Monday, December 31, 2007

Asset Location: A Decision Easily Overlooked

As the new year has arrived for some and is fast approaching for others, reviewing investment portfolios is a common task for many. Decisions will be made regarding reallocating investment assets, i.e., selling under performing assets and/or taking profits in investments that have performed well in order to rebalance ones asset allocation. One decision often not considered is the location of specific assets. For example, should bonds be placed in taxable or non-taxable accounts, etc. Ultimately , an investor will have investments in both taxable and non-taxable accounts.

There are three features of the tax code that favor holding certain assets over others in taxable accounts.
  • First, long-term capital gains are taxed at lower rates when realized in taxable accounts;
  • Second, losses can be realized and the government can share the loss in taxable accounts;
  • Third, capital gains taxes can be avoided by awaiting the step-up in basis at death or giving the appreciated asset to charity instead of a cash contribution in taxable accounts.
A recent article by the American Association of Individual Investors describes which type of assets should be considered for taxable and non taxable accounts.

401(k) Plans and Other Tax-Deferred Retirement Accounts

The first asset to place in retirement accounts is bonds, which tend to generate returns that are almost entirely taxed as income. The exception is that any liquidity reserves—usually short-term fixed income held for emergencies and other short-term cash needs—should be held in taxable accounts where it is readily available. The next choice for assets in retirement accounts are REITs (real estate investment trusts), which pay large cash dividends that, unlike dividends on other assets, are taxed at ordinary income tax rates.

Tax-inefficient stock funds come next in the retirement account pocket, and these include most actively managed stock funds. The most tax-inefficient funds are those that realize capital gains quickly, especially those that realize substantial short-term capital gains.

Taxable Accounts

The first assets to place in taxable accounts are assets you never intend to sell or that you will give to charity as an appreciated asset, and passively held stocks and other assets that are expected to provide substantial long-term capital gain potential. The key is that you want to let capital gains grow unrealized for long horizons. The stocks can be tax-efficient stock mutual funds that realize (and thus distribute) minimal capital gains, such as index funds, or individual stocks that you will passively hold for at least a decade. Other good candidates include tax-managed stock mutual funds and index funds or exchange-traded funds that track a large-cap or total market stock index. Raw real estate that will be bought and held for long horizons would also be a good asset to hold in taxable accounts, as would gold bullion (remember, though, these are not investment recommendations, they are simply suggestions on where to locate them if you want to own them). Although not optimal, it is better to hold actively managed stock funds—especially those that realize minimal short-term capital gains—rather than bonds or bond funds, in taxable accounts. The last asset in the taxable pocket should be whatever asset is needed to satisfy your asset allocation that cannot be held in a retirement account.

One key to reviewing asset location decisions is to not let the tax tail wag the dog. Of utmost importance is one needs to be saving. If this means all investment assets are in a tax deferred account then that is fine. Lastly, other tax deferred accounts, such as Roth IRAs and their special tax rules must be considered as well.


Picking the Right Tax Pocket for Your Assets

AAII Journal

Saturday, December 29, 2007


As 2007 comes to an end a common theme for articles is to outline lists covering a wide range of subjects to consider going into 2008. Following are links to several articles that might be of interest to some readers:
  • The Five Keys to Investing Success, in Kiplinger's Personal Finance Magazine, contains information on making investing a habit and avoiding unnecessary risk, just to name a few of the topics.

Friday, December 28, 2007

Election Year Return For The Dow Jones Industrial Average

The weekly Chart of the Day graphic details the average election year return for the Dow Jones Industrial Average. In the commentary to the chart they note:
With the 2008 presidential campaign now in full swing, today's chart illustrates how the stock market has performed during the average election year. Since 1900, the first five months of the election year have tended to be choppy. That choppiness was then followed with a rally right up to the November election. One theory to support this election year stock market behavior is that the first five months of choppiness is due in part to the uncertainty of the outcome of the presidential election (the market abhors uncertainty) with the market beginning to rally as the outcome of the election becomes increasingly evident.
(click on chart for larger image)

Dow Jones Industrial Average Election Year Average ReturnSource: Chart of the Day

If history provides any clue to the future, the markets could be in for a bit of a bumpy ride in 2008.

Thursday, December 27, 2007

Bears Lead Bullish Sentiment Lower

The contrarian Sentiment Survey indicator reported by the American Association of Individual Investors, as of December 26, 2007, shows individual investors continue to be bearish.
  • The bullish level declined to 30.0% versus last week's 35.9%.
  • The 8-period moving average fell to 34.7%. This is the lowest level since August 2006 when the 8-period moving average equaled 34.3%
  • The level of bearishness increased to 50% versus last week's 47.2%.
  • As a result, the bull/bear spread came in at a -20% versus last week's -11%.
In addition to the 7-year chart, I have included a shorter snapshot beginning December, 2005.

