Dividend Income Questions

[NW-Bound]

"Accounting is an art, not a science".

Reminds me of a joke circulating at the time of the demise of MCI WordCom who cooked the book.

It was about how a candidate got hired to be the CFO of a company: he simply said in the job interview with the CEO that the company's earning would be whatever the CEO wanted it to be.

 

[Mulligan]

Reminds me of a joke circulating at the time of the demise of MCI WordCom who cooked the book.



It was about how a candidate got hired to be the CFO of a company: he simply said in the job interview with the CEO that the company's earning would be whatever the CEO wanted it to be.

American Greed had an episode about World Com. It was a good one. I understand some accounting, but only enough to be dangerous and enough to know I don't know where all the "art" is at. So being a conservative (chicken is a better word) I have most of my money in monopoly preferreds with a guaranteed ROE. If nothing else they can get higher rates approved to overcome an accounting scandal and give me my cumulative dividend in arrears!


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[Running_Man]

Most companies earnings are "managed" not really art unless there is outright fraud. You can control it with end of quarter specials, taking possession of inventory, forward sales, settling for cash law suits that you believe you probably could win but best to settle now with the great sales this quarter or in the other degree decided you are in the right and refuse to settle as no expense needs to be recorded, etc.... but eventually if the auditors are doing there job if the reality is not in the same realm the "story" will not be able to continue.

Back when Cisco was "the" growth company I believe they beat earning expectations every quarter by 1-2 cents for many years in a row, one quarter they only met expectations, the stock dropped 10 percent immediately and well in a few quarters you can go back and see the story. See once Cisco couldn't exceed expectations everyone knew there had to be trouble and there was, they had a severe inventory problem.

World Com merely committed fraud, they called maintenance expenses capital expense and depreciated those over long term instead of expensing as is. There is a lot of pressure on accountants to allow as fixed assets projects of repair that should be expensed and there is a lot of grey area on that topic

 

[Mulligan]

Most companies earnings are "managed" not really art unless there is outright fraud. You can control it with end of quarter specials, taking possession of inventory, forward sales, settling for cash law suits that you believe you probably could win but best to settle now with the great sales this quarter or in the other degree decided you are in the right and refuse to settle as no expense needs to be recorded, etc.... but eventually if the auditors are doing there job if the reality is not in the same realm the "story" will not be able to continue.

Back when Cisco was "the" growth company I believe they beat earning expectations every quarter by 1-2 cents for many years in a row, one quarter they only met expectations, the stock dropped 10 percent immediately and well in a few quarters you can go back and see the story. See once Cisco couldn't exceed expectations everyone knew there had to be trouble and there was, they had a severe inventory problem.

World Com merely committed fraud, they called maintenance expenses capital expense and depreciated those over long term instead of expensing as is. There is a lot of pressure on accountants to allow as fixed assets projects of repair that should be expensed and there is a lot of grey area on that topic

The capitalization versus expensed and other "aggressive" accounting would be impossible for me to detect. I try to read the "little lines of worded information below the numbers" which can be quite informative though.
I own a stock (ARCPP, since renamed) last year had accounting fraud. Being a REIT one didn't know how bad it was. The fraud did cause a suspension of common div until just now and a major drop in price. However, since I just owned the preferred and not the common, there wasn't any material concern and dividends continued uninterrupted.


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[MichaelB]

Actually, cash generation is on the Statement of Cash Flows.... you're showing your age Michael.... the Statement of Changes in Financial Position (aka Sources and Applications of Funds) was changed the the Statement of Cash Flows around 1988.

A rose by any other name ... But yes, it has been a while.

Obviously, I can learn from the more financially oriented guys, or someone with that background.

For example, I am not sure how the cash flow can be so important, if it does not result in earnings. Is it not what you keep at the end of the day that counts?

PS. I just thought of an example. Oh well. Most investors do not look this deep into it. And then, these statements only tell the status quo, not what is in the future for the company anyway.

The reason the cash generation is vital is because the buyer of a business wants to be repaid, and the source of the repayment is not profits, it's cash.

In the case of this thread, if you are expecting a dividend, you want to see the business generating enough cash to pay its debt obligations and invest for the future along with the dividend.

