By Matt Koppenheffer
October 22, 2010

When you hear the phrase “value investing,” Warren Buffett most likely comes to mind. But hopefully, you also think of Ben Graham — the father of value investing. Considering that some of the world’s most successful investors carry Graham’s flag, there’s good reason for Fools like us to be obsessed with the concept.

Graham had a plan
But with thousands of stocks out there, how do we separate the value plays from the throwaways? In The Intelligent Investor, Graham lays out a basic framework for winnowing through the sea of stocks to get to the good stuff.

1. Financial stability. Graham wanted investors to be sure they weren’t investing in castles made of sand, so he put requirements on prospective investments’ balance sheet strength and record of past earnings.

2. Growth. You wouldn’t have caught Graham dead chasing the high-flying stocks of the day, but he did want to see that over the long haul, earnings were at least moving in the right direction.

3. Valuation. This, of course, is what Graham is probably best known for — requiring that a stock be selling for less than it’s really worth. While a simple valuation ratio can’t tell you the whole story, it may signal a stock that’s definitely not a deal.

4. A dividend.

Did you catch that last part?
That wasn’t a typo; whether you are a defensive or enterprising investor, Graham thought it necessary that you stick to companies that pay a dividend.

Dividends have largely been relegated to a dark corner on Wall Street, but Graham didn’t equivocate. The safest stocks would have “uninterrupted payments for at least the past 20 years,” but every investment should have “some current dividend.”

When you think about it, this makes perfect sense. Graham’s whole approach to investing in stocks revolves around thinking and acting like a businessperson, and treating your stock holdings as ownership shares in a business, not gambling slips. When businesspeople buy a piece of a business, they expect to know how much profit will be sent back their way.

http://www.fool.com/investing/general/2010/10/22/the-great-investing-wisdom-wall-street-forgot.aspx

Health is Wealth

Dividends are more stable than earnings, so the payout ratio certainly varies over time. Additionally, corporations have shown less willingness to pay dividends, and investors have shown less inclination to demand dividends, to the payout ratio today is roughly half of what it was in the early 60s.

Earnings don’t grow at a constant rate, either. Over the last 53 years, earnings have grown at a 6.7% rate, but that has included times of shrinkage, and boom times as well.

http://alephblog.com/2007/07/09/the-fed-model/

Health is Wealth

Although many investors consider the current 2% yield offered by the S&P 500 to be trivial, it would be a huge mistake to dismiss dividends. In fact, a look back at statistical data over the past 75 years shows that nearly half of the market’s total returns have come in the form of dividends. Between 1926 and 2004, dividends represented approximately 42% of the total return delivered by the S&P 500. Over that same span, it’s been calculated that $1,000 invested in the S&P would have grown to $2.3 million if reinvested dividends are included, but only $90,000 without the dividends.

If history is any guide, then dividend-paying stocks should also perform better than their non-paying counterparts over the long haul. Contrary to conventional wisdom, studies have shown that dividend payers handily outperformed non-payers from 1970 to 2000. At the same time, those same dividend-paying stocks experienced far less volatility. They could also be counted on to deliver stronger relative returns in difficult market environments. What’s more, according to the latest data from Standard & Poor’s, dividend-payers are still outpacing non-payers in today’s volatile marketplace.

An example of looking at dividend (above graph)
Dividend growth has been steady but not spectacular.

http://web.streetauthority.com/cmnts/pt/2006/02-15.asp

Health is Wealth

We saw Warren Buffett put forth his views on the concept of ‘economic goodwill’ and why he prefers companies that have a high amount of the same. Let us now see what the master has to offer in terms of investment wisdom in his 1984 letter to the shareholders.