(click on charts for larger image)

bullish investor sentiment graph as of December 26, 2007
2-year bullish investor sentiment graph as of December 26, 2007

S&P 500 Dividends Increase 11.5% in 2007 versus 2006

Standard & Poor's reported dividends for the S&P 500 Index totaled $27.73 in 2007 versus $24.88 in 2006. This represents an increase of 11.5%. Additionally, Howard Silverblatt, Senior Index Analyst for Standard & Poor's noted the following dividend action items:

  • Increasing the indicated rate to $28.75 versus $26.55.
  • Expecting a 9.3% gain in the actual cash dividends paid in 2008 over that of 2007 which equates to $30.30 per share.
  • 11 companies in the S&P 500 chose to initiate a dividend payment in 2007, bringing the total to 389, a level not seen in seven years.
  • Tendency for index issues to pay and increase cash dividends is much greater than that of the general market with 77.8% of the S&P 500 constituents paying cash dividends versus just 38.7% for the non-S&P 500 companies.
  • In 2007, over 60% of the S&P 500 increased their dividend payout compared to less than 28% for the non-S&P 500 companies.

S&P Increases Indicated Dividend Rate on the S&P 500 (pdf)
Standard & Poor's
By: Howard Silverblatt and David Guarino
December 27, 2007

Tuesday, December 25, 2007

Topics To Consider Before The New Year Begins

  • Review their portfolio asset allocation. An article from the American Association of Individual Investors, The Basic Truths About Asset Allocation, provides helpful hints on portfolio management.
  • S&P reports 40% of consumers will dedicate more of the increase in their 2007 holiday spending to the Internet than to any other channel. This is coupled with the finding that among those polled, 70% planned to do at least a portion of their shopping online. Participants’ responses further revealed that 22% of holiday shopping in 2006 was done online.

Sunday, December 23, 2007

REITs Firmly In Downtrend

REITs remain firmly in a downtrend since peaking in February of this year. The Dow Jones Wilshire REIT Index has declined over 30% since the February peak. From a technical perspective, recent action in the REIT Indices suggests there could be upside movement in the indices near term.

Bond Rating Agencies: Investors Should Shoulder Much Of The Blame

This week's Barron's contained an article on the bond rating agencies, Failing Grade ($), that indicated more regulation was needed for the rating agencies: Moody's (MCO), Standard & Poor's (MHP) and Fitch. The article contends the rating agencies were key enablers of the subprime mortgage fiasco. This part of the article is correct. However, much of the blame should be shouldered by investors that put money into these investments in the first place. Even individual investors were placing cash in money market funds because the funds had yields that were higher then most traditional money market funds. If an investment seems too good to be true then it probably is.

Investors must understand what they are investing in regardless of whether or not it is a stock, bond or real estate, etc. The same type of due diligence that goes into purchasing a stock should be performed when purchasing a bond. If investors in these CDOs had performed the necessary due diligence, they would have discovered many of the original mortgages within the pools were formally lower grade mortgages subsequently classified AAA rated. It should be obvious that mortgage pools that have high loan to value attributes are higher risk.

In the end, before making any investment, perform the due diligence on the investment. Don't buy a stock simply because a securities analyst says it is a buy. Similarly, bond investments, mony market funds and mutual funds should be scrutinized in the same way.

Thursday, December 20, 2007

Mutual Fund Shareholders Vote With Their Feet

Following is a table showing the mutual funds with the largest outflow of dollars in 2007. Commentary on these outflows can be found in the SmartMoney article, Exiting Shareholders Impact Fund Performance.

(click on table for larger image)

As noted in the article:
...we'd stay invested in a fund whose long-term track record might be taking it on the chin recently because its style isn't in vogue. For example, growth funds have lagged the last five years. But now they are showing signs of life. Selling would mean missing out on a possible rebound. Be wary, though, of perennially poor performers or funds that have experienced several manager turnovers. After all, you might as well resort to a low-cost index fund and save yourself the headaches.

One surprising entrant on our list is the Vanguard 500 Index fund. Morningstar says investors pulled $10.2 billion from this fund in 2007. This is a case where the redemptions don't necessarily mean the fund is in the gutter. Some of the outflow is due to Vanguard recommending its Total Stock Market Index fund over the 500, since it has a more diverse array of stocks in its portfolio. However, that number is a bit deceiving. Earlier this year, Vanguard launched its new Signal share class geared toward financial advisors. By shifting, say, $5 million into this share class, advisors can save 40% on costs compared with other share classes. The option was so popular that money simply flowed out of one share class and into the Signal ones. In the end, only about $1.8 billion actually left the 500 Index fund's coffers. We wouldn't suggest following in those former shareholders' footsteps. This fund is still one of the best low-cost options out there.
In the end, before an investor switches out of one of these funds, they need to know the reason behind the redemptions.


Exiting Shareholders Impact Fund Performance
Smart Money
By: Rob Wherry
December 20, 2007

Bullish Sentiment Declines: December 20, 2007

In the the American Association of Individual Investors sentiment survey released today, the level of bullishness declined to 35.85%. Last week's bullishness level equaled 47.62%. Additionally, the bull/bear spread turned negative a equaled a negative 11%. Last week's bull/bear spread was a positive 12%.

