Dividends and Investors (Part 3)

Are you a chicken farmer, or an egg farmer?

Chicken farmers raise chickens for their meat. Egg farmers raise chickens for what they lay. Investors who plan to sell their stocks to pay for college or to buy a second home are chicken farmers. Investors who hope to use the income from their investments are egg farmers.

The financial press is hopelessly biased against the egg farmer. Every day they report market prices and how they’ve changed. But they almost never report on dividends. This bias causes income-oriented egg-farmer investors to forget who they are and believe that they are chicken farmers. Since they’re confused, they often have a hard time achieving their objectives.

Prices are volatile. If you’re a chicken farmer, when you buy, and especially, when you sell, is extremely important. A chicken farmer needs to watch the market like a hawk. But if you’re an egg farmer, the most striking aspect of dividend payments is how boring they are. They just don’t jump around very much.

Both types of portfolios need management, but managing a dividend stream is different. Risk doesn’t come from market swings, but from factors that endanger a company’s ability to earn profits and pay dividends. Egg farmers like bear markets, because when the market falls they can adjust their portfolios and not pay taxes. By contrast, chicken farmers hate bear markets.

Both approaches are valid; they meet fundamentally different needs. So you never have to ask which comes first.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Dividends and Investors (Part 1)

Why do companies pay dividends?

It’s a good question. After all, dividends reduce management’s flexibility. The company can’t use the money it pays out to invest in research and development or other important internal items. Indeed, a Presidential Commission identified dividends paid as a major way US companies differ from firms elsewhere in the world.

Also, dividends are taxed twice. Companies pay corporate taxes on their earnings, then pay dividends out of earnings. Investors then have to pay income taxes on those same dividends when they receive them. So dividends aren’t very tax-efficient.

But dividends are an admission by the company that the ultimate owners aren’t the managers, they’re the shareholders. Paying dividends gives the owners the option to put the money back into the firm or to do something else with the money. It gives investors more choices. It also eliminates the opportunity for management to do something stupid with that money.

Dividends are totally transparent. Of the many items in a corporation’s financial statements, dividends are the one number that can’t be fudged. Since management is usually highly reluctant to cut them except in extreme situations, they often indicate financial strength as well.

Dividends are a good indicator of a company’s commitment to its current shareholders, in spite of the tax code. It’s no wonder that companies with big, safe dividends often perform quite well.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Dividends and Investors (Part 2)

Oh, grow up.

That’s the advice people need when they act immature. And it’s the advice a lot of companies need, especially regarding their dividend policy.

When a company is young, it needs all the cash it generates just to survive. Later on, growth opportunities abound. The firm can either invest in its own product line, or it can make strategic acquisitions and build out its business.

But there comes a time when a successful corporation needs to return cash to its shareholders. Years ago Microsoft did just that. They had begun paying a small dividend, but in late 2004 they distributed some of their accumulated cash and made a one-time payment of $25 billion. The dividend was so huge that it affected some of the aggregate US economy statistics.

After that, they became more aggressive with their dividends, increasing payments by about 10% a year. There’s no reason why this can’t continue–their earnings have grown about 10% a year as well, and they earn three times as much as their dividend payment. And they still have an ample cash position.

Dividend policies are important. Maturing companies shouldincrease payments to shareholders, who may have better things to do with the money. The primary question is whether management is as mature as the company is.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Overshoot

When people try too hard to hit a target, they often overshoot.

We saw that last week in the disappointing World Cup game against Ghana, when the US shot again and again and again without success. We’re seeing that now in the housing economy. The government wanted to stimulate the housing sector and adopted a home-buyer tax credit. Only they overshot. As the tax-credit was due to expire, more and more people rushed in to take advantage of the program, and the market seemed buoyant.

Now that the program has ended, the housing market looks like a new phase in the Great Recession. Housing sales fell to their lowest levels in 30 years. But that’s just overshoot. Housing wasn’t so hot in the spring, and it’s not so not now. The housing sector is recovering like the rest of the economy, but the stimulus program borrowed some action from the future.

The housing sector is a leading indicator of the economy because it measures what consumers are willing to do with their money. It also anticipates other consumer activities, because after people buy a new home, they often need to update the kitchen or change the carpeting. But when short-term incentives change, then the statistic is less helpful, because demand has been artificially altered.

Housing, like the rest of the economy, is recovering slowly. Artificial measures aside, this will continue for some time.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Getting Lucky

Are the top money managers good? Or just lucky?

Sometimes it’s hard to tell. When Gene Fama and Ken French studied outperforming money managers years ago, they found that most of them were just taking big risks. Thus was born the most humble formulation of the Efficient Market Hypothesis: the market is really hard to beat.

They have a good point. A few years ago I was interviewing international equity managers, and when I examined one who seemed to consistently beat the global developed markets, it turned out that he had a big stake in Brazil and China. In other words, he went outside of his index to beat his index. To my way of thinking, that’s cheating. Brazilian investments are riskier than German ones.

But not everyone cheats. We do observe skill in other professions: lawyers, surgeons, baseball players. It’s not a stretch to think that professional investors show skill as well. And since investors work in a numbers-filled line of work, finding a quantitative way to test for skill ought to be possible.

Only it’s not so easy. While return is simple to measure, risk isn’t. Is it variance? Loss? The likelihood of your company’s CEO testifying before Congress? However it’s stated, risk-adjusted return is the proper yardstick for measuring skill. And top managers have it. Investors just need to ask.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Team Players?

Do we believe in teams, or superstars?

