Bill Miller: These Stocks Could Go 50% Higher

Investment legend Bill Miller recently banged on about how large-cap stocks are the investment opportunity of a lifetime. He offered some more bullish musings on CNBC yesterday:

If the [dividend] payout ratios were dramatically higher than they are today, then people would have a lot more money in the stock market. If you look at IBM (NYSE: IBM  ) , IBM is the only one of the megacap stocks that were popular in the late 1990s to go to an all-time high. The reason for that is, IBM has an absolutely unequal record in capital allocation. They basically return cash to you in the form of dividends and share buybacks; they do it consistently over time.

Hewlett-Packard (NYSE: HPQ  ) hasn't raised their dividend in five or six years. If Hewlett-Packard had a 70% payout ratio, which they should have -- or Microsoft (Nasdaq: MSFT  ) , which they should have, or Intel (Nasdaq: INTC  ) , which they should have -- they would all have over 7% dividend yields today ...

Obviously, they wouldn't trade at 7% dividend yields. The telecom sector is the highest-valued sector in the overall market, and it grows at 3%-4%. But it has a high dividend payout ratio, which is why it trades where it does. If those [tech] companies actually did what they ought to do, which is pay out 70%, the stocks would be up 50%. Easily.

Heck, why stop at those few tech companies? Over the past 12 months, the S&P 500 average paid out 33% of earnings as dividends, vs. a long-term average 51%. The SPDR S&P 500 ETF (NYSE: SPY  ) currently yields 2%. If the index simply reverted to its long-term payout average, the ETF's yield would go north of 3%. If the S&P earns $83 in 2010, as it's on track to, and paid out 72% of earnings as dividends, as was the average from 1930-1950, the index would yield more than 5%. And as Miller points out with telecoms, the market is more than willing to bid up valuations once yield is brought into the equation.

Which is, I think, mostly silly. Investors should be willing to pay a similar multiple for cash flow as they are dividends, provided management doesn't have a fondness for squandering cash (and some do, to be sure). Apple (Nasdaq: AAPL  ) , for example, pays no dividends, yet the immense cash it generates every quarter increases the company's market cap because of its larger cash balances. It's hard to see how higher dividends would materially benefit Apple shareholders. If Apple paid a $10 per-share dividend, mark my words: Its stock would fall $10 on the ex-dividend date. This is precisely what happened to Microsoft when it paid a large one-time special dividend in 2004. The company paid a $3 dividend, and its shares fell $3 on the ex-dividend date to reflect its lower cash balances. Shareholders actually faced a net-negative return once taxes were factored in. The return characteristics of dividends aren't as straightforward as they seem.

But dividends are what investors crave these days. Bonds yield almost nothing. Cash earns less. Yield is in great demand wherever it can be found. It's hard to imagine the S&P dividend yield surging without stock prices surging in response. And the yield could surge without the economy changing a lick if companies just brought payout ratios back to historic averages.

Some will say higher payout ratios makes stocks less attractive because it leaves companies with less cash to invest and grow. This would be a fair argument in normal times. Today it's mostly moot. In aggregate, companies are holding record levels of idle cash and continue to add to those stockpiles. As Miller rightly went on to note, "they don't need the cash; they're hoarding cash." There's plenty of fuel to invest with without tapping into cash flow.

One more comment, although not quite as specific, on current valuations leading to outsized returns. I had a chance to speak with renowned Wharton professor Jeremy Siegel last week while researching another article. Here are his thoughts on the odds we'll undergo another decade of abysmal stock returns:

Extremely small. The super-bull market of the 1980s and 1990s ended in the technology/Internet bubble that pushed stocks too high. But the bear market of 2008-09 sent them below their long-term values. I now estimate that stocks are about 30% below their long term trends and fair market value.

That was the end of our discussion on the topic. No specifics, although the 30%-off level doesn't seem dramatically different to how Bill Miller's argument would apply to the overall market. A 30% increase in the S&P would put the index at around 1,530, which is about 16 times estimated 2011 earnings. Not cheap, but hardly unreasonable. This chart I put together last week that gives some historical context to the issue:

I'll give Bill Miller the last word:

The last ten years have conditioned people to think short term and tactically as opposed to long term. Everybody wanted to think long term in 1999 after 17 years of a great market and ten years of returns that were 20% per year. And that was the wrong time to think long term; things were really expensive. Now things are really cheap, and it's time to go back to thinking long term.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

