Tuesday, July 21, 2009

Share and Share Alike?

As the highly correlated global stock markets and higher yield debt markets levitate on a flood of central bank and governmental "money", observers and investors are left to wonder what it's all about, and what comes next in the short and intermediate term.

In some ways, it's even easier to purchase common stocks than to deposit money in the bank, because the bank needs to meet its depositors in person, whereas E*Trade et al could care less about such matters. Since common stocks are what are easy to buy and what the media focus on, investors should be doubly careful about them. On the other hand, Treasuries are not so easy to buy and I don't know any investors other than my sainted parents who care about owning them. Let's compare.

Take IBM, a recent hero for a beat and raise quarter (ignoring coming in under Street revenue estimates; in a bull market, all sins are forgiven). If you give a current IBM shareholder $116 to own a share of IBM, you can expect to receive a 1.9% yield until the dividend is, presumably, raised. Let's say that IBM raises its dividend every year by 7%, tracking its possible growth in sales. After 10 years, the dividend yield at the current stock price will be 3.8%. Your average return will be about 2.8%. Where the stock will then trade is completely unpredictable. The stock has gone absolutely nowhere for 10 years. If the U. S. is like Japan, just 10 years out of phase, IBM will likely be lower in price in another 10 years. Or, it could triple or better.

Now, consider the much-despised or ignored 10-year Treasury bond. Depending on the market's mood, you will receive 3.6% every year. Not only will you have an average cash return nicely above that from IBM, you have a more certain higher return in the first years. In ten years, you can start over with your Treasury bond. You can buy gold. If rates are higher, you can invest in cash, more bonds, etc. If you own IBM, you have no exit point. Worse, you are likely to get over-optimistic and hold IBM when you should sell it, and you will tend to get pessimistic when the news is going to improve.

If you like corporations and hate the low yield of Treasuries, there are higher yields in the debt of IBM and other, weaker companies.

The lesson of Japan, Europe, many countries with stagnant stock market averages for many years, and the U. S. for the past 12 or more years is that yield and safety of principal matter. If you "make" 14% a year in a non-dividend-yielder for 5 years and then the stock takes a 50% dive-- common now and then even for IBM-- you have nothing to show for your loyalty.

In the case where bonds turn to trash due to massive inflation, forget IBM. Buy gold, gold, more gold and some other "stuff".

The people who run IBM make sure to get paid in cash. For them, stock options are a fillip. Least amongst their concerns are their loyal shareholders. That is why 2/3 of their free cash flow goes to purchase stock from the least loyal shareholders, and only 1/3 goes to dividends. Matters are worse at Cisco, which despite its giant size pretends it is a youthful grower and thus refuses to pay out a penny in dividends. Meanwhile, not only do the insiders take large cash salaries, but simply the normal volatility of the common stock guarantees that from time to time, they will be granted stock options when the stock is low, and they can cash out when it is high. Thus the stock can go nowhere for a decade but the insiders cannot lose and are guaranteed to win big on a portion of their options.

Just like the famous law firm Cheetum, Cummin and Goin.

Copyright (C) Long Lake LLC 2009

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