quality of earnings, quality of assets and quality of management. As fundamental long buyers, we probably don't go beyond 1 or 2 of these.

The first part of the book describes the aspect of short selling, what it is, how opportunities exist, statistics and profiles of great short sellers such as Jim Chanos.

Part Two is made up of 7 chapters. It takes the reader through many examples and situations of which industries and businesses are attractive for short sellers. This whole section is one case study after another which helps the reader to understand what to look for and how the concepts were applied.

As I was reading chapter 9, I couldn't help but be spooked of the similarities between what happened to American Continental in 1988 and the warning signs from that era and the current economy. The danger signs were clear for anyone to see. If I had read this book 1 year earlier, I certainly would have done things differently.

The final part of the book is dedicated to the characteristics a short seller must have, a brief history lesson on previous market controversies such as the South Sea Bubble and a checklist and guide for fundamental short selling such as where to look, the bare requirements for what you must read, how to determine quality, which ratios will help to detect financial shenanigans and a list of questions you need to ask yourself as you go through the proxies and statements.

As you can see, this is some serious analysis and why I now view true fundamental short sellers as such a scary bunch.

Opinion

I found the book to be very helpful in my learning process but this book certainly isn't for the beginner investor. If you have a desire to learn how to detect errors in the financial statements and find evidence in supporting documents, this is for you.

Whether you have a interest in short selling or not, this book will give you an idea of how much work is needed for any thorough investment as well as the conviction and patience required.

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Stock Analysis: PepsiCo, Inc. (PEP)

Linked here is a detailed quantitative analysis of PepsiCo, Inc. (PEP) (alt.1, alt.2). Below are some highlights from the above linked analysis:

Company Description: PepsiCo, Inc. (PepsiCo) is a global snack and beverage company. The Company manufactures, markets and sells a range of salty, convenient, sweet and grain-based snacks, carbonated and non-carbonated beverages and foods.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

  1. Avg. High Yield Price
  2. 20-Year DCF Price
  3. Avg. P/E Price
  4. Graham Number
PEP is trading at a discount to 1.), 2.) and 3.) above. If I exclude the high and low valuations and average the remaining two, PEP is trading at a 21.9% discount. PEP earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
PEP earned one Star in this section for 3.) above. PEP has paid a cash dividend to shareholders every year since 1952 and has increased its dividend payments for 36 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
  1. NPV MMA Diff.
  2. Years to >MMA
PEP earned both of the available Stars in this section. The NPV MMA Diff. of the $16,099 is in excess of the $2,500 minimum I look for in a stock that has increased dividends as long as PEP has. If PEP grows its dividend at 13.0% per year, it will take 2 years to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 3.54%. PEP earned a Star since its Years to >MMA of 2 is less than 5 years.

Other: PEP is a member of the S&P 500, a Dividend Aristocrat and a member of the Broad Dividend Achievers™ Index. PEP's global market positions and stable end markets produce consistent and strong cash flows. The company continues to find domestic and international growth opportunities. PEP's product innovation strategy is considered trend-setting for the industry. Though carbonated soft drinks remain the most popular beverage, PEP recognizes that non-carbonated soft drinks are a faster growing category. The company is focusing on the health and wellness trends. It has eliminated trans fats from many of its snack foods, and is introducing "good for you" foods under the Quaker Oats brand. Risks include the highly competitive and very mature nature of it products, also with more exposure to foreign markets, political and currency risks also increase.

Conclusion: PEP earned one Star in the Fair Value section, earned one Star in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of four Stars. This quantitatively ranks PEP as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price could increase to $92.09 before PEP's NPV MMA Differential fell to the $3,000 that I like to see. At that price the stock would yield 1.79%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the needed $3,000 NPV MMA Differential, the calculated rate is 6.4%. This dividend growth rate is well below the 13.0% used in this analysis, providing a reasonable margin of safety.

PEP is a good value and and an excellent dividend stock. I will continue to add to my position below my buy price of $69.88. For additional information on PEP, including it dividend history, please refer to its data page.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I was long in PEP (2.0% of my Income Portfolio) .

What are your thoughts on PEP?

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Weekend Reading Links - December 28, 2008

For your weekend reading pleasure, the articles listed below contain some of the best dividend and value investing insights found on the web. They were written by various members of the Dividend Investing and Value Network (DIV-Net) over the past week:

Articles From DIV-Net Members

There are some really good articles here, please take time and read a few of them.

If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.


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Finding True Value in Master Limited Partnerships

While many of my bank and finacial stocks such as American Capital (ACAS) did poorly in 2008. I am happy to say my largest holding Kinder Morgan Energy Partners (KMP) performed very well for the year. I am going to add some more pipeline companies to my mix of stocks for their consistent dividend payments and stable share price. I think Master Limited Partnerships such as KMP will do well in 2009 and for the long term.

KMP is down about 15% for the year versus a 40% drop in the S&P 500. KMP also paid out over 7% in distribtions for the year. Here is an article from Morningstar going over Master Limited Partnerships such as KMP. Finding True Value in Master Limited Partnerships

First off, with numerous MLPs in 5-star territory, one needs to consider other factors beyond the star rating to find the business offering the best risk/reward profile. This may also help one consider how large to size one's investment. After all, our Consider Buying price is the point at which you should consider buying units, but "consider" implies deliberation, in our view. In addition to our fair value uncertainty ratings and fair value estimates, we suggest MLP investors weigh these factors.

Consider Commodity Price Exposures
MLPs that gather and process natural gas tend to be more exposed to commodity price movements than traditional pipeline MLPs. The difference in the price of natural gas and natural gas liquids (NGLs), known as a frac spread, can make or break processing margins, and because NGLs tend to be priced off crude oil, processing margins have dropped close to zero in recent weeks. While MLPs can hedge out most of their exposure, it's difficult to impossible to hedge all exposures. However, we see opportunity in fee-based gatherers and processors such as Western Gas Partners (WES) and Quicksilver Gas Services (KGS), which have sold off along with other gas gatherers and processors but are significantly more insulated from commodity prices.

