One of the obstacles that prevents people from being successful investors is that buying stocks tends to lack the tangibility that owning a small business (like a storage unit or cash wash in your community) or real estate can provide for an investor.
When it comes to stocks, it’s an acquired taste to reach the point where you think in terms like these, “Each share of McDonald’s earned $3.67 in 2008, $3.98 in 2009, $4.60 in 2010, $5.27 in 2011, $5.36 in 2012, and $5.55 in 2013, while returning between 47% and 56% of those profits to shareholders in the form of cash dividends over that time frame.” Instead, the initial impulse is to think, “Oh no, the stock fell from the $60s to the $40s in 2008, better sell because this isn’t working.”
Unless you spend a lot of time studying this stuff, it’s easy to think of the stock market as an arbitrary place where things go up and down—after all, that’s what happens on the day-to-day basis, while ignoring the fact that they represent ownership interests in a business.
That’s where I think dividends come in—when you can see the cash coming in each year, it’s a nice reminder, “Hey, there’s a business here, rather than just two or three letters on a screen.” When someone finds himself owning a nice piece of real estate is generating $1,000 per month in rental income after all expenses are accounted for, and assuming the headaches from the tenants are minimal (and this can be a huge if, depending on the location), you’re not going to freak out because the price of the property fluctuated from $150,000 to $140,000 when you look up estimated values of the property online. You know what you own, you receive value from the rents, and the tangibility of the whole experience can be a nice deterrent against short-term thinking.
The problem for investors in the public markets today is that it’s hard to reach a situation where you can get dividend yields that roughly approximate what you’d be generating from owning rental properties or a high-cash producing asset outright.
Imagine having a situation where the GDP declined a percentage point or two, commodity prices slumped, the broad stock market experienced a decline of 20% or so, and the price of BP overshot on the downside to something like $30 per share. It doesn’t feel like it at the time, and you wouldn’t know it from watching CNBC or following most financial news outlets, but that would be the opportunity to lock in the path to riches.
In BP’s case, the $2.34 dividend would give investors an initial yield of 7.8%. We haven’t seen that since the oil spill brought prices down to $27, and again, no one would be talking about how great it is at the time, but could you imagine locking in those shares. With a rental property, it takes hard work and the hassle of dealing with tenant repairs and filling in tenant vacancies to get annual returns in that range. If you could get your hands on BP stock for $30 per share, you’d be able to write your check, and do nothing thereafter while you’d be able to approximate the riches of someone who is out there grinding it out for those kinds of returns.
It’s potential situations like that which explain why investors like Charlie Munger, Seth Klarman, and Donald Yacktman, and Buffett too, like to keep gigantic sums of cash on hand. There is a lot of wisdom in staying fully invested because your assets are always working for you to produce cash, but there’s also an intelligent rationale for a shrewd investor to stack cash up to strike when a good opportunity arises. Usually, the window of opening for good deals is only a couple months or a year at most, and it’s reasonable to want more money than you could generate from a two-week paycheck to be able to invest into the market at that time.
Imagine writing a check for $30,000 worth of BP stock at that time to add 1,000 shares to your account. You’d be collecting $2,340 in immediate dividends. If you were able to reinvest them while prices were so low, you’d pick up 78 more shares and then have 1,078 shares heading into next year’s dividend increase. If BP management raises the dividend to, say, $0.61 per share, you’d suddenly be collecting $2,630 in annual dividends without having to do anything additional, while your yield-on-cost rose to 8.76%.
It’s funny—when Buffett goes on tv and talks about how he likes stock market declines and general pessimism not for the very real harm they cause to the economy but rather the prices produced in the stock market, he gets a patronizing look from everyone in the vein of, “How can anyone want to see stock market declines?” Yet, when you run the numbers, that’s where the money gets made.
Conoco, Royal Dutch Shell, and BP have a long history of shooting a bit more than necessary when stock market corrections arrive. When things go down 20% among non-cylical companies, you tend to see those high-quality assets go down 30-35%. You prepare for that situation by building up cash and then writing a check when the low prices present themselves. Buying oil stocks tend to work out well over the long-term when you buy at fair prices, but if you are able to buy any of those three companies at something resembling low prices, you end up getting the kind of annual income that usually only exists in the private markets.
The added advantage of getting high initial dividends is that the experience becomes much more tangible. When you own something that immediately pays you $60-$75 per year on every $1,000 that you invest, you’re not going to sell when the price falls. You’re going to find it easy to enjoy the asset and keep collecting the dividends.
Originally posted 2014-10-22 08:00:25.