Relevant and even prescient commentary on news, politics and the economy.

And So Happy Xmas…Now with Canadian Content

A couple of days ago, James Bianco, chez Ritholtz, noted a WSJ article entitled “Dividend Stocks Become the Heroes”:

This year, the 100 stocks in the Standard & Poor’s 500-stock index with the highest dividend yields are up an average of 3.7% before dividend payouts, according to Birinyi Associates. The 100 lowest-yielding stocks are down an average of 10%.

Is this a good idea? I understand the move to dividend-paying stocks—companies that admit they don’t know what to do with their excess cash are almost by definition better-run than those that hoard it without announcing future plans for its use (hi, MSFT!). And some companies have a lot of excess cash right now.

But there is a difference between paying a dividend because it’s the best use of funds for your investors and having a high dividend yield. Don’t believe me? Ask Bank of America shareholders ($2.56 Annual Dividend, just under an 8% yield) ca. 2008:

Or those who bought The Big C for its $2.08-cents-per share Annual Dividend (around 6-7% yield) in late 2007*:

Of course, banks might be the except. But here’s the past five years of Toronto Dominion, which was paying around a 3% p.a. Dividend** around the same time period:

What would have happened to your overall investment if you had gone for the higher-paying firms? It’s not pretty:

I like dividends; they’re an admission from a firm that it doesn’t know better than its owners what to do with some of its cash. But high-yielding dividends are often a sign of bad management giving away “excess” cash in good times.***

The first rule of finance: when something appears too good to be true, it probably is. Caveat emptor and may all your investments for 2012 be good ones.

*The graphic scale and dividend amounts were distorted somewhat by the 10:1 reverse split earlier this year.

**An annual dividend of US$2.28, with the stock trading around US$70-75 per share.

***This is not an unusual story, sadly. The collapse of LTCM, for instance, occurred after the fund gave much of its investment monies back to investors and then count not remain solvent for so long as the market remained irrational. (The contemporary equivalent is MF Global.)

(cross-posted from skippy the bush kangaroo)

Everything Old is New Again, The "Value" of Active Investment Managers Edition

First, there was Fred Schwed’s Where are the Customer’s Yachts?, which is still the standard bearer for why Money Managers are overpaid.

Now (via the NYT) there is The Investment Answer (preface here [PDF]).

The Prologue opens more Matt Taibbi than Jason Zweig:

Wall Street brokers and active money managers use your relative lack of investment expertise to their benefit…not yours

Of course, they have a method That Will Work to solve this, which looks suspicuously like what those Active Money Managers say they do. And what you would think Economic Theory would tell you to do, which may be why they have the endorsement of Eugene (“the markets are too efficient”) Fama among many others.

Perhaps it’s time for economists to model why economic theory doesn’t work?

The last time people realized their money managers were taking them for a ride, the market basically sat still for a generation. Whether this dying text is a leading indicator is left as an exercise, though not an academic one.

"Banks Just Don’t Go Under"

Did no one in Georgia pay attention in the 1980s?

It’s not just reputations that are on the line. Board members, also known as directors, could be held personally liable for a bank’s demise.

Experts are expecting a wave of lawsuits against directors to be filed in Georgia over the next year or two as regulators and shareholders seek someone to blame — and someone to pay — for the state’s bank failures.

Eleven Georgia banks have failed in the past eight months, the most in the country, and experts say many more troubled institutions are in danger of being shut down.

But recovery, of course, is just around the corner.

Stock Market Premia, or, Everything Old is New Again

I don’t like talking about stocks. I believe the market is rigged, that the allocations do not favor the investor who is not also a senior executive of the company and/or a member of the Board of Directors, and that reported profits and losses on a quarterly basis is a lousy way to run a company. And those are the moderate objections on a good day.*

That said, I have occasionally commented at Marginal Utility on the wisdom of investing in stocks. When not citing this article, I often reprint a graphic from Burton Malkiel’s A Random Walk Down Wall Street:

This one is fairly easy to explain: when P/E multiples are running high in the market, mean reversion tends to happen. No allocation requirements, no changes in attitude or latitude at the drop of a FedFunds rate: just reasonable odds of whether you will make money on the investment.

(Doesn’t mean you won’t make money, just means it’s “the way to bet.”)

So it comes as little surprise when Felix cites “a handy tool” by Rob Bennett “based on one of Robert Shiller’s favorite indicators, P/E10, or price to previous ten years’ average earnings”:

Right now, P/E10 is at about 22, which mean that stocks are expensive, by historical standards: Rob reckons that fair value, for stocks, is about 14 or 15, and that anything above 20 is “truly dangerous”:

There have been three occasions when we have gone to P/E10 levels above 20. On those three occasions, the average loss in the years that followed was 68 percent. So the general rule is to lower your stock allocation when the P/E10 level goes above 20.

Felix goes on to note several catches that amount to “past history is not necessarily a predictor of future events”:

For one thing, I just don’t think that many investors have anything like the requisite amount of patience needed – where you can happily sit back for a decade or two waiting for the P/E10 to come down to the mid-teens before going overweight equities.

And for another thing, I’m far from convinced that the behavior of the stock market a century ago, when both the world and corporate capital structures were very different from how they look now, can really teach us much about stock-market investing. I don’t believe that the stock-market asset class has rules which govern its long-term behavior, and I can easily believe that we will never again see the S&P 500 trading on a P/E10 of less than 15. (It’s already been 20 years, and I certainly don’t believe that discount rates are likely to go back up to their 1988 levels any time soon.)

But in the end, his argument comes down to the core issue of investing:

I’ve worried for a while that stocks aren’t an attractive asset class any more. The problem, of course, is that there’s not very much in the way of alternatives. And in any case, according to Rob, if I put all my money in stocks today, I can expect a real return of 5.65% over the next 30 years; 4.65% would be unlucky. I’d be happy with that, I think.

If you want to know why we occasionally get speculative bubbles in various markets, there may be no better explanation than that paragraph.

*I have no problem with the Churchillian assertion that it is “better than all others,” but taking that as a sign of encouragement requires a Pollyannaish, or at least DeLongian [PDF], temperament.