(click on graph for larger image)

Wednesday, December 19, 2007

Long Term Investor Reminder

I recently had a chance to read an interview that Charles Kirk of The Kirk Report conducted with Dick Davis. Mr. Davis recently finished a book, The Dick Davis Dividend, after three plus years in the making. One of the pages Mr. Davis features on his website is a reminder page for long term investors. Given the volatile nature of the markets ecently, I thought readers might find the reminder page of interest:

(click on graphic for link to Reminder Page)

Source: The Dick Davis Dividend

Following is a brief biography of Mr. Davis:
Dick Davis is one of the most widely known and highly respected market commentators of his time. He founded the "Dick Davis Digest" in 1982, one of the nation's most successful investment newsletters, with subscribers in 50 states and 50 foreign countries.(He no longer has an affiliation.) Based in South Florida, Davis was the nation's only non-salesman employee of a member of the New York Stock Exchange Merrill Lynch, Walston, Drexel Burnham), to work full-time as a broadcaster.

He pioneered in-depth stock market reporting on radio and television in the mid-'60s to the mid-'80s. On radio, he broadcast as often as 5 times a day for 20 years. On television, he broadcast twice a day for 20 years. His was television's first daily in-depth market report. It won the Janus award for the nation's best business reporting, and it laid the groundwork for the popular PBS "Nightly Business Report," launched from the same TV station in Miami in the late '70s. Davis also wrote a three times a week stock market column for the "Miami Herald," which was syndicated by Knight Ridder to some 100 newspapers for over 10 years.

Born in 1928 and raised in Yonkers, New York, Davis attended Horace Mann School for Boys, Hobart College, Syracuse University and University of Miami with majors in English literature and accounting. He served in the Army Counter Intelligence Corps in Japan during the Korean war. His Investment career started in 1958 in the Miami Beach office of Merrill Lynch. He first went on the air for Merrill in 1965, and he broadcast uninterruptedly for the next 20 years. He resides in Boca Raton, Florida where he looks forward to visits from his six perfect grandchildren.

Monday, December 17, 2007

Pfizer and Eli Lilly Each Raise Dividend More Than 10%

Both Pfizer (PFE) and Eli Lilly (LLY) raised their quarterly dividend by at least 10%.

Pfizer raised its quarterly dividend 10.3% to 32 cents per share versus 29 cents per share in the same quarter last year. The company's projected payout ratio is 55% based on 2008 estimated earnings of $2.34

Eli Lilly
Lilly raised its quarterly dividend 10.6% to 47 cents per share versus 42.5 cents per share in the same quarter last year. The company's projected payout ratio is 48% based on 2008 estimated earnings of $3.89.
(click on table/chart for larger image)

pfizer and lilly dividend analysis table December 17, 2007
pfizer & lilly stock chart December 17,2007

Sunday, December 16, 2007

Inflation Protection For An Investment Portfolio

Last week economic inflation reports showed wholesale inflation rose at the highest rate in 34 years, while consumer prices rose the most in more than two years. One way an investor can protect an investment portfolio from the negative effects of inflation is by investing in Treasury Inflation Protected Securities, commonly referred to as TIPS.

The distinguishing characteristic of TIPS is the principal is adjusted periodically by the level of inflation. The face value of a TIPS is adjusted based on the consumer price index for all urban consumers (CPI-U). As detailed in an article by the Association of Individual Investors on TIPS:
"This inflation adjustment also applies to the coupon interest thrown off by TIPS. The interest rate of TIPS is set when the bonds are sold, at auction. That rate never changes. But because the face amount of the TIPS is adjusted at the rate of inflation, interest income rises as the value of the TIPS rises: The interest income computation is applied to a rising base. Note, however, that interest rates at auction vary as the general level of interest rates varies."
An investor needs to remember that one aspect of TIPS is the additional interest earned due to the inflation adjustment is added to the face value of the bond, but an investor is taxed on this additional earned interest.
"The main attraction of TIPS and TIPS funds is that they provide a hedge against future inflation and insure a modest, but real rate of return over long holding periods."

TIPS for Inflation-Proofing Your Portfolio: A Guide to Inflation-Indexed Securities
American Association of Individual Investors
By: Annette Thau

Buybacks Exceed Earnings in Third Quarter 2007

In the third quarter of this year, Standard & Poor's reports buybacks totaled $171.95 billion dollars in 3Q versus reported earnings of $133.84 billion. Dividends plus buybacks totaled $232.79 billion. Since the beginning 2001, companies have returned nearly 91% of cumulative reported earnings ($3,363 billion) to shareholders via dividends and buybacks combined ($3,052 billion).

(click on chart for larger image)

third quarter 2007 stock buyback chart
As S&P notes, not all companies highlight the impact of share repurchases on earnings per share.
"As a result, P/E and growth evaluations that were not adjusted for the share count reduction effect reflected a higher premium paid for operating earnings."
Standard & Poor's provides the following illustration:

third quarter 2007 eps impact of stock buyback activityDetailed information on buyback activity in the third quarter is contained in S&P's buyback report.