Look for Good Coverage
MLPs with high distribution coverage have a better ability to weather the tough market. That's why we looked favorably on Energy Transfer Partners' (ETP) third-quarter decision to maintain rather than raise its distribution. By holding the distribution at second-quarter levels, Energy Transfer was able to increase its distribution coverage and retain the additional cash to help fund future growth. While traditionally MLPs targeted a 1.1x coverage ratio, in this market we are looking for MLPs that cover distributions by 1.4x or better.

Liquidity Matters
Along the same lines, we think liquidity may be the greatest advantage for an MLP in this market. Having cash on hand or available through credit lines gives MLPs a cushion against the unexpected. Liquidity also can allow an MLP to continue its growth plans, and we continue to think that MLPs with strong balance sheets will be the likely buyers if the industry consolidates. As we recently noted, investment-grade MLPs that can raise capital are doing so, and we think this is a mark of prudence.

The Winner's Circle
So which MLPs make the grade by avoiding undue commodity exposure, maintaining strong distribution coverage, and working from a secure liquidity position? We've picked five names that we think do an exceptional job of balancing distribution stability with distribution growth. Any one of these, in our view, presents a compelling risk/reward proposition.

Energy Transfer Partners
With a successful debt offering adding to the company's liquidity position and several years' worth of major projects just recently entering service, we think Energy Transfer will be able to maintain its growth momentum. We would not be surprised if Energy Transfer slowed or halted distribution growth in 2009, but we would expect to see any nondistributed cash deployed to fund growth projects, generating solid returns in years ahead.

Magellan Midstream Partners (MMP)
Weak demand for refined products, particularly gasoline, has hurt Magellan's throughput volumes this year, but we don't think cash flows are likely to suffer nearly as much as throughput. Investments in storage assets and terminals plus an inflation-adjusted pipeline tariff should continue to enable Magellan's steady growth.

Enterprise Products Partners (EPD)
Enterprise has $2.2 billion in available liquidity and stable, fee-based assets stretching across the entire midstream energy value chain. Its cash position should allow Enterprise to continue its investment program without tapping equity markets in 2009, and it also puts Enterprise on our short list of potential industry consolidators.

Kinder Morgan Energy Partners (KMP)
While the majority of Kinder's cash flows stem from predominately fee-based pipeline transportation contracts, nearly a quarter of Kinder Morgan's cash flows are derived from oil production through its CO2 business. We've long admired Kinder's very conservative hedging program that locks in selling prices for up to five years, creating a predictable, stable cash flow stream.

Plains All American Pipeline (PAA)
As the largest operator of crude oil transportation and storage assets in the United States, Plains All American is in a great position, in our view, to benefit from falling oil prices. When oil is cheaper on the spot market than in the future, producers and traders are willing to pay premium prices to store oil at Plains' Cushing facility. We think this market dynamic will continue to benefit Plains over the next several quarters.

Bonus Round--General Partner MLPs
We feel compelled to mention that, in our view, among the most attractive MLP investments available to investors today are general partner MLPs. Three of the MLPs in our winner's circle--Energy Transfer Partners, Magellan Midstream Partners, and Enterprise Products Partners--have publicly traded general partners-- Energy Transfer Equity (ETE), Magellan Midstream Holdings (MGG), and Enterprise GP Holdings (EPE)--and each of these general partner MLPs have in recent weeks traded at or above the yield of their underlying MLP.

This just doesn't make much sense to us, and it smells like an opportunity. General partner MLPs hold incentive distribution rights (IDRs) in their underlying MLP, and these IDRs provide general partners with an increasing claim on cash payouts over time: As an MLP increases its distribution to limited partners, its general partner will see its share of total cash distributions increase. Thanks to this incentive structure, we can work out the distribution math and know that, for instance, if Magellan Midstream Partners increases its distribution by 8%, its general partner, Magellan Midstream Holdings, will be able to raise its distribution by about 15%. In exchange for faster distribution growth, we'd expect to see MGG trade at a lower yield.

So what does it mean that a general partner and its underlying MLP are trading at or near the same yield? To us, it means that the market is penalizing the perceived riskiness of general partners' cash flows to such an extent that the growth premium we'd expect to see is canceled out. But if we're confident in the underlying MLP's cash flows and in its ability to grow its distribution over time--a confidence we have in all five of our winner's circle picks--then what we see in the market is an opportunity to buy distribution streams growing 1.5 to 2.0 times faster than those of the underlying MLP at the same price--or, in other words, free growth.

Disclosure: The Div Guy owns share of KMP at the time of this post.


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When to sell my dividend stocks?

Investors always look for the perfect formula that would enable them to purchase the best stocks> at bargain prices, which would provide large capital gains over time and an increasing stream of dividend gains. One could line up one or several indicators in order to reach a buy decision. Selling a stock however, is what could ultimately determine whether you succeed or fail in the long run.

As a buy and hold dividend investor, I try to pick stocks that trade at reasonable levels, and then dollar cost average my way into the position. My holding period is forever, as long as certain prerequisites are met. I don’t set target prices at which to exit, as most often than not the market is either going to blast through this level and never look back. Furthermore setting target prices at which to sell at would imply that I know when to sell high and that this “high” price will not be reached again the foreseeable future.

There are two conditions that could make me sell the stock I am holding.
- Company is bought out by another company for cash or stock or it is taken private
- The stock takes a very high portion of my portfolio, relative to other positions
- Company slashes or eliminates its dividend.

I will focus my attention on selling when a stock that I own cuts or suspendsits dividends. One of the main reasons why I would enter into a dividend stock is because I believe that the dividend would be increased over time, bringing my yield on cost upward to a comfortable double digit level. If a company maintains its dividend payment, without cutting it, I would still hold on to the stock. When the dividend is cut or suspended however, my goal of generating an increasing stream of dividend income is no longer valid. Thus, selling my whole position in this company is the best decision to make.

Next week I will discuss why I disagree with the notion that selling after a dividend cut is an example of buy high sell low.

Relevant Articles:

- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates


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A Contrarian Strategy In The Newspaper Industry

Every investor is aware of the slow death of the Newspaper Industry and all the problems that the publicly traded stocks have been having the last few years as advertising migrates to the Internet and circulation dwindles. There is a least one newspaper that has adopted a different strategy.