Fool contributor Morgan Housel owns shares of Microsoft and SPDR. Intel and Microsoft are Motley Fool Inside Value recommendations. Apple is a Motley Fool Stock Advisor pick. Motley Fool Options has recommended buying calls on Intel. Motley Fool Options has recommended a diagonal call position on Microsoft. The Fool owns shares of Apple, Intel, International Business Machines, and Microsoft. Try any of our Foolish newsletter services free for 30 days

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On October 22, 2010, at 3:48 PM, JustHanginOut wrote:

    I don't think it's as simple as "the stock falls the same amount on ex-dividend ". Dividends provides real income to investors which has value and provides more flexibility. If the stock is cheap you can reinvest it back into the company and if not you can allocate accordingly. Paying dividends is essentially just a service that a company provides to its investors. If the company is doing well the dividends will get reinvested either way. There's nothing that says companies can't do both.

  • Report this Comment On October 22, 2010, at 4:16 PM, prime99 wrote:

    The coming tablet battles are good news for Intel. The chip maker is married to PC sales. Unfortunately for Intel the savvy individuals over at Apple decided to power the iPad with their own CPU; the A4. Even better news for INTC, the introduction of the iPad has single-handedly decimated PC sales for the last four months. Sure enough Intel will catch the break it needs as competitors come into the tablet market. Intel might get lift as it is set to make the CPUs for the HP Slate 500 and the Samsung Galaxy tablet. In sickness and in health, check out the lovely relationship of Intel and PC sales.

    Intel vs PC Sales- http://www.hiddenlevers.com/hl/u?ccxhOO

  • Report this Comment On October 22, 2010, at 5:23 PM, langco1 wrote:

    most of millers picks over the last few years have dropped by 50% or more making it a surprise that he is even employed....

  • Report this Comment On October 22, 2010, at 5:56 PM, lazytype wrote:

    Casio calculators and Timex watches didnt have intel inside either. So don't bother with ipad too much.

    Remember how Atom blew away all netbook competition in a few weeks.

  • Report this Comment On October 22, 2010, at 6:21 PM, aleax wrote:

    @Just, don't get me wrong -- I love dividends, and a dozen plus solid, sustainable dividend-payers (and -growers) "anchor" over 2/3rds of my stock portfolio.

    _However_, your assertion:

    """

    Dividends provides real income to investors which has value and provides more flexibility. If the stock is cheap you can reinvest it back into the company

    """

    is too facile and simplistic with regards to stocks held in "ordinary", i.e., taxable, accounts. That is because of the crazy tax treatment for dividends (only interest's tax treatment is even crazier), which is likely to get battier still (at least for high-income investors) starting next year.

    That "real income ... which has value" is TAXABLE right here and now. If the company spends $100 in dividends you get (assuming you have good income) $85 today, or $80 in the most optimistic hypothesis for next year, or $60 if Congress stays paralyzed and the "bush cuts" expire, MINUS your State's level of income tax (quite nicely high here in CA...). _With what little is left_ you can reinvest, buy yourself a lollipop (paying high sales tax;-), whatever. But before you do, federal and state taxes are torn away from it.

    So, from those $100 you've only left (say) $60 to reinvest in the cheap stock -- an immediate 40% haircut for your troubles. If the same $100 had been directly reinvested by the company (in buybacks or whatever cost-effective measure), your resulting $100 capital gain would be unrealized until YOU decide it's time to take some of it out (and, even in the worst case under current law, THAT distribution would only be taxed at 20%, as long of course as you're a long-term investor).

    So, all the trouble is with the crazy tax laws (the same ones which ENCOURAGE a company to get deeply in debt, by making interest expense tax deductible for the company while dividends aren't). If all of your investing is in an IRA (ideally Roth) or 401k, by all means fill it to the brim with securities generating good dividends (and/or interest). But, if some parts of your investments are in a taxable account, you need to take this factor into account (as no doubt does the company itself, despite all the well justified current popularity of dividends!). Ideally you should keep high-yielding securities in the tax safe (or at least tax deferred, if non-Roth) part of your investment portfolio, and balance things with NON-dividend payers in the taxable part.

    Of course, tax laws make things more complex here too (since you're only allowed to save up to X per year in tax deferred or tax safe instruments, there may be income limits to who's allowed to invest in what kinds of accounts, strict limits on safe income producing plays such as covered call writing on most tax-deferred accounts, and so on piling absurdity on top of craziness, of course;-). But, thanks to the tax laws (and to those only), dividends aren't quite the "slam dunk" case they would be if tax laws were simpler and fairer, without pick-and-choose preferences and distortionary effectsw.

  • Report this Comment On October 22, 2010, at 8:46 PM, afamiii wrote:

    Dividend payouts do not directly affect the intrinsic value of a company.