While Buffett has devoted a lot of space in his 84′ letter to discussing in detail, some of Berkshire’s biggest investments in those times, but as usual, the letter is not short on some general investment related counsel either. In a rather simplistic way that only he can, the master gives his opinion on a couple of extremely important topics like ‘investments in bonds’ and ‘corporate dividend policies’. On the former, he has to say the following:

“Our approach to bond investment – treating it as an unusual sort of “business” with special advantages and disadvantages – may strike you as a bit quirky. However, we believe that many staggering errors by investors could have been avoided if they had viewed bond investment with a businessman’s perspective. For example, in 1946, 20-year AAA tax-exempt bonds traded at slightly below a 1% yield. In effect, the buyer of those bonds at that time bought a “business” that earned about 1% on “book value” (and that, moreover, could never earn a dime more than 1% on book), and paid 100 cents on the dollar for that abominable business.”

Berkshire Hathaway in 1984 had purchased huge quantities of bonds in a troubled company, where the yields had gone up to as much as 16%. While usually not a huge fan of long term bond investments, the master chose to invest in the troubled company because he felt that the risk was rather limited and not many businesses during those times gave as much return on the invested capital. Thus, despite the rather limited upside potential, he went ahead with his bond investments. This is further made clear in his following comment:

“This ceiling on upside potential is an important minus. It should be realized, however, that the great majority of operating businesses have a limited upside potential also unless more capital is continuously invested in them. That is so because most businesses are unable to significantly improve their average returns on equity – even under inflationary conditions, though these were once thought to automatically raise returns.”

Years and years of studying companies had led the master to conclude that there are very few companies on the face of this earth that are able to continuously earn above average returns without consuming too much of capital. Indeed, such brutal are the competitive forces that sooner or later and in this case, more sooner than later that returns for majority of the companies tend to gravitate towards their cost of capital. If we do a similar study on our Sensex, we will too come to the conclusion that there are not many companies that were a part of the index 15 years back and are still a part of the same index. Hence, while valuing companies, having a fair judgement of when the competitive position of the company, the one that enables it to consistently earn above average returns is likely to deteriorate. This will help you to avoid paying too much for the company’s future growth.

After touching upon the topic of bond investments, the master then gives his take on dividends and this is what he has to say:

“The first point to understand is that all earnings are not created equal. In many businesses particularly those that have high asset/profit ratios – inflation causes some or all of the reported earnings to become ersatz. The ersatz portion - let’s call these earnings “restricted” – cannot, if the business is to retain its economic position, be distributed as dividends. Were these earnings to be paid out, the business would lose ground in one or more of the following areas:

•  its ability to maintain its unit volume of sales, 
• its long-term competitive position, 
• its financial strength. 

No matter how conservative its payout ratio, a company that consistently distributes restricted earnings is destined for oblivion unless equity capital is otherwise infused.”

While the master is definitely in favour of dividend payments, he is also aware of the fact that not all companies have similar capital needs in order to maintain their ongoing level of operations.

• Hence, in cases where businesses have high capital needs, a high payout ratio is likely to result in deterioration of the business or sooner or later will require additional capital to be infused. 
• On the other hand, companies that have limited capital needs should distribute the remaining earnings as dividends and not pursue investments which drive down the overall returns of the underlying business. 
• In a nutshell, capital should go where it can be put to earn maximum rate of return.

He then goes on to add how his own textile company, Berkshire Hathaway, had huge ongoing capital needs and hence was unable to pay dividends. He also further adds that had Berkshire Hathaway distributed all its earnings as dividends, the master would have left with no capital at all to be put into his other high return yielding investments. Thus, by not letting the operational performance of the company deteriorate by retaining earnings and not distributing it as dividends, he was able to avoid a situation in the future where he would have had too put in his own capital in the business.

http://www.equitymaster.com/detail.asp?date=8/16/2007&story=1

Health is Wealth

http://www.equitymaster.com/detail.asp?date=7/12/2007&story=2

Health is Wealth

19 Mar 2010, 0139 hrs IST, Lovaii Navlakhi,


Retirement is the time when you hang up your boots from the hustle-bustle of daily life, relax, do your own thing. As we say, it’s time to say: “Goodbye tension, hello pension!” Suddenly, from the risk of dying too young, you have transformed yourself to the category where the risk of living too long exists.