One really needs to see all three financial statements - income, balance sheet, cash flow - and then see how they change from one period to the next.

I don't think modern financial statements for most corporations are fraudulent or misrepresented. Most are legitimate efforts to take a snapshot in time of something that is big and dynamic. Exception to this are financial statements for the largest banks, which are IMHO undecipherable, mostly mountains of assumed valuations and predicted behavior.

 

[Mulligan]

A rose by any other name ... But yes, it has been a while.

The reason the cash generation is vital is because the buyer of a business wants to be repaid, and the source of the repayment is not profits, it's cash.



In the case of this thread, if you are expecting a dividend, you want to see the business generating enough cash to pay its debt obligations and invest for the future along with the dividend.



One really needs to see all three financial statements - income, balance sheet, cash flow - and then see how they change from one period to the next.



I don't think modern financial statements for most corporations are fraudulent or misrepresented. Most are legitimate efforts to take a snapshot in time of something that is big and dynamic. Exception to this are financial statements for the largest banks, which are IMHO undecipherable, mostly mountains of assumed valuations and predicted behavior.

Yes cash and profits are two different animals. One of the companies I am invested in is greatly increasing its ROE and profitability, even as its cash temporarily wains. They are spending hundreds of millions of dollars in infrastructure upgrades through borrowings but will get it on the back end through guaranteed rate increases. In fact the holding company didn't even collect a dividend from the common stock this year from the profits of the company as it is all being plowed back in to help with the cost of infrastructure upgrades.
But I do certainly appreciate them holding enough back for me to pay my preferred dividends. But then again, they have little choice. Pay us now, or pay us in a year in arrears when we would get to take control of the Board of Directors and then approve the dividend ourselves.



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[kcowan]

I live off interest yield from bonds and convertible debentures, a non-COLA DB pension and individual stock dividends. In fact, I reinvest the excess revenue in dividend stocks and convertibles. Been retired for 13 years.

Starting to consider selective harvesting of accumulated capital gains to spread the tax hit over multiple years. Will include large charitable donations.

 

[TimSF]

The choice between total return and income-only is really easy for me. In fact, it is not a real choice at all because I do not have a large enough portfolio to sustain my spending through income only. I probably would have had to work an extra 5 - 10 years to get there. Sure, if my assets were ample enough to generate income to keep up with spending and inflation then I'd probably do it. In reality, not an option.

 

[pb4uski]

....I probably would have had to work an extra 5 - 10 years to get there. ....

And there is the rub... not realistic for most people.

 

[Mulligan]

The choice between total return and income-only is really easy for me. In fact, it is not a real choice at all because I do not have a large enough portfolio to sustain my spending through income only. I probably would have had to work an extra 5 - 10 years to get there. Sure, if my assets were ample enough to generate income to keep up with spending and inflation then I'd probably do it. In reality, not an option.

I invest almost totally for income despite not having a pittance of a chance of living off of it. My pension supports my retirement. I just invest for income because I don't have the stones for a real portfolio. In fact I imagine if I didn't have the pension and lived off of a total return portfolio instead, I wouldn't have delayed retirement 5-10 years....I would have had to gone back to work in 5-10 years due to my unique ability to follow REWahoo's investing chart of buying high and selling low!


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[Animorph]

I guess there can be some decoupling between income investing as an investing or as a withdrawal strategy. Certainly you can invest for income while not withdrawing or even if you sell a few shares here and there. But you'd have a harder time living off dividends if you invested for total return. The investing and withdrawal strategies sort of go hand in hand.

Berkshire Hathaway is a good example. Why would an income investor invest in BRK.A or BRK.B when they don't throw off any income? Maybe as a small portion of their portfolio during accumulation, but during withdrawal?

To me a total return investor is willing to hold a significant amount of non-income producing assets in a portfolio. And in withdrawal phase is willing to sell some of those shares to create income. An income investor prefers not to do either.

 

[audreyh1]

That's right, an income investor is limited to assets that throw off income. A total return investor is not.

