Monthly Archives: November 2009

Dividends (II)–what to look for in a dividend-paying stock

November 19, 2009 By in Dividends, Industry Analysis, Retail, Stock ideas Tags: , , , , , , Leave a comment

A couple of caveats to start out with

I’m going to be talking about US stocks in this post.  Company attitudes toward dividends–and toward caring for shareholders in general, for that matter–vary from country to country.  So, too, do investor preferences for dividends.  Tax regimes are also important.  If a dividend recipient has to pay income tax at an 80%-90% rate on the distribution (as was the case in Japan in the Eighties), paying a dividend is an exercise in futility.

Before buying any stock, except if you’re hoping for a quick change of control, you’ve got to make sure that the company is viable and has decent management.  I’m assuming here that work is already done.

I’m not going to write here about highly specialized companies, like public utilities or REITS, where government regulations play a key role in what the company is able to do.

How a company determines its dividend

The dividend is recommended by management and approved by the board of directors.

In my experience, the dividend level is always set by looking a the firm’s past results, not its projections for the future.

Perhaps the most crucial consideration is whether the firm can maintain (not cut) the dividend, even in adverse economic circumstances.

Dividends are supposed to be paid out of profits. Because of this dividends are usually talked about in terms of the % of income that is paid out.  I’ve found, however, that it’s more useful to look at dividends as a % of cash flow from operations (basically net income + depreciation/amortization + deferred taxes) as a way of predicting their future course.

A two-pronged approach:  qualitative and quantitative

1.  qualitative. Like the products or services they sell, companies too have a life cycle.  When they’re young and expanding quickly to stake out territory for themselves, they typically need as much capital s they can get their hands on.  They shouldn’t–and don’t–pay dividends.  As the company matures, growth typically slows, the need for capital to fund expansion diminishes and the company begins to generate excess cash from operations.  In many cases, companies don’t recognize this shift at first.  It’s only when new investments show up with sub-par or negative returns that they start to work the new realities out.  In some cases, firms pigheadedly continue to expand, kind of like the professional athlete who wants to play “one more year,” unable to recognize that age has diminished his skills.

Ideally, you would want to find a company that is maturing, understands this and has adjusted its mindset.  It strikes me that WMT is a good example of this type of firm.  MSFT and INTC may be others.

2.  quantitative. All of the numbers I’ll be writing about can be found in a company’s annual report or 10-K.  Discount brokers may have either analyst reports or databases for customers’ use where they also can be found.  The Value Line Investment Survey, which is available in almost any library, is also a good source, because all of the historical data you’ll probably need are on a single page, with most of the ratios already calculated.

I’m going to be using WMT as an example.  I’m taking all but one of the following figures from Value Line. Here goes:

a.  dividend yield.  2.3% for WMT, slightly higher than that for the typical dividend-paying stock.

b.  dividends as % of profits.  WMT’s payout has grown from 17% of profits in 2000 to 28% in 2008.  There’s still plenty of room for it to grow safely.  The rising percentage implies, of course, that WMT has been raising its dividend at a much faster rate than profits.

c.  dividends as % of cash flow.  The growth here is from 11% to 18%.  Again, plenty of cushion to maintain the payout, as well as to grow it.  My experience is that a mature firm can easily pay out a third of its cash flow in dividends.

d.   has the dividend ever been cut?  In WMT’s case, no.  The recent times of greatest concern would be 1997, 2000-2002 and 2007-2009.  A company that reduced or eliminated its dividend during times of economic stress is, I think, more likely to do so again.

e.  when does the board usually raise the dividend?  In WMT’s case, the company has a pattern of raising the dividend with the June quarter payout.

f.  general indicators of company health.

Although WMT’s capital spending is about 2x its depreciation (i.e., it is expanding), the absolute amount of capital expenditure has been falling (source:  WMT annual reports).

Debt, at 1/3 of total capital, is reasonable and appears to be stabilizing at this level.