The paper is the TriCityNews of Monmouth County, N.J. and according to the article in the New York Times, it is flourishing and profitable precisely because it is not putting its content on the web.

“Why would I put anything on the Web?” asked Dan Jacobson, the publisher and owner of the newspaper. “I don’t understand how putting content on the Web would do anything but help destroy our paper. Why should we give our readers any incentive whatsoever to not look at our content along with our advertisements, a large number of which are beautiful and cheap full-page ads?”

The article in the Times is here.

It's interesting to hear a contrarian point of view on how things should be run.

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Happy Holidays!

I know it is difficult, but all of us need to take a break from dividends, money, and personal finances once in a while. I think we can all appreciate our enriched, healthy lives and the joy that our caring families bring to us. From the moneygardener & The DIV-Net, wishing you a Merry Christmas and a Happy New Year!


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Online Financial Calculator Suggestions

Online calculators are an interesting thing. There are some things you never thought you needed a calculator for, yet someone somewhere has created a nifty look web-app that can calculate the moon cycle of when your next investment should be! In all seriousness though, there are literally thousands of online financial calculators available to help investors manage their portfolios. This post will list a few of them for you to try out.


Advantage of Early Investing

This calculator is pretty cool, however it can be a bit depressing the older you get. Basically it shows you the difference between investing early in live versus later in life. The answer is obvious - the sooner you start the better you will be. However, it is amazing how drastic the difference can be. Check it out at Canadian Financial Calculators and Worksheets - it is in the top right of the screen.

Compound Annual Growth Rate Calculator

This is my favorite calculator. I enter a company's dividend 10 years ago, the dividend today, and the number of years and it tells me what the annual return is. See it at Moneychimp.

Mutual Fund Fee Calculator

Anyone who reads investing blogs regularly knows that mutual funds are the greatest scam to hot the investing public. If you don't believe me, then play around with the Mutual Fund Fee Impact Calculator and see for yourself. It is written with Canadians in mind, but the message is the same. However, Canadians must realize that we get ripped off even more than our neighbors to the south!

Those are just a quick three. There are many others - do a search for "investment calculators" or "dividend calculator" in Google and see what you come up with. Be sure to use the comments to let us all know the gems that you find!

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.


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Stock Analysis: Kraft Foods Inc (KFT)

Linked here is a PDF copy of my detailed analysis of Kraft Foods Inc (KFT) (alt.1, alt.2). Below are some highlights from the above linked analysis:

Company Description: Kraft Foods is the largest U.S. branded food and beverage company, and the second largest in the world.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

  1. Avg. High Yield Price
  2. 20-Year DCF Price
  3. Avg. P/E Price
  4. Graham Number
KFT is trading at a discount to 1.) and 3.) above. Since KFT's tangible book value is not meaningful, a Graham number can not be calculated. If I exclude the high and low valuations and average the remaining two, KFT is trading at a slight discount. KFT earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
KFT earned no Stars in this section. KFT has paid a cash dividend to shareholders every year since 2001 and has increased its dividend payments for 7 consecutive years. Last year's dividend payout was 64%, up from 52% in 2006. Since the increase was in excess of 15 points, a Star is deducted, leaving a net of zero Stars in this section.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
  1. NPV MMA Diff.
  2. Years to >MMA
KFT earned one Star in this section for 2.) above. The NPV MMA Diff. of the $7,218 is below the $10,000 minimum I look for in a stock that has increased dividends as long as KFT has. If KFT grows its dividend at 7.7% per year, it will take 2 years to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 4.61%. KFT earned a Star since its Years to >MMA of 2 is less than 5 years.

Other: KFT is a member of the S&P 500. Its leading global market position has allowed it to build a strong balance sheet cash flows. The company has used its cash flow to pay increasing dividends and currently has a generous yield in excess of 4%. Due to the relatively stable nature of the company's end markets, the stock should benefit from investors looking for defensive or lower-risk investments. Risks include execution of internal restructuring, competitive conditions, higher input costs and possible disappointing consumer acceptance of new product introductions.

Conclusion: KFT earned one Star in the Fair Value section, lost one Star in the Dividend Analytical Data section and earned one Star in the Dividend Income vs. MMA section for a net total of one Star. This quantitatively ranks KFT as a 1 Star-Very Weak stock.

Using my D4L-PreScreen.xls model, I determined the share price would need to decrease to $23.49 for KFT's NPV MMA Differential to increase to the $10,000 that I like to see. At that price the stock would yield 4.77%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the needed $10,000 NPV MMA Differential, the calculated rate is 8.9%. This dividend growth rate is above the 7.7% used in this analysis.

KFT is a strong international brand and has a lot working in its favor. Before purchasing KFT, I would like to see a higher NPV MMA Differential and lower payout ratio (64% in 2007). My buy price for KFT is $23.49.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in KFT (0.0% of my Income Portfolio) .

What are your thoughts on KFT?

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Dividend Aristocrats Performance With One Week Remaining In The Year

Standard & Poor's Dividend Aristocrats are maintaining a large performance edge over the Dow Jones Industrial Average Index, the S&P 500 Index and the Nasdaq Index. With a little over one week remaining in 2008, the Aristocrats' market cap weighted return on a year to date basis is -24.2% versus the S&P 500 Index return of -39.5%. Detail on the specific Aristocrat companies is noted in the below spreadsheet.


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Weekend Reading Links - December 20, 2008

For your weekend reading pleasure, the articles listed below contain some of the best dividend and value investing insights found on the web. They were written by various members of the Dividend Investing and Value Network (DIV-Net) over the past week:

Articles From DIV-Net Members

There are some really good articles here, please take time and read a few of them.

If you enjoyed this article, please vote for it by clicking the Buzz Up! button below.


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Reasons to buy stock now

The markets have not been kind this year and just about every sector has taken a big hit. I just read an interesting article that give some reasons to buy stocks now. Manuel Schiffres has written Six Reasons to Buy Stocks Now and here are some highlights.