 

[Running_Man]

For 15 years from 1958 to 1973 the S&P500 yield hovered between 2.9 % 3.5% after having spent the previous 80 years with yields holding between 4 % and 7 1/2 percent for the most part with a few exceptions. In 1973 and again in 1981 bear markets occurred which put the dividend yield smack back in the middle of that range @ 5.73 by year ends 1974 & 1981.

In 1992 the S&P said goodbye for the most part to a 3 percent yield and from 1996 to 2007 the dividend yield stayed under 2 percent at year end, we then fell back into the range of 1981-1992 after the little market turmoil of 2008 & since the subsequent recovery the dividend yield is staying right around 2 percent.

It was easier being an income investor for most of Firecalc's life before the actual index funds were created. Having a 4% withdrawal is much easier when you start at a dividend level of 5.37% that grows faster than inflation. A fall back to our previous range 3-3.5 percent level (S&P 1200-1400) would be an advantageous time to once again become an income investor. A return to the 1973 levels would make income investing once again a breeze, just need to remember that if we hit S&P 770.

 

[mathjak107]

That's right, an income investor is limited to assets that throw off income. A total return investor is not.

making up short falls in income if dividends are reduced or suspended like in 2008-2009 when billions in dividends were suspended or cut you may have to sell assets a loss to make up the shortfall. in the end we are all total return investors .

 

[Closet_Gamer]

+1

But just think of the fat estate you'll leave your heirs!

Yeah, yeah, yeah...I knew those would be the responses. As I don't have a pension, I at least need to get myself on a good glide path re: passive income. Whether I run it up to 100% replacement level or not is a decision in the future. I do want to do a lot for charity and ideally I will have work that keeps me engaged longer than necessary. My goal is to be retirement capable when I'm 50...what I actually do? Time will tell.

As an aside, some enterprising sociologist could use this forum to replicate Pavlov's experiments...

"I want to live off of dividends..." (Bell rings). "You have lucky heirs"

"I'm thinking of getting an immediate annuity..." (Bell rings). "The return is too low, if you have enough money..."

"I'm thinking of paying off my mortgage..." (Bell rings.)....so many dogs bark in unison it sounds like the coyotes who used to live by my old house. There's some growling though, as the coyotes don't agree...



(Above offered in good humor! As you know, I've been around for a long time!)

 

[REWahoo]

As an aside, some enterprising sociologist could use this forum to replicate Pavlov's experiments...

"I want to live off of dividends..." (Bell rings). "You have lucky heirs"

"I'm thinking of getting an immediate annuity..." (Bell rings). "The return is too low, if you have enough money..."

"I'm thinking of paying off my mortgage..." (Bell rings.)....so many dogs bark in unison it sounds like the coyotes who used to live by my old house. There's some growling though, as the coyotes don't agree...

"I'm going to make fun of sound financial advice..." (Bell rings) "...the disagreeing coyotes yelp as the mountain lion eats their young..."

 

[Danmar]

I guess there can be some decoupling between income investing as an investing or as a withdrawal strategy. Certainly you can invest for income while not withdrawing or even if you sell a few shares here and there. But you'd have a harder time living off dividends if you invested for total return. The investing and withdrawal strategies sort of go hand in hand.

Berkshire Hathaway is a good example. Why would an income investor invest in BRK.A or BRK.B when they don't throw off any income? Maybe as a small portion of their portfolio during accumulation, but during withdrawal?

To me a total return investor is willing to hold a significant amount of non-income producing assets in a portfolio. And in withdrawal phase is willing to sell some of those shares to create income. An income investor prefers not to do either.

Yes, I agree. Being an income investor has a few practical advantages mentioned earlier but since it restricts security selection this approach isn't likely to result in an optimal portfolio return. This has been obscured recently because div stocks have performed so well in this low yield envireonment.

The other problem with div investing are div cuts. I was quite lucky during 2008-09 and wasn't hit by div cuts (CDN markets were generally spared) but it is certainly a risk. To cover this it is best to keep a healthy cash balance as you don't want to be selling stock after div cuts.