That’s a question for sportswriters. It’s also a question for investors. Years ago mutual fund companies seemed to bank on the rock-star portfolio manager. Superstars like Fidelity’s Peter Lynch were all the rage. They wrote books and gave speeches. Everyone wanted to invest with them.

But a funny thing happened. Companies that put all that capital into a shining star found that the star could lose its luster. First, people are fallible. When Peter Lynch retired, his successors never seemed to fill his oversized shoes. Second human capital has a tendency to grow legs. When a money manager is successful, he often will develop a personal relationship with his larger clients, who might be willing to follow him if he moves to another firm.

So mutual fund companies have been fighting this trend. They’ve stopped telling clients who their managers are. Suddenly, the funds are “team-managed.”

Only many aren’t, really. They’re just as dependent as they ever were on one principal decision maker. Only now, investors can’t tell who that is. Or follow him when he leaves. Not to denigrate teams. They’re great. I work with one. But sometimes they’re used to hide the managers from their clients.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Credit Card Follies

We started out trying to prevent the next financial crisis. We ended up arguing about credit card fees. What’s going on?

When consumers use credit cards, the card companies reduce the amount they pay to the merchant. This discount is called an intercharge fee. Different cards charge different amounts. Visa and Mastercard charge around 2%; Discover charges about 6%. American Express charges 8%.

With credit card transactions now totaling $1.3 trillion, banks make about $30 billion annually. This fee pays for frequent flier miles, cash-back programs, and other perks. Consumers get convenience, credit, and fraud protection. Merchants get guaranteed payment and access to a larger market. The issuing banks get a revenue source of moderate risk that’s stable and growing. What’s wrong with this picture?

The fees are complex: when you read about them, your eyes start to glaze over. Some people feel that the card companies are taking advantage of this. In 2003 Australia cut these fees. Consumers ended up paying higher annual fees and getting fewer rewards. There’s always a cost to Congressional price-setting.

But the larger issue is why this is part of financial reform. The banking system broke down two years ago and needs corrective legislation. It’s hard to see what credit cards have to do with that.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Volker Schmolker

Sent: Sunday, June 20, 2010 11:46 PM
Subject: Global Market Update

The “Volker Rule” is da’ bomb.

That’s what’s coming out of Congress. While I confess to having not read the entire 1500 page Financial Reform Bill, it looks like derivatives trading will no longer be part of a bank’s activity.

Only, it wasn’t their derivatives activities that got the banks in trouble.

Sure, Barings Bank was taken down by a rogue futures trader named Nick Leeson who operated out of Singapore. But that was a compliance problem—everyone knew Leeson wore too many hats. And sure Societe Generale lost $7 billion due to unauthorized equity trading by Jerome Kerviel. But this was a guy who hacked SocGen’s system to get his trades in.

No one thinks that legitimate derivatives trading brought down the banks. It wasn’t their trading, it was their lending. The banks made too many aggressive loans to marginal borrowers and held too many securities backed by these same loans. When the real-estate bubble burst, that took down the mortgages, securities, and the banks that held them.

The Financial Reform bill seems to be just so much theater, giving the impression of reform without really changing a thing. It may encourage Goldman to settle with the SEC, but it doesn’t look like it will change much.

There are ways that our banking system could be improved. But the “Volker Rule” isn’t one of them.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

Good Beginnings

Well begun is half done.

When you’re investing, most of the work is done before you ever spend a penny. We’ve discussed before how important beginnings are; having a sound investment plan based on your total financial picture is three quarters of the task. It’s the same with many things: the foundation you lay determines how the rest of the product turns out.

A home’s foundation needs to be level and solid. A car’s frame needs to be true and stable. And in this season of graduation and commencement, it’s important for teachers and parents to lay a straight foundation for the young lives that they touch.

In my case an outstanding history teacher challenged me to get past my initial impressions and explore the deeper issues. I distinctly remember the day he took me aside and informed me that pedestrian prose and superficial analysis would not be accepted in his class. I was shocked; I thought I’d been doing okay. His challenge for me to do better than I imagined has stayed with me through the years.

In investing as in life, it’s critical to get to the bottom of things and understand what’s really going on. A key comment to a growing mind can go far towards encouraging this crucial trait. Thanks, Mr. Anderson, for helping my foundation to set right.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net

The Gods Must Be Angry (Part 2)

How do you win the favor of an angry god?

The traditional answer is to sacrifice. When Artemis was angry with Agamemnon and prevented his army from sailing to Troy, he sacrificed his daughter and gained the goddess’ favor. I mentioned how BP had angered the energy gods by its hubris yesterday. It seems that today they sacrificed their equity investors by suspending their dividend.

But it’s only a token sacrifice. The company earned $8 billion in the first quarter and had planned to pay $2.6 billion in dividends. They’ve agreed to put just over $1 billion a quarter into a special fund for claims. That’s not even half what they normally pay to equity investors.

The company isn’t going to sell any of its crown jewels, like the Prudhoe Bay oil field in Alaska. And they’re not cutting staff or freezing salaries. Instead, they’re diverting some of their excess to this fund. And by agreeing to contribute to the fund over four years, they make the fund claimants their partners, not their adversaries, just as the Tobacco companies did 10 years ago.

But the gods aren’t so easily fooled. If an ancient deity wasn’t satisfied, he could continue to persecute. If the slick continues to grow, lightning bolts will fly.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

Follow me on Twitter @GlobalMarketUpd

direct: 603-252-6509
reception: 603-224-1350

www.chartertrust.com • www.moneybasicsradio.com • www.globalmarketupdate.net