Many investors are angry, frustrated and disillusioned with stocks. Anecdotal evidence suggests that some people have decided to swear off stocks forever. Others may be wondering how much more pain they can endure before they also bail out. Those reactions to the bear market are no surprise.

1. Stocks are battered and cheap. Between its peak on October 9, 2007, and its low on November 20, 2008, Standard & Poor's 500-stock index plunged 52%. That makes this bear market the worst since the Great Depression (through December 12, the S&P was 44% below its high).

2. Stocks are overdue. Let's not forget that the current bear market is the second megacollapse of this decade. From December 31, 1999, through December 11, 2008, the S&P 500 produced an annualized return of -4.0% (if you invested $10,000 in an S&P 500 index fund at the start of 2000, the fund would be worth roughly $6,960 today).

3. The low-risk alternatives are pathetic. Yes, we all know the old Will Rogers line that you should be more concerned about return of investment than return on investment. But will you really be satisfied with a ten-year Treasury note that pays a mere 2.5% (or a T-bill that yields virtually nothing)? It won't take much for stocks outpace the risk-free alternatives.

4. It's not the 1930s. Yes, the economy stinks. Joblessness is up, a growing number of companies are filing for bankruptcy, and consumer spending and sentiment are in the tank. But the economy is nowhere near a depression, which by one popular definition is a decline in real growth of at least 10%.

5. The market shows signs that the worst is over. Between November 20 and December 15, both the S&P 500 and the Dow Jones industrial average climbed 11 of 16 trading sessions. Perhaps more significantly, the stock market has risen on days when the news has been awful -- for example, on December 5, when the government reported that the number of jobs lost in November was the highest since December 1974, and on December 12, the day after authorities accused Wall Street legend Bernard Madoff of orchestrating a fraudulent investment scheme that could cost his clients as much as $50 billion.

6. If not now, when? Say you've sold a bunch of stocks and plan to reenter the market when things look better. Or perhaps you have inherited some money and are waiting for the "right time" to put it to work. The chances that you'll nail the right time -- or come anywhere near it -- are slim.

Why? Bear markets almost always end in an atmosphere of deep gloom, and stocks start going up well before the economy bottoms. For instance, the month with the previous record for most jobs lost was December 1974. The horrific 1973-74 bear market bottomed in October '74. But most people are constitutionally incapable of pulling the "buy" trigger when the news is unfailingly bleak.

If you wait for the news to get better, however, you'll almost certainly miss the initial leg of the next bull market. And the early moves are typically fast and furious. T. Rowe Price, the fund company, looked at returns of the S&P 500 following each decline of at least 20%. In those six instances (not counting the current bear market), the S&P has been up an average of 31% in the subsequent year. The lesson: Not owning stocks can also cost you dearly.


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Don’t chase High Yielding Stocks Blindly

Most investors who are close to or in retirement look for dividend stocks as a source of their retirement income. I believe that this is a great investment strategy, as long as these investors don’t chase high-yielding stocks. With the average market yields at 3%, stocks that yield more than 10% should not be automatically embraced in ones income portfolio, but examined more closely than usual. There are several reasons why a stock is yielding over 10%, one of them could be that the stock price has been in a severe down trend, which has increased the current yield on the stock.

Every dividend investor should be focusing not only on dividend income, but also evaluating the safety of their principal. If the high-yielding stock is paying a 10% current yield, but most of it is a return of capital, then chances are that the dividend payment will not be maintained in the future as the company’s capital base shrinks. Furthermore if a stock used to yield 3% but due to a decrease in its stock price is yielding 12%, the market might be sending a message that the current dividend payment is in danger of a cut. Financial companies like Bank of America (BAC) and Citigroup (C) in 2008 are a prime example of this scenario, as their current yields rose to 8%-10% because their stocks fell sharply in response to the softening of the general economy. Investors who purchased these stocks were hit on two fronts – the share prices dipped lower and the dividends were cut, which decreased yields on cost significantly. In other words if you are chasing a 30% dividend yield, then make sure that you don’t lose a lot in capital gains in the process. My experience with American Capital Strategies (ACAS) was a very good example of chasing a high-yield stock and getting burned in the process.

Before you invest your hard earned money in a dividend stock, always try to gauge how safe the dividend is, by looking at the dividend payout ratio and the dividend in relation to the cash flows per share. A high dividend payout ratio would tell you in most situations that the probability of any further dividend increases is greatly diminished. For most of the dividend aristocrats a dividend payout ratio of 50% or below indicates a healthy relation between the distributions and earnings, which also provides the dividend investor with a margin of safety. Lower dividend payout ratios also provide for more room to support for future dividend increases. There are however certain stocks which pay out more than 50% of their payout ratios to shareholders such as utilities, Canadian royalty trusts, Master limited Partnerships, oil tanker stocks as well as real estate investment trusts. Many investors, focusing on current income are buying onto these stocks in order to generate higher yields on their investments. The reason why these investments produce above average yields in most circumstances is because they also return capital as part of their distribution to stockholders. This is similar to you selling off a portion of your dividend holdings each year, and claiming the proceeds from this exercise a distribution to you. As dividend investors your primary goal is to generate income from earnings, which could be increased over time in order to beat the eroding power of inflation.

Investors shouldn’t focus exclusively on pass through entities such as Canadian Royalty trusts like PGH, PWE, HTE and MLP’s such as KMP and TPP as their investments could easily lose money if there are changes in the tax codes, which could negatively affect their portfolios. For example prior to 2006 many retired Canadians owned income trusts, which were taxed very favorably and paid out very handsome yields. In 2006 however the Canadian government announced that it was changing this corporate structure in 2011, sending trusts shares along with their distributions much lower.

Now I do believe that creating a diversified portfolio of income producing investments could include oil tankers, Canadian royalty trusts, master limited partnerships and real estate investment trusts. The goal of your retirement portfolio should be to not to overweight these investments with high current yield, but unstable dividend payments. In 2008 overweighting of shipping stocks such as DSX or FRO would have lead to decreases in dividend income as these stocks either cut severely or suspended their payments to shareholders.