Returns on capital are high.

Interest expense is covered by income from operations ten times (an impressively big number).

Dividends (l): the return of the cash dividend

November 18, 2009 By in Basic Concepts, Current Market Thoughts, Dividends Tags: , , , , , Leave a comment

How dividends come to be

Company managements are stewards of the capital that the company owners, the shareholders, have placed in their hands.  One of the jobs of management is to decide what to do with the cash the business generates.

There are two main choices:

–reinvest the money in the business if profitable opportunities to do so can be identified, or

–return the money to shareholders.

The return typically takes two forms:

–periodic payment of cash dividends to shareholders, or

–stock buybacks (a more dubious alternative, in my opinion).

“double taxation”

In many countries, including the US, cash dividends are subject to what is called “double taxation,” meaning that although the dividend is paid out of the money that’s already been taxed at the corporate level, the recipient is also required to pay income tax on the amount received.

Corporate managements in recent years have preferred to have stock buybacks rather than cash dividends, citing the avoidance of double taxation as a reason.  I find this a bit disingenuous.  Many times, companies use the buybacks to soak up (and obscure the negative effect on ordinary shareholders of) new stock being issued to managers through stock option programs.   If you watch the money trail, the cash leaves the corporate treasury and winds up in the pockets of corporate executives.

Forty-somethings could care less about dividends

For the past twenty years or so, investors in the US have have worked up virtually no interest in stocks for their dividend-paying ability.   How so?  The Baby Boom was (relatively) young and interested in making its money grow fast, that is, in capital gains.  The coupon on government bonds was over 7% until the internet bust, and interest rates were steadily falling as the Fed drove inflation out of the economy.  So T-bonds were the natural alternative for individuals desiring income, offering high yield as well as the chance of capital appreciation.

In part because of this, stocks of companies whose main virtue was the ability to generate steady income fell to low price levels.  Many were taken out of the public equity market–first, in a wave of junk bond-related acquisitions, and more recently by private equity.

Now, fast forward to the present.

For retirees, it’s a different situation

The Baby Boom is reaching retirement age and starting to shift its investment preferences toward income generation rather than making its capital grow.  Long-dated government bonds are yielding half what they were ten years ago, and have in them the potential for capital loss as/when interest rates begin to rise from the current crisis-low levels.  Money market funds yield close to zero.

For the stock market, too

On the other hand, many integrated oil companies, utilities and telecom firms have stocks that yield about as much as the 30-year T-bond.  In some cases, the yield is higher–but that’s not necessarily a good thing (more about this in my next post).  In addition, many well-known large-cap leading lights, like WMT (2.0%), XOM (2.2%), INTC (3.1%) and MSFT (1.7%) have respectable dividend yields.

Individuals are still mostly oblivious…

I don’t see overwhelming evidence that individual investors have picked up on the attractiveness of dividend-paying stocks yet.  They see their investment issue, but not the solution.  In fact, I pointed out in a post in late February that some basic dividend-related investment concepts, like yield support (the idea that at some point high dividend yields would stop stocks from falling further), seemed to have faded from the market’s memory.

..but maybe not for long

That inattention may not last long.  It seems to me that financially and operationally sound companies have begun to signal their health by raising their dividends.  XOM and WMT did so near the bottom of the market.  INTC has just followed suit.  MSFT, which has shown a pattern of raising its payout in December, may be the next market titan to follow.  WYNN (which I own), a much smaller firm, has just made a very strong statement about its financial health by declaring a $4 a share (about 6%) special dividend to be paid next month, plus the initiation of a regular 20¢/quarter dividend.  Of course, part of the WYNN statement comes from the fact that its bankers have allowed the payouts to happen.  Sooner or later, the market is bound to notice.