The last thing you want to do is to have your money run out before you do. Risks have to be taken in a controlled manner, and post-retirement returns are thus assumed at 1% or maximum 2% p.a. over inflation. During one’s retirement days, the key requirement is safety, liquidity and tax-free returns. It is important to analyse the pros and cons of some of the avenues available to generate cash flow.

Rental Income 

Apart from a self-occupied property, all other real estate investments are made with the objective of either capital appreciation — like the purchase of land — or to generate return on investment, as in the case of rental property. 2008 has been a rude awakening, and we must prepare for the time when rentals may drop, and the property may remain vacant for a few months. Depending on rental income for 100% of one’s needs may be a risk that needs to be mitigated before heading into the retirement days.

Dividend Income 

A few weeks ago, a client approached me to plan some additional investments for his mother who was a retired senior citizen. He did not want to take risks with the investment and during the course of our conversation, we realised that nearly a third of her income was being received by way of dividends. So, while she was averse to risk investing, she was equally reluctant to reduce her shareholding because she was thrilled with the quantum of dividend that she would receive year on year. In this case, there is a need to reduce the risks that this client carries in her portfolio.

Annuities 

In all our retirement planning calculations, we assume a life expectancy of 85 years for males and 90 years for females. However, no one can say today whether that is an under-estimation or an overkill. To do away with this risk, one can consider purchasing of annuities which are paid for your lifetime, and on your expiry, to your spouse. Obviously, if one was to use this as the only source of retirement income, the quantum required to be invested would be large, so it’s best that about a third of one’s retirement requirement is met through this route.

Fixed Income Investments 

Returns on fixed income investments are normally taxable. For the purpose of planning, it may be best to consider these — like senior citizen bonds, post office schemes, fixed deposits — first so that the income is within tax exempt limit for senior citizens — Rs 2.40 lakh per year as per the latest Budget proposals. Practical examples abound which ensure income that is tax-free and carries minimalistic risk for the senior citizen.

(The author is the Managing Director and Chief Financial Planner of International Money Matters Pvt Ltd)


http://economictimes.indiatimes.com/Personal-Finance/Savings-Centre/Analysis/Make-sure-you-have-a-steady-cash-flow-when-you-retire/articleshow/5699880.cms

Health is Wealth

By John Collett
February 3, 201

Conservative investing in dividend-paying companies will soften the blow of negative returns

Fund managers know and understand the benefits of capital preservation. They know negative returns are best avoided because of how difficult it can be to just get back to square one.

But ordinary investors probably don’t appreciate the maths and the sort of high returns required to recover from losses. For example, a loss of 10 per cent requires a return of 11.1 per cent to get back to square one. A 20 per cent loss requires a return of 25 per cent and a 70 per cent loss requires a return of 233 per cent.

So big losses are likely to take a long time to recoup, which is why investing with an eye to avoiding losses in the first place is so important in growing an investment portfolio.

• That is particularly pertinent to the sharemarket because shares quite regularly lose 5 per cent or 10 per cent of their value and, occasionally, much more. 
• From the bull market peak of November 2007 to the bear market trough of March 2009, Australian share prices fell by more than 50 per cent. 
• While the Australian sharemarket has risen by about 45 per cent from the trough, it remains more than 30 per cent off its all-time high of November 2007.

However, the mathematics of capital losses say that for Australian share prices to return to record levels, share prices need to rise by almost 50 per cent from here. And that could take years, says the head of investment market research at fund manager Perpetual, Matthew Sherwood.

Sherwood cautions investors who, tempted by the easy gains, are considering throwing caution to the wind and going headlong into the sharemarket hoping to quickly recover earlier losses.

He says most of the easy gains on the back of the economic recovery have probably already been made.

“The best thing to do is to invest conservatively and reduce the risk in what is going to continue to be a volatile environment,” Sherwood says.

Investing conservatively means selecting good, dividend-paying companies. A portfolio of income-paying shares helps take some of the sting out of the tail of the capital losses, he says. As economic conditions improve, so do dividends.

