Monday, April 27, 2009

Why Dividends are Important—Part III

By Steve Cook.
Steve Cook has 36 years experience in trading and analyzing both fixed income and equity securities, as well as in private placements of debt and equity. CJS Research is currently offering a 30 day free trial of their Dividend Strategy Product.
Why Dividends are Important—Part III

Quick, what’s a stock worth?

Answer: the discounted value of future cash flow. Not book value, not a new technology, not a hundred and one of other factors that you can name.

Sure all those factors may bear on a stock’s dividend or the price for which a stock is ultimately sold. But the only way we as investors get paid a return for the money we invest in a stock is to either have that money returned to us as dividends, or to sell that stock at a price higher than we bought it. Everything thing else is just a bunch of numbers on a piece a paper. You can’t eat them or spend them.

Now think about the decision making process that the companies in whose stock you are investing go through when they make an investment decision. The rate of return on a project is equal to the discounted value of future cash flow--what the project will be ‘worth’ in ten years is irrelevant.

For the company
  • it is when do we get our cash back,
  • how much do we get back
  • and what is the probability of both?
In these calculations, the quicker the return and the higher the probability of the return, the more the cash flow is worth.

So why should you or I analyze our investments any differently? Why should the future market value of a project (price of a stock) matter more to us than it does to the guys who are running it? And why should the future value of a project (price of a stock) matter more than the current return on that project?

A simple way of thinking about this is as follows: Suppose that you just bought Coca Cola today and I offer you three opportunities to increase your investment return on Coke, pick one.
  1.  if Coke pays a dividend on its next scheduled payment date, I will give you a $500 bonus,
  2.  if Coke pays a dividend equal to or greater than its last dividend payment, I will give you a $1,000 bonus 
  3.  if the price of Coke’s stock on its next ex dividend date is higher than it is today. I will give you $1,500.
Which one would you take? If you didn’t chose (2) stop reading, take the dividend you earned from Coke and go buy a Playboy.

The point is that of the two sources of potential return on your investment, (1) dividends a lot more likely to occur on a short term basis than capital gains (2) they are an immediate return on money that you can either re-invest or spend--its Your Money and your choice and (3) a rising stream of cash flow is worth a lot more to you [and corporate management] today than what the project [stock] generating that cash flow might be worth five years from now.

News on Stocks in Our Portfolios

3M (Dividend Growth Portfolio) reported first quarter earnings per share of $.81 versus expectations of $.86 and $1.38 reported in its comparable 2008 quarter.
Subscribe to All American Investor via Email