S&P 500 Buybacks: Three Years and $1.3 Trillion Later (pdf)
Standard & Poor's
By: Howard Silverblatt & Dave Guarino

Saturday, December 15, 2007

The Black Swan: Unpredictable Random Events Impact The Markets

Earlier this year, Nassim Taleb released his book The Black Swan. This is a follow up book to his earlier reading, Fooled by Randomness. The Black Swan idea is essentially Taleb's idea that the major moves in the market are caused by "unpredictable" events. Taken a step further, Taleb's thesis somewhat refutes modern portfolio theory in that MPT is grounded in normally distributed statistical research. Taleb's definition of a Black Swan event is:
A black swan is an outlier, an event that lies beyond the realm of normal expectations. Most people expect all swans to be white because that’s what their experience tells them; a black swan is by definition a surprise. Nevertheless, people tend to concoct explanations for them after the fact, which makes them appear more predictable, and less random, than they are. Our minds are designed to retain, for efficient storage, past information that fits into a compressed narrative. This distortion, called the hindsight bias, prevents us from adequately learning from the past.
Taleb believes these unpredictable rare events account for the impactful occurrences in the marketplace and history. One of Taleb's favorite books at the moment is Happy Accidents: Serendipity in Medical Breakthroughs by Morton A. Meyers. This book tells how most of the major medical discoveries have occurred by accident.

Consuelo Mack of WealthTrack contains an interesting video interview with Taleb and Jason Zweig . Zweig describes how the investing portion of ones brain makes individuals do things that do not make logical sense. He covers this topic in detail in his recent book, Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich.

I do not believe an investor should blindly disregard theory based on normal statistical data; however, the successful investor should be aware of the randomness of major events. Additionally, an investor should understand how emotion can override good judgement. From an investment perspective, investors should maintain an investment approach that follows a sound discipline.

Friday, December 14, 2007

State Street Increases Dividend 10.8%

Today, State Street Corp. (STT) announced a 10.8% increase in its quarterly dividend. The new quarterly dividend is 23 cents per share versus 21 cents per share in the same quarter last year. State Street has a history of increasing its dividend every third quarter. The last increase was in the third quarter of this year. The new payout ratio is estimated at 19% based on 2008 estimated earnings of $4.76. The company's 5-year historical average payout ratio is approximately 24%.

(click on table/chart for larger image)

state street corp dividend analysis table December 14, 2007
State Street Corp stock chart December 14, 2007

Thursday, December 13, 2007

T. Rowe Price Increases Dividend 41%

T. Rowe Price (TROW) announced it was increasing its quarterly dividend by 41.2%. The new quarterly rate will be 24 cents per share versus 17 cents per share in the same quarter last year. Not counting this increase, TROW's dividend has double over the past 5-years. The 5-year average payout ratio is approximately 33%. The projected payout ratio on the new dividend is about 34% based on 2008 estimated earnings of $2.82. The payout ratio in 2003 was approximately 43%.

(click on table/chart for larger image)

T. Rowe Price dividend analysis table December 13, 2007
T. Rowe Price stock chart December 13, 2007

Bullish Sentiment Moves Higher For Third Straight Week

The American Association of Individual Investors sentiment survey recorded an increase in individual investor bullishness this week. The level of bullishness climbed to 47.6% versus last week's 40.6%. The bull/bear spread also widen to +12% versus last week's +1%.

(click on graph for larger image)

Wednesday, December 12, 2007

General Electric and US Bancorp Announce Dividend Increases

Both General Electric (GE) and US Bancorp (USB) announced increases in their quarterly cash dividends this week.

General Electric
General Electric announced a 10.7% increase in its quarterly dividend to 31 cents per share versus 28 cents per share in the same quarter last year. GE's 5-year historical dividend growth rate is about 9% versus the recent rate increase of 10.7%. The new payout ratio is approximately 51% based on 2008 estimated earnings of $2.42. The 5-year historical average payout ratio is about 51% as well.

US Bancorp
US Bancorp announced a 6.25% increase in its quarterly dividend to 42.5 cents per share versus40 cents per share in the same quarter last year. USB's 5-year historical dividend growth rate is about 15% versus the recent rate of increase of 6.25%. The new payout ratio is approximately 61% based on 2008 estimated earnings of $2.80. The 5-year historical average payout ratio is about 48% as well.

(click on table/chart for larger image)

dividend analysis General Electric and US Bancorp December 12, 2007
General Electric and US Bancorp stock chart December 12, 2007

Tuesday, December 11, 2007

Stock Buybacks: Do They Increase Shareholder Value or Not?

Some market analyst contend stock buybacks do increase shareholder value. In a recent article in Kiplinger Personal Finance Magazine the author notes,
"The obvious reason is that when companies buy back their stock, they reduce the shares outstanding and increase earnings per share. What's less obvious is that companies typically buy back their shares at advantageous times; they know things that you or I may not. They're the ultimate insiders."
Certainly, over the long run, it has been proven that buybacks increase shareholder value through stock appreciation. However, are there differences today that might suggest buybacks are not necessarily shareholder friendly? As Matt Hougan at Seeking Alpha notes,
"In the good old days, companies did buybacks mostly in extraordinary circumstances, like when the stock fell excessively in reaction to relatively minor news. Now, however, buybacks are almost a line item in corporate budgets. X dollars for salaries, Y dollars for office supplies and Z dollars for corporate buybacks.