    The indirectly influence the intrinsic value, by taking free cash flow away from the managers (probably more than half of them) who do not invest their retained earnings in projects that do not deliver a high return (given the tax advantage of retained earnings to the longer term investor vs. paying out a dividend this would translate roughly to projects between 11% and 15% RoIC depending on the companies cost of equity capital.)

    I'm not convinced that increasing payout would boost the share price 50%

  • Report this Comment On October 22, 2010, at 11:33 PM, jabaseball wrote:

    I have a difficult time taking in anything Bill Miller says these days after he lost his shirt (and those of his investors) on Washington Mutual et. al. Why would anyone pay attention?

  • Report this Comment On October 23, 2010, at 12:08 PM, daveandrae wrote:

    "I have a difficult time taking in anything Bill Miller says these days after he lost his shirt (and those of his investors) on Washington Mutual et. al. Why would anyone pay attention?"

    jabaseball

    From my investment notes...

    Bill Miller- November 9th, 2009 (s&p 500 is currently trading at 1090/DJIA is currently trading at 10,220)

    " There have been 14 10-year periods where stock returns have been negative, including this one. In every one of the previous 13, the subsequent 10-year returns have exceeded 10% real, about 50% more than average, and more than double the return of government bonds. So every time stocks have performed poorly for 10 years, they have performed better than average for the next 10 years, and they have beaten bonds every time by an average of 2 to 1, yet investors can't put money fast enough into bond funds, and continue to redeem equity funds."

    Market close as of October 22nd, 2010.

    S&p 500 1183.

    DJIA - 11,132.

    November 9th 2009- October 22nd, 2010 year over year return (which excludes dividends)

    s&p 500 - 8.33%

    DJIA- 8.92%

    My own portfolio - (which is also 100% equity, yet is adjusted from 10/23/09 to 10/22/10. My turnover ratio was 0%)

    McDonalds-36.58%

    Dow Chemical - 22.69%

    Harley Davidson- 14.64%

    General Electric - 8.45%

    Pfizer - 5.64%

    Total return ( which includes reinvested dividends)

    17.60%

    Maybe now you're start paying attention.

    Finally, if capital appreciation is truly your goal, then I would DE-emphasize dividends.

    Thomas Edmonds

  • Report this Comment On October 23, 2010, at 2:54 PM, dstb wrote:

    You were fine until you said this (and then you were wrong):

    "Apple (Nasdaq: AAPL), for example, pays no dividends, yet the immense cash it generates every quarter increases the company's market cap because of its larger cash balances. It's hard to see how higher dividends would materially benefit Apple shareholders. If Apple paid a $10 per-share dividend, mark my words: Its stock would fall $10 on the ex-dividend date. This is precisely what happened to Microsoft when it paid a large one-time special dividend in 2004. The company paid a $3 dividend, and its shares fell $3 on the ex-dividend date to reflect its lower cash balances."

    Apple's hoarding of cash absoluely does NOT help its market cap. In fact, this is one of the key factors, along with a very large market cap, that keeps Apple's shares persistently undervalued relative to its growth. Large cash balances are a problem for much of the tech sector right now. Investors simply do not believe that most of it can be deployed in high return projects.

    The reason that Microsoft fell about the same amount as its one time dividend is that it was ONE TIME. People knew that it was not likely to happen again so why would they give the shares a dividend premium? This is no different than the government giving on-time tax credits to businesses instead of permanent tax cuts. You can't plan around it and it won't stimulate growth. Easily predictable human behavior.

    Apple does need to pay a dividend but it should be a minimum of an annual dividend (if not quarterly) and should provide a yield of at least 3%. Anything less would likely not be enough to draw in the income investors. This is also Microsoft's current problem. They have the right idea with a recurring dividend but their yield is not high enough to be attractive.

    The more cash Apple hoards the more worried investors will become that Jobs is going to make a huge value-destroying acquisition. Mark my words, this issue will keep a lid on Apple's valuation.

  • Report this Comment On October 23, 2010, at 3:34 PM, TMFHousel wrote:

    "Apple's hoarding of cash absoluely does NOT help its market cap."

    Disagree, and it's certainly not absolute. Look, I like dividends as much as the next guy, and most of the stocks I own pay good dividends. I just don't think the return characteristics are as straightforward as some assume. The phenomenon of stocks falling on ex-dividend days isn't unique to one-time payouts -- cash is a real asset that's reflected in market cap. Does the market put a discount on cash hoarders for the possibility they'll squander it? Sure. Some much more than others. But there are also taxes (15%, perhaps 20% next year) on dividends, and the possibility that a CEO will make a great acquisition. That has to be discounted too. Dividends serve a constructive purpose and I generally love them, but they're not the end-all of shareholder returns.