I also believe that dividend investors should be tracking their yield on cost more closely than current yield. Yield on cost tracks the dividend yield on your original investment. If you bought a stock like JNJ, PG, MO one or two decades ago, you would be making a pretty decent yield on cost nowadays, which is close to what certain high yielding investments generate today.

Relevant Articles:
- The price of higher current yield -Canadian Royalty Trusts
- The case for dividend investing in retirement
- Ten Things to Know About Dividends:
- Diversification and portfolio allocation
- Best CD Rates

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This Guy Has Balls

I just came across a contrarian opinion on the existence of the supposed "credit crunch" they we are in. The opinion comes from Octavio Marenzi, the CEO of Celent, which is a financial strategy consulting group.

Marenzi was interviewed on CNBC at the link below. I tried to upload it but was unsuccessful so you will have to view it below:

Credit Crunch? What Credit Crunch?

Marenzi maintains that official data from the Federal Reserve and from European Central Banks indicate that credit is expanding, not contracting. The summary of the report is on the Celent web site. It's hard to critique his argument without seeing the entire report, so if anyone knows of a journalist or blogger who has looked at his assumptions and conclusions, pleas post a URL for me to look at.

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Energy Dividends on the Chopping Block?

Oil has really come off dramatically due to the horrible economic state and outlook. This has occured very quickly as only short months ago oil was trading at $145/barrel and now it sits just above $40. At these levels one has to wonder if dividends paid by oil and gas firms are sustainable, considering they are selling their wares for dramatically less than they were as they raised these dividends.

BP (BP) and Husky Energy (HSE) both yield over 6.5% and have been consistent raisers of dividends over the past few years. The companies have pay out ratios of 42 and 35% respectively. BP's earnings per share would only have to drop back to 2004 levels to prompt them to take a serious look at cutting their dividend. Husky has been growing EPS more rapidly so their earnings would only need to drop back to 2005 levels for their pay out ratio to jump to 85%.

Many Canadian energy trusts have already taken the step of slashing their distributions. Corporations could be next.

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5 Dividend ETFs for Diversification

If there is one thing I have to admit as a dividend investor is that it can take a lot of time to track my stock holdings. With each dividend stock I own I must consistently monitor company performance to watch for signs of real bad management - and as I do not need to tell you there has been a lot of it lately. Citigroup (sold) and Bank of America (sold) are two examples of the risks of holding individual securities. So what it you do not have the time (or desire) to track individual stocks, but still want to invest using a dividend based strategy? Dividend ETFs and funds can help.

Dividend ETFs and funds are just like other index funds and ETFs in that they track a specific index and try to mimic that index as closely as humanly possible. They provide both diversification and risk management all in one package. As dividend investors, there are a few choices to choose from. Here are 5 of them that may be worth a look:

1. iShares Dow Jones Select Dividend (DVY)

The iShares Dow Jones Select Dividend Index Fund seeks investment results that correspond generally to the price and yield performance, before fees and expenses, of the Dow Jones U.S. Select Dividend Index. The Dow Jones U.S. Select Dividend Index, measures 100 of the leading U.S. dividend-paying companies.

2. PowerShares Dividend Achievers Portfolio (PFM)

he PowerShares Dividend Achievers Portfolio (Fund) seeks to replicate, before fees and expenses, the Broad Dividend Achievers Index, which is designed to identify a diversified group of dividend paying companies. These companies have increased their annual dividend for ten or more consecutive fiscal years.

3. WisdomTree International LargeCap Dividend Fund (DOL)

The WisdomTree International LargeCap Dividend Index is a fundamentally weighted index that measures the performance of the large-capitalization segment of the dividend-paying market in the industrialized world outside the U.S. and Canada. The Index is comprised of the 300 largest companies ranked by market capitalization from the WisdomTree DEFA Index. Companies are weighted in the Index based on annual cash dividends paid.

4. Vanguard Dividend Appreciation ETF (VIG)

Vanguard Dividend Appreciation ETF seeks to track the performance of a benchmark index that measures the investment return of common stocks of companies that have a record of increasing dividends over time.

5. First Trust Value Line Dividend Index Fund (FVD)

The index begins with the universe of stocks that Value Line gives a SafetyTM Ranking of #1 or #2 using the Value Line Safety Ranking System. All registered investment companies, limited partnerships and foreign securities not listed in the U.S. are removed from this universe. From those stocks, Value Line selects those companies with a higher than average dividend yield, as compared to the indicated dividend yield of the Standard & Poor's 500 Composite Stock Price Index. Value Line then eliminates those companies with an equity market capitalization of less than $1 billion.

That should give most investors a good starting point. As with all ETFs, there are also dividend ETFs focused on small-caps, mid-caps, regionally specific or pretty much whatever area of the market you would like to focus on. However, my suggestion for most investors is to keep it simple and stick with a solid asset allocation and build your portfolio from there.

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.


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Stock Analysis: Associated Banc-Corp (ASBC)

Linked here is a PDF copy of my detailed analysis of Associated Banc-Corp (ASBC) (alt.1, alt.2). Below are some highlights from the above linked analysis:

Company Description: Associated Banc-Corp operates as the bank holding company in the United States. It offers various banking and nonbanking services to individuals, businesses, and governments/municipalities in Wisconsin, Minnesota, and Illinois.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

  1. Avg. High Yield Price
  2. 20-Year DCF Price
  3. Avg. P/E Price
  4. Graham Number
ASBC is trading at a discount to 1.), 3.) and 4.) above. If I exclude the high and low valuations and average the remaining two, ASBC is trading at a 11.9% discount. ASBC earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
ASBC earned one Star in this section for 3.) above. ASBC has paid a cash dividend to shareholders every year since 1970 and has increased its dividend payments for 38 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
  1. NPV MMA Diff.
  2. Years to >MMA
ASBC earned both of the available Stars in this section. The NPV MMA Diff. of the $13,764 is in excess of the $2,500 minimum I look for in a stock that has increased dividends as long as ASBC has. ASBC's current yield of 7.12% exceeds the 4.61% estimated 20-year average MMA rate.