And that’s bad news for shareholders. Why? For one, buybacks are used to cover up costly options schemes that would otherwise dilute the company’s stock. It’s a neat trick to report profits and then use those profits to cover the real expense of an options program."
Not too surprisingly, there is an exchange traded fund that invests in companies that buy back their own stock. The ETF is the Powershares Buyback Achievers Index (PKW). This ETF has an inception date of December 20, 2006. The Powershares literature does show hypothetical returns going back to February 29, 1996. Over this longer time period, buyback companies have outperformed the S&P 500 Index as noted in the chart below.

(click on chart for larger image)

Powershares buyback index performacne since 1996
Since inception of the Powershares buyback index though, the index has underperformed the S& 500 Index.

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powershares buyback index performance since inception December 2006
As Matt Hougan also notes,
...buybacks favor management over current shareholders. Corporations have two choices on how to return money to shareholders. They can pay it out as dividends to current shareholders, or they can buy back stock. The problem with buybacks is that they raise the value of both existing shares and shares that have yet to be issued, aka options. Buying back stock today increases the value of the options that executives will cash in tomorrow. And faced with the option of choosing buybacks vs. dividends, not surprisingly, most corporate officers are choosing buybacks.
In the end, an investor must do their homework before assuming buybacks will increase shareholder value through stock price appreciation. The options factor is a larger issue today than it was in the mid to late 1990s when buybacks seemed to be a pretty good indicator of positive future stock price performance.

Barry Rehfeld of the International Herald Tribune noted in an article late last year,
"On a basic level, a buyback can make a stock look attractive by giving an immediate boost to earnings per share, simply by spreading profits over fewer shares. If a share is more valuable, it stands to reason that its price on the open market should be bid up — and very often it is.

Still, hold the rush. Investors who randomly sweep up shares in companies that are buying back stock with the goal of beating the market are likely to be disappointed. According to a recent study of the S&P 500 by Birinyi Associates, a research firm in Westport, Connecticut, companies that bought back stock outperformed those that did not by a mere percentage point over the period from 2000 to 2005.

Zero in on the right stocks, though, and the gains can be significant."
A related post from this site: The Out of Balance Balance Sheet: A Hidden Treasure Trove or Fools Gold

Buying Into Stock Buybacks
Kiplinger Personal Finance Magazine
By: Anne Kates Smith
December 2007

Buybacks: A Wolf In Sheep's Clothing
Seeking Alpha
By: Matthew Hougan
October 11, 2007

Entry Level: Buying into buybacks? Do your homework
International Herald Tribune
By: Barry Rehfeld
December 15, 2006

Market Does Not Like Magnitude of Fed's Rate Cut

Given the stock market's reaction-Dow Industrial Average down 294 points or 2+%- to the Fed's 25 basis point cut (or .25%) in the Fed Funds Rate today, it appears market participants wanted at least a 50 basis point cut (or .50%). The Kirk Report detailed reactions from some market participants. One that I particularly agree with is below:
"Boom Boom almost did the right thing. Had it spared us the pandering 1/4 point begged for by financial speculators, he would have finally shown the kind of stones that will be needed to guide us out of the current mess. Equities do not like it one bit, as well they shouldn't; the wimpy move is likely to worsen the credit environment and the financial markets as a whole could be in for a year-end pasting. So why do I suggest the Fed did the almost right thing? Because one cannot devalue its way out of a gigantic pile of debt. Companies, many companies, need to fail, go away forever, and allow those who have a business existing to once again prosper not on the back of borrowed money, but on the strength of real demand, rather than demand generated by a need to circulate make belief money. Had the Fed figured this out in 2001, by 2003 we would likely have forgotten the then recession. Instead it decided to try to fool everyone into believing that we could borrow our way into a permanent plateau of prosperity."- Fil Zucchi

Thoughts on the Fed
The Kirk Report
By: Charles Kirk
December 11, 2007

Monday, December 10, 2007

Aristocrats Furthest Below 52-Week High

A number of S&P's Dividend Aristocrats are trading at a wide discount from their 52-week high as noted in the table below. A large percentage of these firms are trading at these lower levels due to the impact surrounding the subprime mortgage market. Although a number of these companies fall into the financial sector, many have seen share prices increase over the past four weeks. Financial related firms have been some of the better performing stocks during this four week period.

(click on table for larger image)

dividend aristocrats trading below 52-week high December 10, 2007
bank sector versus S&P 500 December 10, 2007

Sunday, December 09, 2007

Income Oriented Closed-End Funds Trading at a Discount to NAV

A number of income oriented closed-end funds are trading at a discount to net asset value (NAV). The ones with the largest discount tend to be those with a high percentage of the fund assets invested in the financial sector. The subprime mortgage issues have weighed heavily on financial shares.

