Schreiber and Stroik, All About Dividend Investing

What’s all the fuss over dividends? Do they really make that big a difference? In All About Dividend Investing, 2d ed. (McGraw-Hill, 2011) Don Schreiber, Jr. and Gary E. Stroik argue that they make a huge difference. In a classic dividend story they compare the portfolios of twins who were each given $10,000 in 1944 to invest in companies that made up the Dow Jones Industrial Average. The twin who spent his dividends each year had a portfolio worth $767,000 in 2009; he spent more than $370,000 in dividend income from 1944 through 2009.The conscientious twin reinvested his dividends until he retired in 1984 and needed his dividend income to help support his lifestyle. By the end of 2009 his portfolio was worth more than $4.7 million, and since 1984 he had collected more than $1.7 in dividends. So the first twin realized a little over $1 million from his initial gift; the second, about $6.5 million.

Dividend stocks are often recommended in down cycles. In the particular cycle the authors picked (or cherry-picked) $100,000 invested in the DJIA Index in 1966 would have declined to $90,275 by 1981. Had a person reinvested dividends, thereby acquiring more shares as prices were falling, the account would have been worth $186,661 in 1981. And had he taken his dividends in cash, he would have received $64,978 over those years; instead of losing $10,000 he would have netted about $50,000.

In bull markets dividend-paying stocks may underperform the more speculative non-dividend-paying growth stocks (in 1999 the NASDAQ gained 85% while the DJIA advanced only 25%). But with dividends reinvested the return would have increased substantially. An investment of $100,000 in the DJIA in 1982 would have been worth $1,302,760 at the end of 1999; with dividends reinvested, the value would have been $2,056,109.

The authors are writing for the relatively uninformed investor. They offer basic advice on how to screen for stock candidates and how to rank them. They outline alternatives to individual stocks such as folios, ETFs, and mutual funds. They explain simple risk management techniques and write about the current tax treatment of various kinds of dividends.

All About Dividend Investing is a good book for investors who are planning for their retirement needs, although it may not take the place of a financial planner. It offers a model portfolio: 70% dividend payers, 14% tactical choices, 14% noncorrelators, and 2% cash. Within the dividend payers segment the allocation is equally divided into five slices: value, growth, quality, yield, and overall best. But then the reader has to get down to work to find the right stocks to plug into these slices. Otherwise, he can use what he learned to find the right advisor for his needs.

Dion, The Ultimate Guide to Trading ETFs

The Ultimate Guide to Trading ETFs: How to Profit from the Hottest Sectors in the Hottest Markets All the Time by Don Dion and Carolyn Dion (Wiley, 2011) is a workmanlike account of the benefits and pitfalls of investing in ETFs, many of which have been amply documented in the financial press and on blogs. The authors, however, give structure to the tidbits that the investor can pick up from other sources. The result is (contrary to the subtitle) a well-organized, balanced book that should serve the ETF investor well.

Although most investors know the advantages of ETFs over mutual funds, they are undoubtedly less aware of some of their potential disadvantages. The authors begin with the basics: appropriateness, liquidity, and concentration. Consider liquidity, for instance. The authors explain that ETFs have both primary and secondary liquidity. Primary liquidity refers to the liquidity of the fund’s underlying basket of securities whereas secondary liquidity refers to demand for the ETF itself. If either primary or secondary liquidity is lacking or dries up, the ETF “will tend to trade at a noticeable premium or discount” to its NAV. (p. 9)

Domestic, international, and derivative-based ETFs each come with their own sets of complications. International ETFs can become disconnected from their underlying equities because of time-zone differences; futures-based funds can trade at significant premiums to their NAV when position limits are imposed or threatened.

I appreciate a book that exposes the underbellies of trading vehicles since too many investors have a decent investing idea (hedge a winter’s supply of heating oil with an ETF, circumvent the short-selling restriction in an IRA by buying short ETFs, increase leverage with the 2X and 3X ETFs, gain exposure to an individual country with an ETF) without truly understanding the product they are using to execute their idea. How closely does it track the underlying? Is it best used for short-term trading or investing?

