Insurance Against Management Stupidity

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Think about all the dumb (or at least regrettable) things that companies have done with the money at their disposal. For example, here are a few stupid mistakes that many companies have made:

• Bad buybacks. In 2007, Starbucks (Nasdaq: SBUX) spent close to $1 billion buying back shares of its stock at around $30 per share, on average. Not too long after, the stock was trading for about $7 per share -- it has recently recovered to the low $20s. General Electric (NYSE: GE) spent almost $8 billion buying back shares in the fourth quarter of 2007 -- when the stock was trading in the $30s. Shares then fell to below $6 before recovering recently to around $16.
• Falling behind. Motorola (NYSE: MOT), a cell-phone pioneer, has struggled to keep up with competitors. That has cost the company billions in losses and forced it to suspend its dividend this year.
• Ill-advised acquisitions. Time Warner (NYSE: TWX) and AOL executives might have spent their energies more profitably had they not agreed to merge in 2000. Many sources cite figures that as many as two-thirds of all acquisitions fail to produce the synergies expected by the companies involved.
• Overpaying executives. In 2008, Abercombie & Fitch's (NYSE: ANF) stock plunged 71% while its CEO received $71.8 million in compensation, according to CNN Money. The same study says that International Paper's CEO took home $38 million in 2008 while the company's stock dropped 63%. And according to Forbes, Chesapeake Energy's (NYSE: CHK) CEO received compensation topping the $100 million mark in 2008.

It's all head-shaking stuff, isn't it? Here's the main problem, though: That wasted money didn't belong to those companies' managements -- it belonged to the shareholders, to investors like you and me.

A nice tonic
Fortunately, there are ways to combat management stupidity. One good way is to oust an ineffective leader and install a more effective one. But this sometimes takes time, time during which a company loses value (or doesn't grow in value as much as it otherwise might have). Another way, one we rarely think of, is this: dividends.

That's right. As long as a company pays a generous dividend, it's obligated to cough up a certain significant amount regularly, to be paid to its shareholders. Some grouse that this is an ineffective way to reward shareholders because the income is taxed twice (initially by the company and then as income to shareholders). On the other hand, though, that money does not get spent on something stupid.

Think of Coca-Cola (NYSE: KO), with its hefty dividend yield of 3.2%. The company pays $1.64 per share and has about 2.3 billion shares outstanding. That comes to an annual payout of $3.8 billion. The company reported about $6.3 billion in net income over the past 12 months, so the dividend payout is a big chunk of that. Around 60% of the company's income is simply unavailable for regrettable stock buybacks, pointless acquisitions, or executive overcompensation.

Even if a company falters and loses value, until it stops its dividend, it will still be rewarding you in some way. Motorola shareholders, for example, collected dividend payments while their stock swooned.

What to do
When you look at a company and its earnings, remember that its management has many choices regarding what to do with that money. It can use it to buy other companies. It can buy back shares, which can be a good thing if the shares are undervalued. It can pay down debt, which is often smart, especially if it's being charged steep interest rates. It can stockpile it, as Apple has recently, with more than $24 billion in cash and short-term investments on its balance sheet. Or it can pay a dividend.

Dividends are much more powerful than you think. Dividend-paying companies tend to outperform non-payers. Many companies pride themselves on raising their dividends regularly. Hang on to solid dividend payers and you can end up with an effective yield of 30% or more. Imagine receiving $3,000 annually from an initial $10,000 investment.

So, if you want some insurance against bad management, look for dividends. The more money you get, the more control you have over your company's profits.

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