According to Thomas J. Herzfeld, publisher of The Investor's Guide to Closed-End Funds,
"these funds issue a fixed number of shares, which then trade on exchanges like stocks. As a result, prices are determined by investor demand and often differ from the value of the funds' portfolios. When the market swoons, as it did this year, investors often dump them indiscriminately for tax losses. That's what creates the discounts."
An investor can search for closed end funds using various criteria on the Closed-End Fund Association website. Following are some of the income oriented funds with wide discounts to NAV.

(click on table for larger image)

income oriented closed-end funds at discount to NAV December 9, 2007
Source: Closed-End Fund Association

Investors should keep in mind some of these closed-end funds can be more volatile due to higher exposure to certain sectors like financials. For example, in the Dreman/Claymore fund noted above, the financial sector represents 40% of the investments. Additionally, the largest holding, Altria Group, accounts for over 16% of the assets within the fund.

For Closed-End Funds, It's Open Season
By: Lewis Braham
December 17, 2007

Saturday, December 08, 2007

Dividends Per Share and S&P 500 Index Exhibit Strong Relationship

The Political Calculations website recently detailed the relationship between the value of the S&P 500 Index and dividends per share going back to 1871. One conclusion drawn from the analysis is
over "long periods of time...the relationship between the S&P 500's index value and its dividends per share nearly parallel [each other from a] long-term trend perspective."

(click on chart for larger image)

S&P 500 graph versus dividend value

S&P 500 versus dividend per share
One will need to read the entire article to see the graphic representation of some trend and regression analysis. However, the data indicates:
"what the presence of so many straight lines tells us is that for long stretches of time, the ratio of the growth rates of price per share and dividends per share may be treated as a constant (emphasis added) during the periods where these lines exist.

"...the value that investors have placed on stocks has generally increased faster than the value they can expect to receive in dividends over time.

"This makes sense when you consider that the rate of dividend growth reflects only the rate of growth of company earnings that the boards of directors feel can be sustained for the foreseeable future. In addition to this additional earnings component, there are also a number of intangible components that may factor into investor valuations, including the value of the companies' brands, intellectual property, future expectations, etc., all of which add to the typical premium that investors are willing to pay for stocks.

"More than this, this premium in the growth rate of stocks compared to the growth rate of dividends explains why dividend yields have decreased over time, and to a lesser extent, why the price earnings ratio itself has tended to increase over time. It's a mathematically inevitable outcome of how investor's have historically valued stocks with respect to dividends (or rather, sustainable earnings.)"

The Sun, in the Center
Political Calculations
December 6, 2007

Friday, December 07, 2007

Investing Success: Stick with a Philosophy that Works

From an investment perspective, investors are faced with a multitude of decisions surrounding the investment style to pursue in their portfolio. Investment success is more likely to occur if one sticks with a proven strategy.

Some aspects of a proven strategy entail:
  • Buying good companies at cheap prices.
  • Following a consistent philosophy
  • Maintaining a sense of perspective and,
  • Following a daily discipline
Ron Muhlenkamp of the mutual fund carrying his name, admits, discipline is the most difficult to achieve. If you have the first two, you see, you have them forever. But daily discipline is a daily battle. Every investor has the urge to bail out when a stock starts tanking. The key is not to. You may still sell, but you want to do so rationally -- and with good evidentiary reasons.


Stock Advice That Will Change Your Life
The Motley Fool
By: Tim Hanson and Brian Richards
November 30, 2007

Stryker Increases Dividend 50%

Stryker (SYK) announced a 50% increase in its annual dividend on Thursday. Stryker pays one dividend during the year. The new annual rate is 33 cents per share versus last years 22 cents per share. The company's 5 -year average payout ratio is approximately 8% with the payout ratio on the new dividend equaling 11.5% based on 2008 estimated earnings of $2.88 per share. The company has an S&P quality ranking of A.

(click on table/chart for larger image)

Investor Sentiment: Bulls Take Charge

In this week's release of the American Association of Individual Investors sentiment survey, the level of bullishness spiked higher to 40.65% versus the prior week's bullishness reading of 28.57%. The bearish sentiment fell to 39.84% versus last week's reading of 56.12%. On the other hand, this is the seventh straight week the 8-period moving average has declined. The most recent 8-period average of bullish sentiment equals 35.2% versus last week's 37.0%. The bull/bear spread increased to a +1% versus last week's -28%.

(click chart for larger image)

Wednesday, December 05, 2007

Fannie Mae Follows Freddie Mac and Cuts Dividend By 30%

Fannie Mae (FNM) announced it was reducing its quarterly dividend 30% to 35 cents per share versus the prior quarter dividend of 50 cents per share. Additionally, Fannie Mae will issue $7 billion of preferred stock to further absorb anticipated additional subprime mortgage losses.

