Would you pay $60,000 for a shower curtain ... for someone else?
Sounds crazy, but if you bought Tyco
Here's why I ask ...
My old pal Mathew Emmert flies in once every few months, and that's how he greets me: with that ridiculous shower-curtain question. What did I expect, "Hey, man, how's it going?" No chance. The obligatory "Sssuppp?" Dream on.
Let's face it, the guy is a dividend kook, and I'm the enemy. So he browbeats me over my castles-in-the-air, small-cap growth portfolio, about how I am just begging Mr. Market to walk off with my money because I stubbornly -- and stupidly -- refuse to get paid to invest.
And you know what's worse? I've heard it all before. Deep down, I even know it's true. If I had listened to this very same dividend mantra my first time around, I might be a wealthier man today. I certainly would have slept better.
Don't you fall for the agency lie
Naturally, you assume that corporate geniuses can handle the cash their businesses generate. That's what former Enron front man Ken Lay wanted you believe. And Tyco's Dennis Kozlowski or the Rigas family who allegedly shook down Adelphia.
In fact, this couldn't be further from the truth.
"Agency conflicts" is a snappy way of saying that even honest execs act in their own interests, not yours. And as a result, the more of your cash you let them keep, the more likely they will waste it on gaudy buildings, useless acquisitions, corporate jets, and, yes, $6,000 shower curtains.
Professor Michael Jensen even suggests that managers waste all free cash flow under their discretion. Yikes! No wonder Jensen isn't surprised that high stock prices and low dividend-payout policies set the stage for the scandals and perp walks that ended the great bull market. Neither am I.
What you can do to stop the madness
Insist on dividends. Keep your CEO honest. Because Professor Jensen is right when he says, "Dividend payments enhance share value by preventing managers from wasting money on negative net-present-value projects."
I recently got this refresher course in agency conflicts over lunch from -- you guessed it -- Mathew Emmert, who pounds the table with this stuff constantly to his Motley Fool Income Investor subscribers. But like I said, I had heard it before.
Some years back, I worked for a cantankerous millionaire who worshiped dividends as the Holy Grail of investing. The year or so I spent with that guy was the most miserable of my working life. For context, here are some odd jobs I have worked:
- Performed data entry of financial-aid forms
- Graded fifth-grade student essays
- Recorded books on tape
- Taught poetry writing to prisoners
- Worked as a janitor in a synthetic blood lab
You see my point.
Anyway, this guy loved drawing these bar charts showing the historical returns of such stocks as Coca-Cola
Don't tell me I'm an income investor!
Those charts were creepy, but I wish I had listened. To rub in it further, I ran some numbers using Ibbotson data. According to my calculations, if you had invested $10,000 in Ibbotson's large-cap universe back in 1980, you could sell them today for about $130,000. Nice.
Had you reinvested the dividends along the way, you'd be sitting on more than $400,000. And remember, that universe includes traditional grind-it-out utilities, but also some screamers such as Bank of America
Apparently, dividends really do matter. Big stocks have done well overall since 1980, no matter how you slice it. You can see that clearly from our example. But you can also see that earning, and then reinvesting, those dividends can make the difference between doing well and quietly amassing a fortune.
This rant ain't over yet
In the next few weeks, I'll run down the reasons why dividends make sense. We'll look at why Mathew calls dividends (1) the closest thing to a guarantee on Wall Street and (2) the telltale sign of a great business. We'll also see how (3) dividend stocks flat outperform and (4) new tax treatments have made a sweet deal even sweeter.
As for corporate execs' tendency to squander your money, don't take my word for it. Take it from my favorite investor, Peter Lynch, who in his classic One Up on Wall Street, is ruthless. "Companies that don't pay dividends," says Lynch, "have a sorry history of blowing the money on a string of stupid diversifications."
Shower curtains ... stupid diversifications? Choose your poison. Or do yourself a favor and play it safe. Get some of that money back.
What to do now
Don't get me wrong, I still love my small caps. I'm just looking for some balance. More importantly, I need the perfect dividend stock to put into my IRA this year. This way, I can get the full tax-advantaged benefit reflected in that hideous skyscraper -- over the next 30 years. You should consider it, too.
Fortunately, Mathew is offering a 30-day trial to his Motley Fool Income Investor newsletter service. It's free, and there is no obligation or pressure to subscribe. Which reminds me: I was looking over Mathew's stock scorecard and noticed he is handily beating the S&P 500 -- with a portfolio of safe, dividend-paying stocks. Go figure.
To learn more about how any Fool can beat the market with dividends, click here.
Fool writer Paul Elliott (the big dummy!) owns none of the stocks mentioned. The Motley Fool is investors writing for investors.