Companies Changing Over Time

by Mr. Cheap

I’ve had this post bouncing around in my head for a while. It would have been far more valuable to post it before Oct 7th: some of the ideas may be obvious in hindsight now.

Dividend investors love seeing a long history of uninterrupted dividend payments (ideally growing steadily as well). Often we’ll trot out the idea that “Bank of America (BAC) has been paying dividends steadily since 1903” or “Bank of Montreal (BMO) is the longest-running dividend-paying company in Canada, having been paying a dividend since 1829”.

The reasoning goes, if BMO has paid a dividend for 179 years, through the great depression and 2 world wars, why would it stop today? In answer to that question, Bank of America cut its dividend in half yesterday (back in June MoneyGardener asserted that BAC was priced for a dividend cut, my hat’s off to him for his prediction).

What does 105 or 179 years of dividends really tell us? Clearly no one who was involved with the company when they started paying a dividend is still there. Without a doubt, the companies have changed in major ways over the years. What does their history really tell us?

From one perspective, Bank of America disappeared as a company in 1997 when it was acquired by NationsBank.  NationsBank decided to use the BAC name, but it was really the stronger company.  Perhaps we should view Bank of America as a re-branding of NationsBank, and from that perspective its recent acquisitions of Countrywide Financial and Merrill Lynch make sense.  Perhaps BAC (née NationsBank) is now good at acquiring companies, not at paying a regular and increasing dividend?

The counter-argument is that investors value stability and predictability with companies, and NationsBank adopted the BAC identity to offer that.  By undermining it now, they’re undermining a big part of what they bought from BAC.  There have been cases where stock prices GO UP after bad news is announced, as investors are reassured to know what the problem actually is instead of the rumors that have been floating around.  For any company that is a long term dividend payer, maintaining that reputation has value.  Yesterday BAC kicked itself off of the dividend aristocrats AND the dividend achievers (and, worse, greatly annoyed Mr. Cheap).  I suspect in years to come, they’ll be the cautionary tale to anyone focusing on a blue-chip dividend strategy (Mike and the Canadian Capitalist have always been good at warning that no dividend is guaranteed).  What is the cost to the company of ending its incredible dividend payment history?

BAC made some interesting decisions recently, which we’ll only be able to evaluate from a historical perspective.  They picked up a couple of great companies dirt cheap, but did so by snatching money out of their shareholders’ pockets.  In addition to cutting our dividend, they’ve also diluted our ownership in the company by issuing $10 billion dollars of new common shares (much as GE has also done with Warren Buffett’s recent sweetheart deal – where can I get a deal like he did?).

Only time will tell if the acquisitions were worth kicking shareholders between the legs.

For any BAC shareholders, what are your plans with your stock?  Have you already sold?  Planning to?  My intention is to wait 6 months, let BAC shake off some of the stigma of their dividend cut, then sell it (it doesn’t fit the type of company I want to own anymore).  If it gets some good news and surges close to my average cost, $35.90, before 6 months is up, I’ll take it as an opportunity to dump it).

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{ 21 comments… read them below or add one }

1 Benjamin

BAC is more transparent now that it ever has been. That is, every conceivable scrap of information that would have any impact on it and the market as a whole (with the exception of illegal insider trading) is already factored into market prices.

We already know that housing prices have lost value; we already know that energy prices are high. We know that the market went down because particular companies have declared a huge quarterly loss.

The problem is no one can predict how much more negative or positive information will come out on any given day. If they could then that information would already be available and factored in to the markets.

When we lose sight of the main reasons we invest in a particular security (good products, services, poised for growth, exc.) all we have left as investment guides are our emotions.

My BAC shares are not going anywhere!

2 Nurseb911

“where can I get a deal like he did?”

BRK.B 😉

3 Four Pillars

Nurse – very true!

Interesting thoughts – Bear Sterns was very successful for 150 years as well before they vanished one day…

Leafs are one of the oldest NHL teams therefore they must be good right? 🙂

4 nobleea

oldest NHL team, and they still have a typo in their name.

5 Kyle

I think now is a great time to buy the large, strong banks. Citi and Wells Fargo, for instance, are going to make out like bandits from this crisis. It pays to have a strong balance sheet when the chips are down.

6 mjw2005

Sometimes I prefer it if a company retains earnings and invests it in a good deal that may give shareholder a higher return than just handing out the money to shareholders….

Remember when you recieve dividends you might be taxed twice on the earnings (depending on your situation)…once when the government taxes the corporation on income and then secondly to invidual shareholders when they receive dividend income.

I don’t know much about BAC but from your post it sounds like they bought some good assets at cheap prices….that sounds good to me.

I think this is why Berkshire Hathaway does not pay a dividend, because Warren Buffet does not want his shareholders to be double taxed and he believes his company can invest money better than an individual might be able to….

On the other hand if I was depending on that dividend I might be a little disapointed if it was taken away……

7 Jerry Hung

BAC and BRK.B holders here

It’s unfortunate BAC has to cut its dividends, but I am holding it for long (5~10 years) and it should not affect the long term pictures

I do like them shopping for cheap deals rather than paying insane high % dividends, although $50 billion seemed too much for MER when one could’ve bought LEH for dirt 😛

If BAC goes under, then we’ll be in real trouble
should’ve sold more at $38 🙁 problems when you have $35 options

8 Mr. Cheap

mjw2005: I definitely understand the case for retaining earnings, but ultimately a stock is only worth what it pays out to owners over the long term (if it never pays anything out, it becomes pure speculation, worthless except for what you can get someone else to pay you for it).