The authors stress again and again that the investor has to educate himself. For example, “there is a world of difference between … iPath Dow Jones-UBS Platinum Subindex Total Return ETN (PGM), which is based on platinum futures contracts, and ETFS Physical Platinum Shares (PPLT), which is backed by a physical stockpile of platinum. The word ‘platinum’ is the only thing these two funds have in common. The ways they provide exposure to that market are diametrically opposed.” (p. 152)

The book also has useful appendixes. One ranks all U.S.-listed ETFs and ETNs (as of April 30, 2010) on a scale of 1 to 5, a scale which is intended to be a guide to their complexity. A second is a tax guide for ETF investors. Yet another appendix offers sample portfolios for various trader/investor types.

The Ultimate Guide to Trading ETFs is not a revolutionary book. But any ETF investor who is not familiar with all of the material included in it is bound to stumble.

Waltzek, Wealth Building Strategies in Energy, Metals, and Other Markets

I have many vices, but listening to talk radio (Internet or otherwise) is not among them. Reading Chris Waltzek’s Wealth Building Strategies in Energy, Metals, and Other Markets (Wiley, 2010) doesn’t tempt me to change my mind. Waltzek is the host of Goldseek.com Radio, a weekly two-hour broadcast. He has thousands of enthusiastic followers, some of whom have written glowing reviews of this book on Amazon.

Well, it’s certainly different from the run-of-the-mill investment book. Where else can you read about survivalist techniques to ensure against food shortages and rationing, commonplace in times of rampant inflation? If you really want to know, “a home-based safety net can be purchased for less than $5 per week, by simply adding a few canned items and/or a 5 lb. bag of rice to the grocery store shopping cart on each visit.” (p. 79) And then there’s the home garden, which I happen to have but never viewed as a key to survival in the event of runaway inflation. Waltzek even explains how to grow potatoes which, “pound for pound of yield, … requires 75 percent less garden space than does grain or rice.” An interesting statistic, but how many home gardeners grow grain or rice? Perhaps more telling, “Since potato tubers grow underground, unlike tomatoes, corn, and so on, hungry neighbors are far less inclined to borrow a meal without express written permission.” (pp. 79-80) He also recommends replacing credit cards with a cash emergency fund, best kept in a fireproof home safe in the event of a prolonged bank holiday.

It is within this “build the bunker” framework that Waltzek recommends investing in precious metals (especially silver) and energy. “Thanks to Fed monetary gamesmanship the greenback has relinquished 99 percent of its purchasing power since the unconstitutional Federal Reserve seized control of the national money supply.” (p. 47) The United States is following a monetary path similar to Voltaire’s France and risking Voltaire’s doomsday prediction: “Paper money eventually returns to its intrinsic value—zero.”

Waltzek also devotes considerable space to the housing crisis and offers rules of thumb that “every home hunter needs while stalking real estate prey” in 2012. And for those not familiar with Sun Tzu’s The Art of War and the uninspired Sun Tzu’s Art of War for Traders and Investors, Waltzek provides a few summary points.

“Standing on the shoulders of the great philosopher and mathematician, Vilfredo Pareto, as well as Taleb and Mandelbrot,” the author presents his major theoretical contribution: the Pareto-Waltzek Hypothesis. It comes in the form of two rules. First, “although prices typically gyrate in a random manner, eventually all markets enter protracted trends.” (p. 10) And second, “all primary market movements (trends) are the result of at least one fundamental event, the significance of which is rarely recognized at the time.” (p. 13) Punkt.

If you are anti-government and anti-Fed, and if you think it’s essential to prepare for a financial Armageddon, you may like this book. If you really want to learn about commodity investment strategies, much better alternatives are available.

Bogle, Don’t Count on It!

Don’t Count on It!: Reflections on Investment Illusions, Capitalism, “Mutual” Funds, Indexing, Entrepreneurship, Idealism, and Heroes (Wiley, 2011) is an anthology of recent writings and speeches by John C. Bogle, the venerable founder of Vanguard. It is a substantial book, over 600 pages long, and, as its subtitle indicates, covers a range of topics. Here I’m going to confine myself to two. I’ll begin by exploring three principles that underlie Bogle’s well-known case for low cost passive index funds. Then I’ll jump to the lecture he gave to the Risk Management Association in October 2007: “Black Monday and Black Swans.”