(click on chart for larger image)

S & P Announces Rebalancing of Aristocrats Index

The annual rebalancing of S&P's Aristocrats Index will occur after the close of trading on December 21, 2007. The companies being removed from the index are:
  • First Horizon National (FHN)
  • Altria (MO)
  • SLM Corporation (SLM)
The companies that will be added to the index are:
  • Aflac (AFL)
  • Air Products & Chemicals (APD)
  • Exxon Mobil (XOM)
  • Integrys Energy (TEG)
  • Pitney Bowes (PBI)
According to S&P, the S&P 500 Dividend Aristocrats Index is designed to measure the performance of S&P 500 constituents that have followed a managed-dividends policy of consistently increasing dividends every year for at least 25 years. The index is equal-weighted, with constituents being re-weighted every quarter. Membership is reviewed each December.

Standard & Poor’s Announces Results of the Annual Rebalancing of the
S&P 500 Dividend Aristocrats Index (pdf)

Standard & Poor's
By: David Blitzer & Dave Guarino
December 4, 2007,3,2,2,1148449665924.html

Monday, December 03, 2007

Better To Be A Dividend Paying Stock Versus Non Paying One In November

For the month of November, Standard & Poor's reported that the dividend paying stocks in the S&P 500 Index outperformed the non paying stocks, -4.44% vs. -7.53%, respectively. As noted in the table below, the payers still lag the non payers on a year to date basis. For the 12-months ending November 2007, the payers did outperform the non payers, 3.39% vs. 1.78%, respectively.

(click on table for larger image)

Saturday, December 01, 2007

Currency Exchange Rates And Their Impact On International Returns

U.S. investors have experienced strong returns from their international investments over the past five years. A large part of the strong international results can be attributed to the weak dollar versus many foreign currencies. The U.S. investor's returns are enhanced because the foreign currency buys more dollars when converted.

An article in the November 2007 American Association of Individual Investors AAII Journal, Currency Exchange Rates: The International Wild Card ($), notes some economic impacts on exchange rates:
From an economic viewpoint, common sense dictates that if the demand for a currency exceeds its supply in the short term, the currency will appreciate. So when the goods and services of a country are in demand by foreign purchasers—a net trade balance surplus—the currency has a tendency to appreciate. Conversely, when foreign goods and services are in demand domestically—a net trade deficit—the currency tends to depreciate.

Inflation, productivity and costs in a country all contribute to trade balances and currency pressures. In addition, fiscal policy that stimulates or depresses economic growth, monetary policy, the money supply and central bank action—all move markets and currency exchange rates.

There is no precise or direct summary indicator of all these forces. But differences in interest rates between the domestic market and a foreign market or markets can reveal a great deal.

The differences in real rates of return, nominal return less inflation, probably provide an even better window to currency risk. In order to protect exchange rates, some countries at times maintain relatively high real rates of interest to generate demand for their currency. High real rates of interest, however, take their toll on domestic economic growth, many times forcing countries to devalue their currency or reduce interest rates, adversely affecting foreign investors who hold investments denominated in the currency.
The following table that appears in the article shows the return enhancement for a U.S. investor versus some foreign currencies over the past five years.

(click on table for larger image)

U.S. Dollar foreign currency adjusted returns November 2007
An investor needs to keep in mind that foreign currency exchange rates can boost ones returns and possibly make an underperforming investment look more attractive. Also, prognosticators that forecast foreign exchange rates are often incorrect. The point is, a continued weak dollar is not necessarily a given.

Lastly, the AAII Journal article provides several tables detailing the impact on returns for various percentage changes in the dollar exchange rate. The formula for calculating currency adjusted returns is:

(click on formula for larger image)

foreign currecy adjusted return formula
Currency Exchange Rates: The International Wild Card ($)
AAII Journal
November 2007

Thursday, November 29, 2007

Bearish Sentiment Near Early 2003 Level

In the American Association of Individual Investors sentiment survey released today, bullish sentiment moved slightly higher. On the other hand, investor bearishness increased to a level last seen in early 2003. The bearish sentiment this week was reported at 56.12%. This is the highest level since February 20, 2003 when the level of bearishness equaled 57.9%. This sentiment indicator tends to be a contrary one and the market performance since that time seems to support this.

(click on table/chart for larger image)

investor sentiment table November 29, 2007
historical investor sentiment chart as of November 29, 2007

Wednesday, November 28, 2007

McCormick & Co. Adds Spice To Dividend

McCormick & Co. (MKC) announced a 10% increase in its quarterly cash dividend today. The new quarterly dividend increases to 22 cents per share versus 20 cents per share in the same quarter last year. The projected payout ratio equals 41% based on November 2008 estimated earnings of $2.11 per share. The historical 5-year average payout ratio equals 38%.

(click on table/chart for larger image)

McCormick dividend analysis table November 2007
McCormick stock chart November 2007

Tuesday, November 27, 2007

Freddie Mac Cuts Dividend In Half

The mortgage fiasco hit Freddie Mac (FRE) investors today. The company announced it would pay a fourth quarter dividend of 25 cents per share versus 50 cents per share in the same quarter last year. This 50% cut jeopardizes FRE's listing on Standard & Poor's list of company's' that have increased annual dividends for at least 10 straight years. In addition to the dividend cut, the company announced plans to sell $6 billion of preferred stock in anticipation of more loan losses.