Other: ASBC is a member of the Broad Dividend Achievers™ Index. ASBC has a long history of profitability. The company is a conservative lender and has avoided lending exposure to the most troubled areas of the U.S. economy. Risks include a severe and protracted economic slowdown adversely affecting loan growth and credit quality, along with its small size and lack of geographical diversity.

Conclusion: ASBC earned one Star in the Fair Value section, earned one Star in the Dividend Analytical Data section and earned two Stars in the Dividend Income vs. MMA section for a net total of four Stars. This quantitatively ranks ASBC as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to increase to $28.14 for ASBC's NPV MMA Differential to drop to the $3,000 that I like to see. At that price the stock would yield 4.51%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the $3,000 NPV MMA Differential I'm looking for, the calculated rate is -2.8%. This dividend growth rate is well below the 4.1% used in this analysis; thus, providing a margin of safety.

ASBC is worthy of serious consideration at prices below $21.14. At the $18.63 close (12/12/08), it is noteworthy to point out that ASBC is trading below its Graham Number of $19.77, indicating that is also an excellent value buy.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in ASBC (0.0% of my Income Portfolio) .

What are your thoughts on ASBC?


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Dogs Of The Dow Are Dogs This Year

One strategy that has gained a fairly good following over the years is investing in the Dogs of the Dow. This strategy consists of investing in the highest yielding stocks in the Dow Jones Industrial Average at the beginning of each year. At the end of the year an investor would invest in the then current Dow Dogs for the subsequent year. The performance of the Dow Dogs has underperformed the Dow Jones Industrial Average so far this year.

The below table lists the Dow stocks that were a part of the Dow Jones Index at the beginning of 2008. The table does contain the performance of the Dow before the three member changes this year and the performance with the three Dow changes. In both cases, the Dow Dogs are underperforming the Dow Index itself.

(click to enlarge)

Dow Dogs performance December 13, 2006
Source: Dogs of the Dow


As an investor, yield alone does not ensure a stock's outperformance.

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Weekend Reading Links - December 13, 2008

For your weekend reading pleasure, the articles listed below contain some of the best dividend and value investing insights found on the web. They were written by various members of the Dividend Investing and Value Network (DIV-Net) over the past week:

Articles From DIV-Net Members

There are some really good articles here, please take time and read a few of them.

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Stock Screen: Low-Beta Dividend Stocks

After nursing my wounds from recent dividend cuts, I thought a screen of Low-Beta stocks is what the Dividend Dr. would recommend. BusinessWeek has a screen of Low-Beta stocks by By Beth Piskora of S&P. I will remove the non-dividend stocks from the screen. Stock Screen: Low-Beta Beauties

S&P's latest list finds top-ranked stocks that tend to be less volatile than the broader market. Among them: PepsiCo, and Wal-Mart.

The risk metric known as beta can be a useful investment criterion during these times of market volatility.

An issue with a beta of 1.5, for example, tends to move 50% more than the total market in the same direction. An issue with a beta of 0.5 tends to move 50% less. If a stock or stock fund moved exactly as the market moved, it would have a beta of 1.0. Thus, high beta is typical of a volatile stock, while a low beta is typical of a stock that moves less than the market as a whole. A stock with a negative beta moves in the direction opposite to that of the market. With a beta of -1.0, a stock has the same volatility as the market, but tends to rise when the market falls, and vice versa.

Stock fund betas are calculated once a month using 36 months of return data.

Considering the overall market's performance over the past three years, we screened for four- and five-STARS stocks with negative betas (suggesting inverse performance) or a positive beta of 0.25 or lower.

Company/S&P STARS Rank
Abbott Laboratories (ABT)/5 STARS
Associated Banc-Corp (ASBC)/4 STARS
BB&T Corp. (BBT)/4 STARS
General Mills (GIS)/5 STARS
Kinder Morgan Energy (KMP)/5 STARS
NuStar Energy (NS)/4 STARS
Owens & Minor (OMI)/4 STARS
PepsiCo (PEP)/4 STARS
Southwest Airlines (LUV)/4 STARS
Wal-Mart Stores (WMT)/5 STARS
Wells Fargo (WFC)/4 STARS
Zions Bancorporation (ZION)/4 STARS

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What Dividend Growth Investing is all about?

Dividend Growth Investing is a strategy that allows investors to purchase dividend stocks that have a long history of increasing their dividend payments to shareholders. These stocks have sound business models which have withstood the test of many recessions. Most of the dividend growth stocks that I follow represent strong consumer brands like Coca Cola, Aflac or Procter and Gamble which people use on a daily basis. Recessions do affect these companies, but not to the degree that a car manufacturer is affected. As a result of this stability in sales and earnings, these stocks can afford to not only pay a stable dividend every quarter, but also share their prosperity with shareholders by consistently increasing the payments every year. Stocks that regularly increase their dividends tend to be more careful with the way the allocate their financial resources, because they realize that cutting or eliminating the dividends to shareholders would result in lost confidence in company’s management which could take years to recover from.

Dividend Growth Investing is also about consistency and getting a decent dividend growth and dividend yield. The balance between dividend growth and dividend yield is more important as opposed to focusing exclusively on yield. A dividend stock like Pepsi Cola (PEP) yields only 3.10%. However if the stock continues increasing its dividends by 11-12% over the next decade, your yield on cost would end up at over 12% in twelve years. As a dividend investor your main goal is to generate an income stream, which is increasing above the rates of inflation. In order to achieve that, you have to select sound dividend stocks, which represent strong brands and which could afford to pay you an increasing payment year after year.

For that reason I don’t believe in chasing high-yielding stocks. Most higher yielding stocks indicate a high chance that the dividends could be cut. Several high-yielding financial stocks like BAC, C and KEY provided very high dividend yields, which were never paid to shareholders, as the dividends were cut. Other stocks like oil tankers, and higher yielding Canadian royalty trusts which pay out very high dividends, can only afford to do that because their payments vary and are not as consistent. As a dividend investor you have already taken a considerable amount of risk by purchasing individual stocks. You want to minimize that risk by selecting stocks which could not only maintain but also increase your dividend income. You don’t want to guess whether you will be paid a large dividend next quarter or whether you won’t be paid anything at all.