Why, according to Bogle, is it preferable to invest in broad index funds rather than actively manage a portfolio? First, “the past is not prologue” (p. xxiii) or, put another way, “historic stock market returns have absolutely nothing in common with actuarial tables.” Bogle continues, quoting Keynes: “’It is dangerous to apply to the future inductive arguments based on past experience [that’s the bad news] unless one can distinguish the broad reasons for what it was’ [that’s the good news]. For there are just two broad reasons that explain equity returns . . . (1) economics and (2) emotions.” (p. 7) The math here is blissfully elementary. Add earnings growth and dividend yield to get investment return. Calculate the percentage increase in the P/E ratio to get the speculative return. Add investment return and speculative return to get total return. “In the short run,” Bogle writes, “speculative return drives the market. In the long run, investment return is all that matters.” (p. 66)

Second, actual investor returns and theoretical market returns are miles apart. About 98 percent of the theoretical return of $212,000 on a $1,000 investment 50 years ago would have gone up in smoke as a result of inflation, intermediation costs, and taxes (and here Bogle assumes a hit of only 2% for taxes). We end up not with $212,000 but a mere $4,300.

Third, we should respect the power of reversion to the mean: “reversion to the mean is the rule, not only for stock sectors, for individual equity funds, and for investment strategies that mix asset classes, it is also the rule for the returns provided by the stock market itself.” (p. 65) A chart showing the investment real return of $1 versus the market real return (1900-2009) nicely illustrates this point.

Now on to Bogle’s lecture given on the twentieth anniversary of Black Monday (October 19, 1987). In this lecture Bogle reviewed the literature on risk and uncertainty: Popper, Knight, Mandelbrot, Keynes, and Minsky. Elaborating on Minsky’s prediction that the financial economy would come to overwhelm the productive economy, Bogle said: “When investors—individual and institutional alike—engage in far more trading—inevitably with one another—than is necessary for market efficiency and ample liquidity, they become, collectively, their own worst enemies. While the owners of business enjoy the dividend yields and earnings growth that our capitalistic system creates, those who play in the financial markets capture those investment gains only after the costs of financial intermediation are deducted. Thus, while investing in American business is a winner’s game, beating the stock market—for all of us as a group—is a zero-sum game before those costs are deducted. After intermediation costs are deducted, beating the market becomes, by definition, a loser’s game.” (pp. 177-78)

In this lecture he also pointed to the staggering growth of the financial sector. Financials accounted for only about 5 percent of the earnings of the S&P 500 25 years ago; in 2007 that figure was 27%. Adding in the likes of GE Capital and the auto-financing arms of GM and Ford, he figured that financial earnings probably exceeded one-third of S&P 500 annual earnings. This growth was spurred by the explosion in intermediation costs and the boom in complex financial instruments.

By October 2007 banks were beginning to cut the values of their mortgage-backed portfolios, a clear sign that systemic risks were rising. But how, Bogle asked, “can it be that risk premiums on stocks are at less than one-half the historic average?” He quoted Alan Greenspan, who said in 2005: “History has not dealt kindly with the aftermath of protracted periods of low risk premiums.” (pp. 182-83) Indeed.

Don’t Count on It! is a wise book. As most traders and investors remain convinced that they can beat the market, it’s always sobering to hear a compelling voice from the other side.

Rotblut, Better Good Than Lucky

It seems that Lefty Gomez, who played for the Yankees in the 1930s, gets credit for having said “I’d rather be lucky than good.” Charles Rotblut turns this around in his book title: Better Good Than Lucky: How Savvy Investors Create Fortune with the Risk-Reward Ratio (W&A Publishing, 2010). His central tenet is that being a successful investor is about making good decisions, not about being lucky.

In this slight book Rotblut introduces the beginning investor (as well as the investor who is trying to rejigger his portfolio in a more thoughtful way) to the rationale for value investing and to some of its basic principles.

“One reason,” he writes, “why stock prices rose too much in the 1920s and the 1990s—as well as other periods—was that forecasts were given more weight than valuations.” (p. 9) Analyst forecasts usually have about as much predictive value as the divination that comes from reading entrails. “Placing an emphasis on valuation provides a margin of safety against making mistakes.” (p. 10)

Rotblut takes the reader through the fundamentals of corporate analysis: business models, the balance sheet, income statement, and cash flow statement. He then cuts to the chase and offers what he considers the two most profitable measures of valuation (price-to-book and price-to-earnings) and “a sanity check to ensure you are not overpaying for a stock” (discounted cash flow).