(click on chart for larger image)

Freddie Mac stock chart November 27, 2007

Saturday, November 24, 2007

Dividend Increases Improve Valuation Multiples More Than Share Buybacks

The Boston Consulting Group's 2007 Value Creation Report notes dividend increases do more to increase shareholder value than stock buybacks. The report notes one reason company's use cash to buy back shares is "buybacks boost EPS above the level that underlying organic growth in net income would on its own." The BCG report notes, "that EPS growth is not necessarily a differentiator of multiples. And when it is, investors are extremely sensitive to how the EPS is delivered."

The BCG research demonstrated that:
  • dividends have a far more positive impact on a company's valuation multiple than share repurchases do.
  • the report also noted that share repurchases actually erodes a company's valuation multiple as detail in the table below.
(click on graphic for larger image)

dividend payout versus stock buyback impact on valuation multiple September 2007
Avoiding the Cash Trap
The Boston Consulting Group
By: Eric Olsen, Frank Plaschke, Daniel Stelter
September 2007

Thursday, November 22, 2007

Low Bullish Investor Sentiment

The level of individual bullish investor sentiment as reported by the Association of Individual Investors declined to 25.58% versus the prior week's level of 33.01%. The bull/bear spread widened to -27. This level of bullishness was last achieved in July 2006 when the bullishness level equaled 23.85%. The bull/bear spread at that time was -34.

(click on graph for larger image)

Wednesday, November 21, 2007

Modern Portfolio Theory: Is It Over Relied On?

Before I get into the discussion on a recent article that indicates Modern Portfolio Theory (MPT) might not work as many are led to believe, following is a common defintion of MPT:
Introduced by Nobel Prize winner Harry Markowitz in the 1950s, modern portfolio theory proposes that investors may minimize market risk for an expected level of return by constructing a diversified portfolio. Modern portfolio theory emphasizes portfolio diversification over the selection of individual securities. A simplified version of modern portfolio theory is "Don't put your eggs in one basket". Modern portfolio theory established the concept of the "efficient frontier." An efficient portfolio, according to modern portfolio theory, is one that has the lowest risk for a given level of expected return. An underlying concept of modern portfolio theory is that greater risk is associated with higher expected returns. To construct a portfolio consistent with modern portfolio theory, investors must evaluate the correlation between asset classes as well as the risk/return characteristics of each asset.
Many investment advisors present to their clients that MPT minimizes portfolio volatility as ones investment portfolio is allocated to assets less correlated to other assets in their account.

Now onto the discussion on MPT. Recently, SmartMoney featured an article, Modern Portfolio Theory Looks Very Outdated. The article features an interview with Niels Clemen Jensen, a former senior executive at Lehman Brothers (LEH), Goldman Sachs (GS) and Oppenheimer (OPY) who now runs Absolute Return Partners, a $400 million London fund of funds. SmartMoney notes, "Jensen is a pro well versed in the nuts and bolts of modern portfolio theory and risk management. I am here to testify that, in this case, knowledge is not bliss, more like a long leap into the unfathomable."

Following are excerpts from his October 2007 newsletter:
  • Here is the problem. Central to all the academic work referred to above is the assumption that returns are normally distributed. If they are not, you might as well bin everything to do with modern portfolio theory. Risk management tools such as volatility, covariance and value-at-risk, all so critical to how we deal with risk, become meaningless if the return pattern does not match the famous bell curve.
  • For returns to follow a normal distribution, you must have a set of independently distributed returns with no extremes. You find these mostly in static systems.
  • Now, what investors really should worry about is what we call extreme risk – 3-6 SD events which can potentially wipe out years of profits. This is often referred to as fat tail risk. It is to be found to the extreme left of the below chart (encircled in red). However, according to the text book, they do not occur very often. Take a closer look at the following table:

normal bell curve

odds of risk event table
  • Statistically, assuming you are not an ‘├╝ber human’ vastly outliving the average person on this planet, you should experience only a couple of 2 SD events in a lifetime. The problem is that recent years have been littered with 6, 7 and 8 SD events. A 7 SD event equals 1 every 3 billion years or approximately the lifetime of our planet. Since the 1998 Russian debt crisis, financial markets around the world have experienced at least 10 extreme shocks none of which were supposed to occur more than once every few billion years.
Given these higher standard deviation events AND that returns are not normally distributed, Jensen concludes, "Clearly, the theory doesn’t work in practice and it may be time that we ditch modern portfolio theory altogether. Surprisingly few academic resources have been dedicated to this subject so far."

As one considers building an investment portfolio, they must stick to an investment discipline. Warren Buffett's sage advice, "the most important quality for an investor is temperament, not intellect and "what you need is the temperament to control the urges that get other people into trouble in investing."

More often than not, this means not following the crowd.


Wagging the Fat Tail (pdf)
The Absolute Return Letter
Absolute Return Partners LLP
By: Niels Clemen Jensen
October 2007

Modern Portfolio Theory Looks Very Outdated
By: Igor Greenwald
November 20, 2007