In fact, Wall Street may already be taking heed.  Another, more subtle, indicator of the market’s attitude toward dividends is to examine what happens on the day a stock begins to trade ex dividend, i.e. the first day when buyers are not entitled to receive an upcoming payment.   Does the stock in question decline by the amount of the dividend, or more?  That’s bad.  Or does it “carry” some or all of the payout, i.e. not decline at all or decline by less than the dividend.  Tis is typically a strong sign of approval.

WYNN is a case in point.  It paid out $4 a share, but declined by $1.52 in a more or less flat market.  So it “carried” $2.48.  I interpret this as meaning that investors are not as unaware of dividend events as they were in February.  (Now, it may be that investors missed the fact of the payout completely, thought the bottom had dropped out of the stock at the open and stepped in to grab a “bargain.”  That would mean the stock’s rise would be a sign of ignorance, not approval.   Maybe so, but I’ve always found it a dangerous to underestimate the collective intelligence of the market.  Yes, LVS and MGM rose, too, but their financial conditions are so more precarious that I’m not sure they’re comparable.)

Naturally, the earlier we are in recognizing a trend toward buying dividend-paying stocks, the better it is for us–as long as somebody else follows.

That’s it for today.  In my next post, I’ll write about how companies decide on a dividend increase–because you want steady and rising income, and where to look for assurance the dividend is secure.

Activision’s Call of Duty: Modern Warfare 2–implications for consumer spending

November 17, 2009 By in Current Market Thoughts, Entertainment, Industry Analysis, Recent Market Action, Technology Tags: , , , Leave a comment

Last Thursday, ATVI released Call of Duty: Modern Warfare 2. First day sell through was 4.7 million units, according to the company, or $310 million worth, in the US +UK.  By the same time this week, sales could be over $700 million.  ATVI is calling this “the biggest launch in history across all forms of entertainment.”  It comes as the US and UK are only starting to crawl out of the biggest economic downturn of a generation.

Before I go any further, I should say that I own ATVI stock.  It has been a so-so performer vs. my expectations for it.  That’s because, I think, investors are worried about overall retail spending and about the future viability of the shrink-wrapped game software business.  I think these fears are understandable, but misplaced as far as ATVI is concerned.  But that’s a story for another day.

Call of Duty:  Modern Warfare 2 illustrates three characteristics that I think will show themselves to be true throughout the holiday season,namely:

1.  People are able to spend.  They won’t buy indiscriminately, as they did during better economic times, but if they see something they really want, they’ll find money for it.

2.  Buyers of MW2 are mostly male and mostly under 35 years old.  The first attribute isn’t that important, I believe, but the second is.  Video gamers are generally not high-cost fifty-something workers who are prime targets for downsizing.  They’re also not worrying about what the stock market has done to their retirement nest eggs. I think consumers under 40 will be much more liberal holiday spenders than their older counterparts.

3.  The tide won’t lift all boats–but it will lift some. Witness the performance of ATVI’s rival ERTS.   When demand is strong, the number one firm in an industry won’t be able to fill all orders promptly (if at all), so some sales overflow to the second- and third-tier market entrants.  In bad times, there is no overflow, so sales revert to the industry leader.   This holiday season it appears the tide is not going to rise very much.  But beneath the surface there will likely be a sharp differentiation between winners and losers.

The next data point may well come from another ATVI game, Tony Hawk Ride, which launches today.  The game costs $120 and includes a simulated skateboard, which players “ride” and help perform the tricks the game requires.  To me it seems a neat, if unusual idea.  But will potential buyers be put off by the price?

Disney’s September quarter conference call

November 16, 2009 By in earnings conference calls, Entertainment, Industry Analysis, Stock ideas Tags: , , , , Leave a comment

Me and Disney

I know DIS from only years ago.  But since I’m a prospective owner through my stock in MVL, I decided to try to get to know the company a little better.  My first look–of potentially many–made me buy a small amount of DIS itself.

Admittedly, although my family and I love Disneyworld and think the makeover of Disneyland is terrific, my expectations were low going in. Watching the stock for years out of the corner of my eye, I was aware of the debacle of Eurodisney (perpetrated by management imported from Marriott, which soon moved on to perform their management act at Northwest Air) and the stagnation culminating in the Eisner years.  But nothing much else registered.