  • Report this Comment On October 23, 2010, at 9:33 PM, Diagoras wrote:

    I just wanted to point out something about stocks falling when their dividends are paid: It is actually the exchanges, not the markets, which adjust the stock prices down after dividends are paid. However, stock prices tend to rise before ex-dividend dates. Dividends are advantageous for shareholders if each new dollar earned by a company in cash adds less than a dollar to the company's market capitalization, so if some is paid as a dividend, the stock price will go down by the same amount on that particular day. Since the cash is to be "liberated" (and becomes worth more to the market), the stock's price goes up before the dividend is paid.

  • Report this Comment On October 23, 2010, at 10:18 PM, TMFHousel wrote:

    "Dividends are advantageous for shareholders if each new dollar earned by a company in cash adds less than a dollar to the company's market capitalization"

    Agreed. I just don't think the discount is terribly drastic for most companies. And some of that discount is a reflection of dividend taxes, which lessons the value to shareholders.

    I appreciate the debate from everyone. This is a topic I think about often. To reiterate, I like dividends. They serve a great purpose. But as is the case so often in investing, they aren't a free lunch. As I see it, a dividend-paying stock vs. a dividend payer should mimic the difference between a regular bond and a zero-coupon bond -- very different characteristics, but similar products *with similar intrinsic values.* With most companies and most markets, that's usually the case. But as Miller points out, it isn't right now for many companies, which I find pretty silly. Silliness, though, makes opportunity.

    Thanks again,

    Morgan

  • Report this Comment On October 23, 2010, at 10:20 PM, TMFHousel wrote:

    sorry, that should be "a non-dividend paying stock vs. a dividend payer ..."

  • Report this Comment On October 24, 2010, at 1:34 AM, lowmaple wrote:

    One day or perhaps manyy days acompany will come up with a real apple masher (an idea ahead not behind apple) then almost any price will be needed to buy them out. That means cash.

  • Report this Comment On October 25, 2010, at 6:05 AM, FreethinkerKW wrote:

    Companies are holding record amounts of cash, but what you failed to mention is this: companies are holding record amounts of liabilities. And the liabilities outweigh the assets.

    Most of this "cash" is not really cash. The "cash" was created by taking on more debt. It isn't cash created by selling doodads and doohickies at good margins.

    Mish cover this very well in two recent blogs:

    http://globaleconomicanalysis.blogspot.com/2010/10/cash-cow-...

    and the follow up to that initial blog is this one:

    http://globaleconomicanalysis.blogspot.com/2010/10/cash-cow-...

  • Report this Comment On October 25, 2010, at 8:49 AM, TMFHousel wrote:

    "Companies are holding record amounts of cash, but what you failed to mention is this: companies are holding record amounts of liabilities"

    This is a good point. I've discussed this here:

    http://www.fool.com/investing/general/2010/09/28/hoarders-co...

    To your point: "Most of this "cash" is not really cash. The "cash" was created by taking on more debt."

    Well, it really is cash. It's in the bank. It can be spent. There are just future liabilities attached.

  • Report this Comment On October 25, 2010, at 5:30 PM, slpmn wrote:

    I think Miller has a good point, and it raises a great question about how corporations are managed in this country. It goes back to things they covered in my MBA program years ago. Fundamentally, corporations are supposed to be managed to maximize shareholder value, aren't they? Does maintaining a gigantic pile of cash (or more accurately, short term investments) maximize value? My quick, old school MBA answer is hell no! When you invest in a company like Apple, you are essentially saying, okay, Steve Jobs can do more with my money than I can, because he will use it to develop the next cool gadget that will sell a billion units and generate a gigantic return on investment, thus generating big profits. Every penny not needed to do that should be paid out to shareholders who can then decide on their own how to redeploy the capital. Maybe they reinvest it in Apple, maybe they invest it in a new start-up. Depends. However, the choice should be theirs, not Steve Jobs'. When Apple sits on billions in cash, it is an example of inefficient capitalism. They don't have a use for the money. I'm not worried about them using it to pay an inflated price for an acquisition (they'll use their inflated stock to do that), I'm worried they're going to let it stagnate in 90-day treasuries! The bottom line is, you don't give money to corporations so they can save it in a piggy bank. You give it to them to reinvest in projects that earn a good return. Any extra should be paid back to the shareholders.

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