Fund managers tend to favour companies that pay consistently high dividends because of the fact that it helps smooth out the volatility of share prices for the investors in their funds.

Even when a company’s share price is falling, it usually keeps paying dividends to investors. “Since 1882 the Australian sharemarket, on average, has returned about 12 per cent a year and half of that has come from dividends,” Sherwood says.

The importance of dividends to Australian investors is not only that more of the total return from Australian shares is made up of dividends than is the case with overseas shares but that the dividends are favourably taxed in the hands of investors through our dividend imputation system.

The point for investors is simple. The best way for investors to get ahead is by having a well-diversified portfolio of consistently performing investments. That is likely to be a much more profitable route for investors in the long-term than holding a portfolio of investments whose returns are highly volatile and do not pay much by way of dividends.

Successful fund managers, such as Perpetual and Investors Mutual, have an investment philosophy that focuses on capital preservation and on investing in income-paying investments with the aim of delivering consistent total returns of regular income and capital growth.

Such an approach means the fund manager is unlikely to appear at the very top of performance league tables in any year but instead will provide the unit holders in their share funds with higher returns in the long run. Individual investors would do well to follow their lead.

The smoother ride provided by a lower-returning, income-paying investment will also help ensure investors stay invested.

Faced with significant losses, investors are more likely to take fright, sell their shares and put their money into cash, which in the long-term is the lowest-returning asset class of all.

Sticking with a portfolio that produces consistent returns has another advantage in that investors do not feel pressured to seek out the next big thing in the hope of making spectacular returns.

Trading not only takes up much more time, “churning” a portfolio also increases both transactions costs and taxes, particularly if the share is held for less than a year.

What you need to make to recover your lossesCost    Loss    Price   Returnprice   (%)     After   required (%)                loss (%)$100    5       95      5.3$100    10      90      11.1$100    20      80      25$100    50      50      100$100    70      30      233$100    90      10      900SOURCE: FAIRFAX

http://www.businessday.com.au/news/business/money/planning/sure-and-steady-in-volatile-times/2010/02/02/1264876022132.html

Health is Wealth

That a company earns a lot of money doesn’t necessarily mean the stockholders will benefit.  The next big question is:

• What does the company plan to do with this money? 

Basically, it has 4 choices.

1.  It can plow the money back into the business, in effect investing in itself.

• It uses this money to open more stores or build new factories and grow its earnings even faster than before. 
• In the long run, this is highly beneficial to the stockholders. 
• A fast growing company can take every dollar and make a 20% return on it. 
• That’s far more than you and I could get by putting that dollar in the bank.

2.  Or it can waste the money.

• It can waste on corporate jets, teak-paneled offices, marble in the executive bathrooms, executive salaries that are double the going rate, or buying other companies and paying too much for them. 
• Such unnecessary purchases are bad for stockholders and can ruin what otherwise would be a very good investment.

3.  Or a company can buy back its own shares and take them off the market. 

• Why would any company want to do such a thing? 
• Because with fewer shares on the market, the remaining shares become more valuable. 
• Share buybacks can be very good for the stockholders, especially if the company is buying its own shares at a cheap price.

4.  Finally, the company can pay dividend. 

• A majority of companies do this. 
• Dividends are not entirely a positive thing – a company that pays one is giving up the chance to invest that money in itself. 
• Nevertheless, dividends are very beneficial to shareholders.

A dividend is a company’s way of paying you to own the stock.  The money gets sent to you directly on a regular basis – it’s the only one of the above 4 options in which the company’s profits go directly into your pocket. 

• If you need income while you’re holding on to the stock, the dividend does the trick. 
• Or you can use the dividend to buy more shares.

Dividend also have a psychological benefit. 

• In a bear market or a correction, no matter what happens to the price of the stock, you’re still collecting the dividend. 
• This gives you an extra reason not to sell in a panic.

Millions of investors buy dividend-paying stocks and nothing else. 

• Compile a list of companies that have raised their dividends for many years in a row. 
• In Wall Stree, one company has been doing it for 50 years, and more than 300 have been doing it for 10.