If you had to choose between a stock which is yielding 6% but not growing its dividend versus a stock yielding 3% but growing its dividend by 7% per year, which one would you choose? If you are looking for current income, you might choose the higher yielding stock. But over time the increase in dividends in the second stock would provide for a much higher yield on cost compared to the second stock.

Relevant Articles:

- Dividend Aristocrats List for 2009
- Dividend Aristocrats
- Best Dividends Stocks for the Long Run
- Best High Yield Dividend Stocks for 2009
- Best CD Rates

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Why I Hate Earnings Guidance

I was driving down to New Orleans earlier this week for an Energy conference when it occurred to me that I have a real hatred of earnings guidance and all its permutations.

The desire by management to meet earnings guidance encourages them to do stupid things like managing the company for short term rather than long term goals. One can even make the case that management obsession with hitting earnings guidance was the precursor to many illegal acts at public companies including Enron and Worldcom. I recently read a book about the scandal at Equity Funding back in the 1970's. The architects of that scandal were also obsessed with not disappointing the street, and eventually ended up creating fictitious insurance policies on on its books.

It seems that one of the original purposes of providing earnings guidance was to reduce stock price volatility. Analysts where given ranges were earnings were likely to be so they could put then in their models and reports. Can any one truly say that providing earnings guidance reduces stock price volatility in the market today? How many stocks have you seen in your investment portfolio go down 40% after missing earnings by a penny?

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New Interactive Financial Statements at SEC

First of all, I'm no accountant and I've never taken a finance or accounting course in my life. Like many people, I felt overwhelmed and lost once I opened the financial statements. Google, Yahoo and Morningstar were my go to guys to get the information. Thankfully, I've overcome this and now immediately go to Edgar to find the information I require. This process has saved me from losing more than what I have already lost.

As the internet continues to evolve, so do the applications and services. This includes the SEC. Reading the financial statements from Edgar is a severe pain but companies can now voluntary submit filings in XBRL format.

Check out the interactive format here. Currently, only the blue chips have been submitting, but as time goes by, I hope the SEC will make it compulsory for every company.

Here is a screenshot of 3M's statements.

In the next few days or so be sure to visit my blog Old School Value as I go through more examples of what to look for in the financial statements to save yourself from potentially risky investments.

You can first read about my analysis of AeroGrow's Statement of Cash Flows here.

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Enbridge Hikes Dividend 12%

Firms are still raising dividends in this environment. This particular raise was from a company that you might expect to stand up well against a recession. Enbridge Inc. (ENB) is an energy delivery company that transports natural gas and crude oil, which are used to heat homes, power transportation systems, and provide fuel and feedstock for industries.

Enbridge hiked it's dividend by 12% last week citing expectations that it's 2009 earnings would come in at more than 20% 2008 levels. Enbridge is the main conduit for oil transportation to the United States from Canada. Here is a look at Enbridge's recent dividend activity:

2004 - $0.915
2005 - $1.04
2006 - $1.15
2007 - $1.23
2008 - $1.32
2009 - $1.48 EST

This represents a compounded annual growth rate of the dividend of 10.1%. Enbridge has paid dividends for 54 years, but it should be noted that their dividend was static between 1986 and 1995.

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5 Successful Traits of a "Successful" Investor

Notice I did not say trader. There is a difference between trading and investing and it is important to distinguish between the two. The problem is that these days the people who actively trade their portfolios are very vocal about the death of buy and hold and I believe are starting to win people over and fleece them into thinking that trading is the answer. Just listen to a podcast by Andrew Horowitz, and you will hear him go on and on about how wonderful he is because his trading style is working in THIS market and how wrong all the buy and holders were. This is based on 6-months of a very bad market. However 6-months does not a market make!


That is why in this post I have summarised the thinking I have done to get back to basics and remind myself of what really makes a successful investor. Here, in my mind, are the top 5 investor traits that will make an investor successful in all markets:

1. A Successful Investor will Focus on Asset Allocation Above Everything Else

Asset allocation has the largest input to return in an investor's portfolio and the "good" investor ensures that his/her portfolio is structured with a disciplined and diversified asset allocation. Research obtained from The Only Three Questions That Count shows that asset allocation makes up approximately 70% of a portfolio's return.

2. A Successful Investor will Have the Right Risk Profile for Them

I think the biggest problem for people in the past 6-months to a year of this market is that they did not REALLY understand their risk profile. This market caught millions of people off guard and the impact a down market can have. For example, there are numerous stories of seniors who have been all in equities losing 60% or 70% of their portfolio. Markets will always go down over short periods of time and if you have found yourself unable to stomach, or worse financially deal with, the volatility in your current portfolio then you are not as risk adverse as you thought. Successful investors know their emotional reactions to problems and structure their portfolio in a manner that minimizes the likelihood a emotional reaction will occur. The easy thing to do is be more conservative than you think.

3. A Successful Investor Always Has a Plan

Having a plan is all about goal setting and knowing where you want end up. The reason this is important is simply because a plan minimizes the likelihood that an investor will make unstructured and emotional decision. Of course this requires a good plan, which can be obtained by reading books such as Live It Up Without Outliving Your Money and the dividend classic The Single Best Investment.

4. A Successful Investor Buys When Others are Selling

Warren Buffett has said that you investors always pay a premium for a cheery consensus - such as when markets are constantly rising. However, when markets are crashing I believe that many investors will come out ahead over the long term through buying quality assets now that are priced at a discount. This can mean buying a big basket of individual dividend stocks or an index fund. It really does mean buy low and sell high. Even if we don't know what low really means, an disciplined investment strategy of buying consistently should come out ahead.

5. A Successful Investor Has a Long Term Focus

As I said, the anti-buy and holders are having a field day right now because in this market buy and holding has been a painful thing. However, most of the people I hear talking are looking at the market from a day-to-day perspective and not the long term game it is. Successful investors think long-term, and in my mind that is at least 10 years. 20 is even better. They key is ensuring your portfolio has the right allocation, is structured based on your true risk profile, is implemented according to a proven plan, and consistently buys good assets over time. This is where I spend my energy.