I also agree it's hard for most people to live solely off divs. A pension can help of course but the real problem is bond yields not div yields. If bond yields were back to normal it wouldn't be very difficult to construct a balanced portfolio that yields a reasonable SWR of 3.5%-4%. So portfolio size wouldn't be an issue as income would be the same size as a SWR. And if income yield is close to a reasonable SWR I don't see why heirs would be any better off with an income approach vs a total return approach? Most investors will be faced with a decision about large legacies either way?

 

[clifp]

I guess there can be some decoupling between income investing as an investing or as a withdrawal strategy. Certainly you can invest for income while not withdrawing or even if you sell a few shares here and there. But you'd have a harder time living off dividends if you invested for total return. The investing and withdrawal strategies sort of go hand in hand.

Berkshire Hathaway is a good example. Why would an income investor invest in BRK.A or BRK.B when they don't throw off any income? Maybe as a small portion of their portfolio during accumulation, but during withdrawal?

To me a total return investor is willing to hold a significant amount of non-income producing assets in a portfolio. And in withdrawal phase is willing to sell some of those shares to create income. An income investor prefers not to do either.

I'm an income investor but Berkshire is my largest holding (10%). I don't even write covered calls on it.

The M* dividend investor newsletter guy had a great line. "In Buffett we trust all other pay cash." I think anybody that's ever sat in at capital/budget meeting at big company understands that that there are only so many great investment opportunities.

At Intel there were always three no brainer investments.
1. Develop process technology to keep Moore's Law alive
2. Design a new x86 microprocessor that was faster and did more.
3..Build new factories to make the new microprocessor.
Now there were always 20 other projects a good many of which got funded, and while some were successful the vast majority lost shareholders tens of billions of dollars.

To me one of the strongest reasons for biases to dividend stocks is because paying a dividend deprives management of the cash for making stupid acquisitions and investment. I want Exxon manager to have enough money to buy new oil and gas fields, build refineries. I don't want them to have enough money to buy semiconductor manufacturers.

Buffett has proved that he is a better investor than I am,and he has actually hired two guys as chief investment officers who are going to hopefully continue the legacy.

I consider myself as much a value investor as a dividend investors. Most medium to high yielding stocks are value stocks and most value stocks pay dividends its just that Berkshire is an exception. I also view Berkshire as a defensive investment when the financial world collapses as it did in 2008/09 I expect Berkshire to be standing strong.

 

[clifp]

I also agree it's hard for most people to live solely off divs. A pension can help of course but the real problem is bond yields not div yields. If bond yields were back to normal it wouldn't be very difficult to construct a balanced portfolio that yields a reasonable SWR of 3.5%-4%. So portfolio size wouldn't be an issue as income would be the same size as a SWR. And if income yield is close to a reasonable SWR I don't see why heirs would be any better off with an income approach vs a total return approach? Most investors will be faced with a decision about large legacies either way?

I think this is really important, and my biggest concern when I see folks on the MoneyMustache forum talk about retiring at 40 with 4% withdrawal. It is the lack of fixed income for them. I discovered that I could join PenFed because of this forum. Shortly after I did they had a 6% 3-5 year CD special. At 6% Any AA with 30%+ bonds/CD makes its very easy to hold a dividend mutual funds or handful of blue chip dividend players, in addition to a basic index fund with 2% dividend yield and end up being able to support 3.5-4% WR entirely on the income generated by the portfolio.

We don't live in that world anymore.

 

[modhatter]

I think this is really important, and my biggest concern when I see folks on the MoneyMustache forum talk about retiring at 40 with 4% withdrawal. It is the lack of fixed income for them. I discovered that I could join PenFed because of this forum. Shortly after I did they had a 6% 3-5 year CD special. At 6% Any AA with 30%+ bonds/CD makes its very easy to hold a dividend mutual funds or handful of blue chip dividend players, in addition to a basic index fund with 2% dividend yield and end up being able to support 3.5-4% WR entirely on the income generated by the portfolio.

We don't live in that world anymore.

Normal interest rates would double the current federal budget deficit and make any effort to contain the national debt far more difficult. They are not going to take any measures to significantly raise rates, as it would be working against the governments own best interest. Even though the Fed and Congress are supposed to work independently, in the real world there is a lot of political will being thrown at the Feds. Just my opinion. I would love to be wrong though.