May 15, 2016 Graham

Risk/Reward Vol. 307

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

“ I could be your payback
Hey, gonna help you get your sway back”---lyrics from “Payback’ sung by Rascal Flatts

“You are the apple of my eye,
Forever you'll stay in my heart”---lyrics from “You Are the Sunshine of My Life” sung by Stevie Wonder

“Flow river flow
Past the shaded tree
Go river, go
Go to the sea”---lyrics from “The Ballad of Easy Rider” sung by The Byrds

One result of lower first quarter earnings (discussed in last week’s edition See Vol. 306 www.riskrewardblog.blogspot.com ) is that a higher percentage of profits is being paid out as dividends. Do the math. Dividends are paid from earnings. If dividends remain the same and if earnings decrease then perforce a higher percentage of earnings must be allocated to dividend payments. Recently, the average percent of earnings paid in dividends, by those companies in the S&P 500 that pay dividends, has risen to 50%, noticeably above the 43% paid out in 2014 and the ten year average of 46%. Recently, this increase in dividend percentage prompted Larry Fink, the CEO of BlackRock, to write to the boards of directors of each of the S&P 500 companies to warn them to be more careful on how they allocate capital. Fink wants these boards to invest more in innovation and to pay out less in dividends. Fink’s missives are not dismissed lightly considering that BlackRock manages $4.5 trillion (more than 2% of ALL of the world’s financial assets!) much of which is invested in large chunks of each of the 500. But is he correct? Not according to Benjamin Graham, Warren Buffet’s mentor and the father of modern portfolio management. According to Graham, the hallmark of a healthy company is a long record of dividend payments in the magnitude of 67% of corporate earnings. Indeed, before 1970, the 30 companies comprising the Dow Jones Industrial Average paid over 60% of earnings out as dividends. Not so today. But in a world that pays no return on savings accounts, cd’s or bonds how is one to derive income if not from dividends? I look for such shareholder friendly companies and put them on a list for further study. Dividends are a way to “get your payback/ to get your sway back.” Accordingly, I am in Graham’s camp; not Fink’s.

The antithesis of Benjamin Graham was Steve Jobs---and his successor at Apple, Tim Cook, is not much better. Although Apple has started paying a dividend, it is a pittance in comparison to what it should be. For this and other reasons, Mr.Market no longer considers AAPL the “apple of his eye” which necessarily must “forever stay in his heart”---or his portfolio. Allow me to elaborate. As of the most recent quarter, AAPL holds $233billion in cash or cash equivalents on its balance sheet. To put this in perspective, with just this free cash, AAPL could purchase all but a handful of the world’s other companies. Moreover, it continues to accumulate cash, quarter after quarter, because its capital needs are met from current earnings. AAPL trades at less than 9 times earnings, well below the average for the S&P 500 which means that Mr. Market places no value at all on AAPL’s huge cash position. So, Mr. Cook, why not reward your shareholders by paying them a dividend FROM THE MONEY THEY HAVE EARNED? After all, you do recognize, do you not, that it is the shareholders’ money? Given that much of the cash hoard is oversees and upon repatriation would be taxed at the corporate level, AAPL still would have over $170million to distribute which equates to about $31/share, a one time 30% dividend given AAPL’s current price. Okay, spread the payments out over a few years, but pay it out! Won’t happen, will it.

One sector that remains dedicated to rewarding shareholders with dividends is the oil patch. Indeed, its leaders are committed to doing whatever is necessary to maintain those dividends even in the face depressed oil prices and earnings. Will they be able to do so? Time will tell, but their task has become easier given that the price of oil has now climbed above $45/bbl. As discussed last week, contributing to the recent price increase are geopolitical issues that raise questions on whether “the river of oil “ in some hot spots will continue to “flow/Past the shaded tree/and Go to the sea.” The hot spot this week was Nigeria where insurgents have disabled pipelines and taken nearly 1million barrels off the market. This portends well for those invested in this sector as the summer driving season approaches.

Ever so cautiously, I continued to add to positions this week hoping to prosper in this bunny hop market (Dow up 200 points one day; down 200 points the next). In the words of The Byrds:

“To everything - turn, turn, turn
There is a season - turn, turn, turn”

Hopefully, in the near future, it will be “time to 5, 20reap”--- profits that is.