Dividends are VERY SEXY-- no joke

About three years ago I split my portfolio in half between three Vanguard mutual funds and seven dividend paying stocks. I did this based on the theory (and a decades of data indicating such) that a basket of dividend paying stocks will appreciate over time at a greater rate than non-dividend-paying stocks. So far, so good. Although both halves appreciated, the stocks lead the funds by 6.6%.

In essence I created the Sheldon Index. Given there are no taxes to pay in a Roth IRA this approach focused on dividends actually should appreciate even faster than the historic data which does include taxes. The three mutual funds are the Vanguard Total Stock Market Index, the Total International Stock Index and the Health Care (managed) fund which is sometimes closed to new investors and has a spectacular track record. The seven stocks are Johnson & Johnson (JNJ) , Mercury General (MCY), Municipal Bond Insurance of America (MBI), Merck (MRK), Petro China (PTR) , Southern Company (SO), & Washington Mutual (WM). All pay dividends and have consistently for years and all were purchased at great prices. I could have picked any number of other companies but these were the ones providing value at the time and each one has a story. The PTR story I shared in an earlier post.

So how do our great eight size up? Not very well.

Some Dividend (Only GE would make the "Sheldon Roth Index") GE has a yield that exceeds the market average which is a must for my Roth experiment. I do not own any currently but it has been on my watch and I would buy some if I got a steal, otherwise forget about it. It is too big. Of the eight the only one I own is TWX, but not in my Roth, and that will story will appear in the near future.

• General Electric (GE) = .94 (2.9 Yield) ,
• Microsoft Corp (MSFT) = .34 (1.5 Yield)
• Wal-Mart Stores (WMT) = .67 (1.3 Yield)
• Time Warner (TWX) = .15 (1.1 Yield)

No Dividend No stability here. This group is highly speculative and there is far less assurance that any of them will exist in their current form a few years from now. The likelihood of a dividend is also far off.

• Apple Computer (AAPL) =  0.0
• eBay Inc (EBAY) = 0.0
• Google, Inc (GOOG) = 0.0
• Yahoo Inc (YHOO) = 0.0

The great eight stink as an index focused on dividends and consistency. However there might be some value here when we add ROIC as a consideration from my previous blog: Screaming: Google (GOOG) 50.01 & Apple (AAPL)  26.31 Worth while: Microsoft (MSFT)  16.38,  eBay (EBAY) 15.81, Wal-mart (WMT) 14.81 Poor: General Electric (GE)  5.31 & Time Warner (TWX)  4.41 You must be joking: Yahoo (YHOO)  0.00

The Run Down: Clearly Yahoo with no dividend and zero ROIC does not look worthy of investment. There might be other reasons to consider this stock for investment but not here and not now. Only General Electric offers a better than average dividend to their marginal ROIC. Over time that is very powerful. In the case of GE what makes this worth adding to your watch list is that they have the highest probability of continuing to perform consistently for years and they will likely grow at least as much as the world economy does. If you buy this company on sale, say at just a 10% discount from the long term growth path then you will have one very strong long term core holding. 

MSFT, WMT, TWX from a dividend perspective do not beat the S&P average so other motivations are required for me to have an interest. However, all three seem to be in a malaise, perhaps because of their size, or more likely because they do not seem to have a definitive plan for significant growth-- again this may be a reflection of their scale. Apple has performed well over the past few years but you have to wonder if they will continue to grow since inventing the next IPOD type product does not have a high level of probability. Google has the same problem with a ridiculous ROIC over 50% (but no dividend). Their original product for web advertising will not be equaled by anything they are considering now and that means growth has to slow. As for eBay after spending a fortune on Skype it has to demonstrate how they are going to translate the investment to cash flow.

Dividends tend to be indicative of a more predictable future.  You often read that companies on steep growth paths with high ROIC should not be offering dividends and that to start one is throwing in the towel.  I think that this is not so. This is contradictory in some ways because not having a dividend also shows less confidence in the companies future cash flow and the need to protect cash because of uncertainty in the business.

Combining dividends with the ROIC adds some clearity to the investment picture for our great eight which indicates they are not so great. Other metrics to be added in later blogs will contribute to better understanding but all is predicated on finding the right price points for a buy and these companies do not appear to be there from my perspective.

I have stated before and it is worth repeating a thousand times: Warren Buffett the undisputed king of investors does not believe in paying a dividend as long as he can invest the cash better than his shareholders (which he has been right about) However, MOST of his stock purchases and long term holdings DO PAY A DIVIDEND and the latest two examples of BUD and WMT are good examples. The most basic premise of value investing is buy good companies at a discount and this means dividend paying companies for good cash flow and consistency over time which is VERY SEXY.