Segment earnings

Anyway, the company is a lot more interesting than I had thought.  Here’s what segment earnings for the past two fiscal years (ends in September) look like in $ millions:

—————2009———-2008

Media                 $4765            $4981

Parks                  $1408           $1897

Studio                 $175              $1086

Consumer         $609               $778

Total                  $6957          $8742

(Note that I’ve excluded the fledgling Interactive segment, which lost $295 million in fiscal 2009 and $258 million the prior year.)

Media breaks out into Cable (mostly ESPN) and Broadcast (the ABC network).  Their figures are:

————— 2009———-2008

Cable              $4260             $4139

Broadcast      $505                $842.

First impressions

1.  The most obvious thing about Disney is that the lion’s share of its earnings come from ESPN, which is also its fastest growing and strongest business.  In fact, another company might be considering splitting in two or changing the corporate name to ESPN, much in the way that Dayton Hudson renamed itself Target some years ago, to make sure investors understood what they were getting when they bought the stock.

The Disney brand is too important to bury it inside a renamed ESPN, though.  IPO 10% of ESPN to highlight the value?

2.  From a business cycle point of view, the company has two arms, Media and Studio, that lead the cycle and two, Parks and Consumer (mostly wholesaling of Disney-branded items), that lag.  As the US economy turns back up, Disney should benefit from higher ad rates in the first two divisions and later on a bounceback in the second two, as consumers begin to open up their wallets again.  This timing may not be so important to investors.  If the first two begin to give evidence of a cyclical upswing, the stock market will likely assume the others will follow and begin to discount the Parks and Consumer upturn before it starts to occur.

3.  Lots of interesting things seem to be happening now at Disney, like:

–the acquisitions of Pixar in 2006 and Marvel Entertainment this year,

–ESPN’s expansion into the UK with Premier League soccer,

–the revamp of Disneyworld and the theme park expansion into Shanghai,

–the family resort in Hawaii and the new cruise ships,

–the ongoing management reshuffling, which could be taken as a refreshing openness to new faces and different perspectives.

You might argue–it’s much too soon for me to be sure–that Bob Iger, the chairman since 2005, is shaking up a previously lumbering giant in a way that will make its long-term growth rate rise.  Add to that a cyclical upturn in earnings and you may have a compelling investment case.

4.  On the other hand, really the only bad thing I’ve noticed about Disney so far is its communications with investors.

Try to find investor relations on the Disney website.  Try to find the phone number of someone to speak with.  You can do it, but it’s not easy.  Then, try to get someone to return your call.  How did Bloomberg, the Wall Street Journal, the Financial Times and the New York Times all get the terms of the Marvel acquisition wrong?  I don’t actually know, but I’m guessing it’s because they were all working from an incomplete press release and had no one at DIS to talk to.

True, the CFO seems to be providing for the needs of brokerage house analysts.  But that’s the model of yesterday, and it’s getting more broken by the day.  One would think that a consumer-oriented company would want to attract individual shareholders who loyally buy their products and use their services.  Disney IR seems to have forgotten about regular people like us in a way that would get them quickly shown the door if they were working for one of the company’s theme parks.

You might say that this is a nitpicking point.  Maybe so.  But my experience is that failure to communicate with actual or prospective shareholders is most often coupled with mediocre, inwardly focused management.

The conference call

The main positive for Disney, I think, is the news they announced that the advertising market is giving signs of recovery, especially for ESPN.  Auto, grooming, insurance and retail are all increasing their ad spending.  Also, ad customers are starting to allocate general advertising money, not just funds targeted specifically for sports, to ESPN.  Digital offerings, ESPN.com, ESPN mobile and ESPN 360 are all improving.  For example, DIS  4 million iPhone users have downloaded ESPN’s Sports Center app.  Of those, 2 million are regular users, and therefore watchers of imbedded ads.  The only obvious area of weakness is NASCAR (why am I not surprised?).