Some owners want a company to retain earnings and fuel growth (in hopes of higher payouts in the future), but others want the money now (in the form of steady dividends). Up until this week, BAC presented itself as a company that was friendly to people who wanted steady and reliable dividends. Not to disparage companies that retain all or most of their earnings, but that wasn’t how BAC presented itself (it would have been nice if they’d given shareholders notice that they were planning to change how they operate the company).

Ultimately I think it was a mistake for them to be making big purchases that they couldn’t afford (hmm, now why does that sound familiar?).

9 Four Pillars

Cheap, I have to disagree. The purpose of a company is to make money for its shareholders – how the money is paid out is irrelevant.

If a company can increase its earnings and raise its stock price then that provides more wealth for the stock holders.

Ultimately the important number is the return on investment – not the dividend yield.

For example if you buy $100k of two companies – one pays a dividend (which you reinvest) and the other doesn’t (let’s call it BRK). After 12 years both your stock positions are worth $200k. Which one (ignoring taxes) was a better investment?

10 Mr. Cheap

Mike: I understand what you guys are saying, what I’m saying is that at SOME POINT the company has to pay money back to shareholders for it to be worth anything. If Bill Gates sold 49% of Microsoft and pledged that it would never pay a cent out to any investor ever (and that his first born son would inherit the company upon his death), that’s a pretty sucky investment – regardless of how much money the company makes.

People like it when Microsoft retains its earns, both for the tax benefits you guys are talking about AND the fact that Microsoft gets a good annual return. Ultimately it has to pay out money at some point (and recently Microsoft *has* started paying a dividend).

I don’t care whether a company retains its earnings or pays a dividend (I do agree that from a business perspective and a pure earnings perspective retaining is better). Its just that I’m going to invest in the later, but not the former (my whole reason for investing in individual companies is to get a steady income stream – if earnings are going to be retained, I’ll just buy an index fund thank you very much). What irritates me about BAC is they’ve changed how they’re doing business and paying out shareholders. The change isn’t wrong per se (people who like their new direction and like when companies retain earning will probably be more likely to buy BAC).

The dividend yield doesn’t matter to all investor (nor should it), but it matters to ME! 🙂

11 Four Pillars

Actually I don’t think the company has to ever pay the money to the investor. The investor always has the option to sell some shares if they want some cash.

As for BAC – I don’t know much about them but I suspect they didn’t intend to change their business model – it got changed for them while they weren’t looking.

12 mjw2005

I totally understand where your coming from Mr. Cheap…in regards to getting income for your ownership…but I disagree that just because a company never pays a dividend you the owner of the share never gains….if the company was wise with its investment of its equity than more than likely you would have a share that had increased in value considerably and you could sell all of your shares or a portion if you wanted to get your money from the company….

13 Mr. Cheap

Sweet. I’ve got some great investment products to sell you guys! All you have to do is agree that I never have to give any money back to you or anyone you sell them to. Heck, I’ll even increase their “value” 30% per year!!!

Feel free to e-mail as much money as you want to cheapcanuck@gmail.com

14 Four Pillars

All you have to do is agree that I never have to give any money back to you or anyone you sell them to.

That’s the definition of a growth stock. Of course most growth stocks eventually either crash and burn or grow up to become mature dividend players.

15 Mr. Cheap

Mike: *EXACTLY!* Eventually it either crashes, or it grows up to become a mature dividend payer (that’s the “what Im saying is that at SOME POINT the company has to pay money back to shareholders for it to be worth anything” I was talking about a few comments back).

They don’t agree to never give any money back to their shareholders. They agree not to give it back until they can’t grow it at a high rate any more.

16 Four Pillars

What about BRK? Is Buffett stealing everyone’s money because he’ll never pay out a dividend?

17 Mr. Cheap

There’s an implicit promise with BRK that when / if the run of incredible returns ends (perhaps when the old man is gone), they’ll start returning cash to investors. W.B. hasn’t said he’ll NEVER pay out a dividend:

“We feel noble intentions should be checked periodically against results. We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained. To date, this test has been met. We will continue to apply it on a five-year rolling basis. As our net worth grows, it is more difficult to use retained earnings wisely.”
Source: Berkshire Hathaway’s Owner’s Manual

Mr. Buffett:: “We will either pay large dividends or none at all if we can’t obtain more money through re-investment (of those funds). There is no logic to regularly paying out 10% or 20% of earnings as dividends every year.”

18 Four Pillars

All right – you win! 🙂

19 Mr. Cheap

hmm, for some strange reason your concession ended up in the akismet spam comment bin. I rescued it though! ;-).

Is this wordpress’ way of saying it wants us to keep arguing? 🙂

20 Four Pillars

I always end up in the spammer when I comment at work. I’d like to try a different spam filter some time. Akismet never seems to learn anything….

21 Dividend Growth Investor

I agree with Mr Cheap that generally a company should consider paying out a portion of its profits as dividends to shareholders. The problem with retaining all of the profits to the company is troublesome in the real world since most probably the money gets spend on projects/acquisitions which yield terrible results. In addition to that a company cannot grow forever at the same pace and earn the same returns on equity as before. Thus a distribution of porfits in terms of dividends make sense.
During bear markets getting some sort of a return when your stock price is down the toilet is always a positive sign.

And last but not least over the past 30 years it had paid to own dividend payers in the USA. Check out this total returns chart:

http://www.dividend.com/img/dividend-graph.jpg

Best Regards,
Dividend Growth Investor

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