Book value, the theoretical value of a company’s net assets or equity, is according to many studies the best valuation measure of a stock’s performance because “no quality company should sell for a price equivalent to or less than its theoretical liquidation value.” (p. 123) But the P/E multiple should not be ignored, since a high P/E increases the possibility of downside risk whereas a low P/E increases the potential for upside reward. DCF, a mathematical model that calculates the current worth of a company’s future cash flows and that is most often invoked to calculate a stock’s price target, should be used not “to determine a stock’s worth, but whether a stock is undervalued or overvalued relative to its projected future cash flows.” (p. 166) As rules of thumb Rotblut recommends looking for stocks trading at a P/B multiple of 2.0 or lower, a P/E of 12 or lower, and a discount of 10% or more to their DCF-calculated value.

Better Good Than Lucky is an entry-level book. In addition to its discussion of value investing it explains where to get investment advice, how to apply modern portfolio theory, and how to own stocks and still sleep at night. Rotblut, by the way, makes one recommendation that should be followed by everyone, quite independent of investment style: keeping an investing journal, writing down the reasons you bought each stock as well as the factors that would cause you to sell it.

Investors who want a meaty book would be better served with John Price’s The Conscious Investor. But for those who want a quick and easy introduction to value investing, Rotblut’s Better Good Than Lucky is an excellent choice.

Statman, What Investors Really Want

Meir Statman’s What Investors Really Want: Discover What Drives Investor Behavior and Make Smarter Financial Decisions (McGraw-Hill, 2011) is a book that every investor should read. Statman is an academic, but he writes like a best-selling author. He uses the findings of behavioral finance, in which he himself has done extensive research, to expose the mistakes we make and to offer advice that ranges from the “ka-ching” practical to the rabbinical.

For those who are acquainted with the mainstays of behavioral finance literature, let me assure you that there’s a lot of new material in this book. Even where Statman covers familiar ground, he does it in such a winning way that he often unlocks something that was hitherto unknown, or repressed.

He uses the World’s Work, a magazine published a century ago, as well as Internet ads to illustrate his points. He retells stories about such characters as the notoriously stingy Russell Sage; he writes about herding from China to Finland, from librarians to institutional investors. He explores the rationalization that allows investors to find it easier to sell losers in December than in November: “What is framed as a loss in November is framed as a gain, in the form of a tax deduction, in the following December.” (pp. 142-43)

Statman also ventures into world of values because ultimately, he argues, “investments are about life beyond money.” He explores socially responsible investing, our demand for fairness, and our investments in our children and families.

All in all, this is a rich book—and a book that might make you richer in a multitude of ways.

Standard & Poor’s 500 Guide, 2011 Edition

This is a very big paperback—8 ½” x 11”, more than 1000 pages, and weighing in at about 4.5 lbs. With so much information available online, why would anyone need this book? I can think of several compelling reasons.

First, a personal preference: I enjoy flipping through pages, making serendipitous discoveries. I don’t have the same kind of experience online since I normally am looking for something specific, not just seeing what comes my way.

Second, the two pages devoted to each company in the S&P 500 are jam-packed with data, including ten years of company financials (per share data, income statement analysis, and balance sheet and other financial data), five years of revenue and earnings per share, and the five most recent dividend payments. The summary of the company’s business is also more analytical than the run-of-the-mill online fare.

Third, and taking up almost half of the space allocated to each company, is proprietary S&P information, ranging from analysts’ reports to the famous five-star system of investment recommendations. The analysts’ reports, I should note, are not especially timely; some date back to July and the most recent are from October. The book seems to have gone to press in late October; most of the closing prices are from October 22.

Other data include S&P’s qualitative risk assessment, its quantitative evaluation, and each company’s relative strength rank. There is also a price chart from June 2007 through October 2010 overlaid with S&P proprietary metrics.

For the reader who cannot live without stock screens, the book provides lists of companies with five consecutive years of earnings increases, stocks with A+ rankings, rapid growth stocks, and fast-rising dividends.

The book is somewhat unwieldy to handle (it’s definitely best read on a desk, which I personally find awkward), but this is a small price to pay for the amount of information available.