The low point seems to have been passed for the US theme parks, as well, although DIS is still only able to stabilize attendance through discounting.  Current discounts are a bit less than they were earlier in the calendar year, though, which is encouraging.  The parks have less visibility than usual, since visitors are waiting longer before booking.

Fiscal 2009 was a dreadful one for the DIS film business.  But here, too, the worst seems to be behind the company, which appears to have stronger releases on tap for the coming fiscal year.  Yearend writedowns of the underperforming films from fiscal 2009 means that they are unlikely to hurt current year results.

Perhaps the most interesting comment on the call, other than the incipient advertising rebound, was about DVD sales.  In prior downturns, the sales falloff was primarily seen in new releases; older “classics” continued to sell well.  In this downturn, however, sales of everything declined.  How so?  Was it the severity of the recession, or confusion over new formats?  DIS doesn’t think it’s either.  Rather, the company feels this is part of a structural change in the way customers use filmed entertainment.

If so, the consequences for the film business are severe.  DVD sales make up over half the revenue most films enjoy.  On the other hand, it also makes the Marvel Entertainment acquisition look that much better, since MVL has seen strong DVD sales for Ironman and only slightly disappointing results from Hulk.  Also, almost anything would be better than fiscal 2009 film performance for DIS.

All in all, the call had no information to invalidate the investment concept of cyclical earnings rebound plus application of better management to the company’s assets.

Stay tuned.

 

 

a little more on MTLQQ–Motors Liquidation

November 15, 2009 By in Autos, Industry Analysis, pink sheets Tags: , , , , , , Leave a comment

The website is better

I happened to look at the MTLQQ website last Thursday.  It has been expanded considerably since my last visit, some months ago.  The site now has links to thousands of pages of bankruptcy-related documents.  And for nostalgia fans, you can also get past General Motors annual reports.

One section of the bankruptcy filing gives 852 pages of pending lawsuits.

Another lists MTLQQ’s properties, which include the Hyatt Hills golf complex in Clark, New Jersey.  HH has nine holes of regulation golf and a miniature golf layout.  It’s being carried at about $5 million.  How did that get in there?  Why only nine holes?

The most important section lists MTLQQ’s assets, as of the bankruptcy, at $2.1 billion and its liabilities at $27.4 billion–meaning a total company  deficit of $25.3 billion.

Monthly SEC filings

The newest are an 8-K and a copy of the monthly report for September to the bankruptcy court, filed on November 12th.

Excerpts:

MTLQQ had a $100 million loss for the three months ending September.  That’s not so surprising if you read the interview summary below.

Liabilities have expanded to about $35 billion.  The major creditors are unsecured bond holders ($27.3 billion), unions ($3.5 billion) and product liability claims ($1.5 billion).

A Financial Times interview with the CEO

The interview with Al Koch, a liquidation specialist whose firm was hired by the bankruptcy court, has a few salient points:

1.  he’s developing a ten-year plan to dissolve MTLQQ

2.  MTLQQ is still receiving about a thousand new claims a day, which is more than had been expected.  They fall into three main categories–vehicle liability, tax, and environment.

3.  Koch doesn’t expect to net anything from asset sales.  “It’s not so much about how much we’re going to get as about how much we’re going to pay,” since maintaining an idled car plant can cost $3 million a year.

Conclusion

Yes, MTLQQ does own 10% of the “new” GM plus warrants to buy another 15%.  But, even assuming the liabilities don’t expand from here, which they have already shown a tendency to do, the first $35 billion of that is owed to MTLQQ’s creditors.  In other words, for you to make any money from owning MTLQQ, you have to believe that when it eventually relists, the “new” GM will have a market cap as big as IBM or GE.  What are the chances of that?

You can also see my first post, dated September 9, 2009.