This article was written by The Dividend Guy. You may email questions or comments to me at info@thedividendguyblog.com.


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Stock Analysis: Donaldson Company, Inc (DCI)

Linked here is a PDF copy of my detailed analysis of Donaldson Company, Inc (DCI) (alt.1, alt.2). Below are some highlights from the above linked analysis:

Company Description: Donaldson Company operates as a worldwide manufacturer of filtration systems and replacement parts.

Fair Value: I consider four calculations of fair value, see page 2 of the linked PDF for a detailed description:

  1. Avg. High Yield Price
  2. 20-Year DCF Price
  3. Avg. P/E Price
  4. Graham Number
DCI is trading at a discount to 1.), 2.) and 3.) above. If I exclude the high and low valuations and average the remaining two, DCI is trading at a 21.1% discount. DCI earned a Star in this section since it is trading at a fair value.

Dividend Analytical Data: In this section I consider five factors, see page 2 of the linked PDF for a detailed description:
  1. Rolling 4-yr Div. > 15%
  2. Dividend Growth Rate
  3. Years of Div. Growth
  4. 1-Yr. > 5-Yr Growth
  5. Payout 15% of avg.
DCI earned three Stars in this section for 1.), 2.) and 3.) above. Rolling 4-yr Div. > 15% means that dividends grew on average in excess of 15% for each consecutive 4 year period over the last 10 years (1999-2002, 2000-2003, 2001-2004, etc.) I consider this a key metric since dividends will double every 5 years if they grow by 15%. DCI has paid a cash dividend to shareholders every year since 1956 and has increased its dividend payments for 21 consecutive years.

Dividend Income vs. MMA: Why would you assume the equity risk and invest in a dividend stock if you could earn a better return in a much less risky money market account (MMA)? This section compares the earning ability of this stock with a high yield MMA. Two items are considered in this section, see page 2 of the linked PDF for a detailed description:
  1. NPV MMA Diff.
  2. Years to >MMA
DCI earned no Stars in this section. The NPV MMA Diff. of the $109 is below the $7,500 minimum I look for in a stock that has increased dividends as long as DCI has. If DCI grows its dividend at 15.0% per year, it will take 15 years to equal the cumulative earnings from a MMA yielding an estimated 20-year average rate of 4.61%. The 15 years is more than the 10 years maximum I like to see.

Other: DCI is a member of the Broad Dividend Achievers™ Index. At the end of November, DCI lowered its fiscal 2009 earnings outlook, anticipating a stronger dollar and possibly weaker demand. The company, which has benefited for several years from the weak dollar, adjusted its full-year outlook "due to the combination of exchange rates and weaker customer demand."DCI also reported an 11 percent increase in net income for its fiscal first quarter, outpacing Wall Street expectations on the strength of its aerospace and defense, industrial and gas turbine businesses.

Conclusion: DCI earned one Star in the Fair Value section, earned three Stars in the Dividend Analytical Data section and did not earn any Stars in the Dividend Income vs. MMA section for a net total of four Stars. This quantitatively ranks DCI as a 4 Star-Buy.

Using my D4L-PreScreen.xls model, I determined the share price would need to decrease to $20.00 for DCI's NPV MMA Differential to hit the $7,500 that I like to see. At that price the stock would yield 2.27%.

Resetting the D4L-PreScreen.xls model and solving for the dividend growth rate needed to generate the $7,500 NPV MMA Differential I'm looking for, the calculated rate is 19.6%. This dividend growth rate is significantly above the 15.0% used in this analysis.

DCI is an interesting stock as a potential value investment. However, the numbers don't add up as a dividend investment.

Disclaimer: Material presented here is for informational purposes only. The above quantitative stock analysis, including the Star rating, is mechanically calculated and is based on historical information. The analysis assumes the stock will perform in the future as it has in the past. This is generally never true. Before buying or selling any stock you should do your own research and reach your own conclusion. See my Disclaimer for more information.

Full Disclosure: At the time of this writing, I held no position in DCI (0.0% of my Income Portfolio) .

What are your thoughts on DCI?

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High ROE Danger

I have written a couple of articles in the past on on the benefits of reviewing a company's ROE or return on equity. One of the benefits of this measure is the resulting ROE calculation provides an investor with insight into managements use of capital. In general, higher ROE's point to better managed companies.

One danger looking solely at ROE is the ability of leverage (debt) to overstate ROE. In 2006, Bear Stearns' ROE was over 19% and this was an increase over the prior years ROE of 16%. What occurs is any debt taken on by a company reduces the equity figure. Since the ROE calculation is essentially net income divided by equity, a higher ROE would result for a company that uses debt versus equity to finance its operations. An example:

If you buy a house for $100,000 and borrow $50,000 to buy it, you have 50 percent debt and 50 percent equity in the home. Say the home is worth $110,000 a year later (this really is a hypothetical situation, isn’t it?). Your ROE is 20 percent: the $10,000 gain is divided by $50,000 in equity.

Now let’s say instead that you borrowed $75,000 to buy the home. The ROE would be 40 percent: $10,000 divided by $25,000 in equity. You’ve taken on more debt, but the results look more impressive.

Additionally, interest on debt (as compared to dividends) receives favorable tax treatment as well. The interest is deducted from a company's income before determining the level of taxes owed. On the other hand, dividends are paid out of net income and a company does not receive a tax deduction for the dividends that are paid. A company can enhance its ROE by using debt so long as the cost of the borrowing is less than the company's ROE.

Another way to calculate ROE is to use the DuPont Model. The DuPont Model formula is:


ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage

  • Net Profit Margin = Net Income/Net Sales
  • Total Asset Turnover = Net Sales/Total Assets
  • Financial Leverage = Total Assets/Total Equity

The DuPont formula enables one to see more directly what is driving the increase in ROE.

As an investor analyzes a company and its ROE, it is important to know what is influencing the ratio. A high ROE in and of itself does not necessarily imply a strong management team or ongoing viability of the company.

Source: Checking for Bloated ROE ($)
BetterInvesting Magazine
By: Michael Maiello
January 2009
http://www.betterinvesting.org/Public/Store/Store/Membership/default.htm

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