One of the main themes today is an emphasis on "stable" companies with generous dividends. Various advisors point out that periods with flat stock prices can nevertheless be profitable once dividends are factored in. Over longer periods, dividends make make a huge difference. These folks are absolutely right; without dividends, stock investing is, over time, a pretty pallid affair. Huge appreciation is often followed by stomach-wrenching drops. A steady diet of reinvested dividends can smooth everything out, and ultimately result in nice long-term results.
So, why not seek out those large, stable companies with stable dividends? Well, the main problem is that stable dividends are actually fairly rare and disturbingly fragile creatures. For example, the website dividendinvestor.com has a list of star performers. There are about 275 companies with three stars, indicating dividends increased for 5-10 straight years. 10-20 has about 170 entries, while 29+ (yes it jumps from 20 to 29 to make the top list) has a mere 77 members. Considering the thousands of publicly traded companies in the U..S., this is a relatively small group of companies.
So what do these income stars mean for a person looking for a steady stream of retirement income? Well, the picture is not so hot. That first groups of winners (5-10 years) means that almost all of them, at some time, either cut their dividend, froze it, or terminated it. None of those are good things. As a retiree, you need to count on income far longer than ten years. So, you'd want to pick from list two or three, the companies you can really count on. This is a relatively small group. And again, they are all only as good as their most recent results. All lists were substantially larger before 2008. Dozens and dozens of companies fell out of the all-star rankings once the great recession hit. How can you safely target the winners?
Here is the evil dynamic that can kill dividend chasers. A company runs into financial trouble for one of many possible reasons. Alert stockholders begin selling, which causes the dividend yield to rise, perhaps very sharply. A 2% dividend for a $10 stock becomes a 6% dividend if the stock falls to $3.33. At this point, yield-hungry dividend chasers might jump in, hoping to lock in those juicy returns. Like clockwork, though, this temporary situation is followed by a dividend cut, or elimination as the company pursues survival at all costs. Now, the stock plummets further, as the disillusioned income investers bail out. Finally, don't forget that some companies terminate the dividend due to financial distress, only to then file for bankruptcy or reorganization. In those dire cases, you don't just lose income, you lose your entire investment as well. So, a bit of free advice; never buy a stock just because it has a high dividend yield. You will usually wish you had held back. I have a LONG list of such dividend-oriented regrets. In nearly every such case, I would have done better to sell the stock short; in time, my returns would have been fabulous! (No, I am not touting a new "can't miss" scheme, in case you're wondering).
A dividend freeze is not so bad; the company might weather the storm and move forward in a couple of years. A dividend cut is far worse; I've cited the example of JP Morgan (a true blue blood) that cut from $.38 to $.05 in 2009. They still haven't restored that dividend completely. Bank of America is still at a penny, down from $.64 and higher). GE, perhaps the most famous "safe dividend" company of all, cut it to $.10 quarterly, a 70% drop. The dividend still only back to $.17. These are crushing cuts, if you're trying to live on the income. A complete loss of principal, though, might reduce you to munching on cat chow.
Can you see why I'm much more enthusiastic about interest income? The track record of investment grade bonds is hugely better than that of dividend stocks. Companies can go through periods of great turmoil, cut or eliminate dividends, and still pay interest like clockwork. Do they do this because they have greater loyalty to bondholders? Of course not. They pay for two fundamental reasons. First, they are legally obligated to. If there's money in the till, the bondholders can demand it. Second, every company wants access to the credit markets. If they stiff one group of lenders, they will either be unable to borrow in the foreseeable future, or at least pay painfully high interest rates. Viable companies will, therefore, go to great lengths to stay current on their bond payments. This even applies to lower-rated (i.e. junk) companies, not just investment-grade firms.
To put all this in personal terms:
Since 2008, I have bought 42 separate bond issues from 24 different companies. All of them have either been retired (paying back the entire investment at par), or continue to pay interest. Only one of the issues, Clear Channel Communications 7.25% of 2027, has been problematic. It was already junk-rated when I bought it (shame on me, a violation of my rule against buying junk), and has since descended to near-default levels (CCC). Even it, though, continues to pay on time. I did suffer a capital loss when I sold (after the downgrade), but the loss is very small compared to the huge gains most of my positions have achieved. When you consider how terrifying the world looked when I started buying these positions, I think this performance is remarkable. Bottom line? Bonds might cause you some sleepless nights, but things usually work out just fine. I don't think you can say the same about dividends.
Friday, May 25, 2012
Sunday, May 13, 2012
What Have You Done for Me Lately?
The word is out: bonds have nowhere to go but down. Is this really true? Well, basically yes. Certainly, as to short term rates, the game is up. You'd have to be crazy to buy treasuries (of any kind), and the great majority of corporate bonds have yields so low that an upward movement in rates will trash their market value. On the whole, this is one of the least propitious times I've ever seen to invest in bonds.
So, is there NOTHING I can do for your now? Well, if I had a large lump sum, I would NOT pour it all into bonds. But if you're investing bodaciously, then this too is a year in which you will buy some bonds (remember, this is your base investment amount adjusted yearly for inflation plus any income you aren't spending). So, you would want to examine the horizon for a decently rated bond that beats present inflation by a good margin.
How would you look? My absolute favorite site for researching bonds inexpensively is E*Trade. They have a bond search function that is first-rate. Put in the your search parameters (say yields over 6.5%, ratings above junk, and maturities after 2025), and it will spit out bonds matching the parameters. I did that today, and got 18 results (excluding a number of split grade bonds rated at junk by S&P or Moodys, but investment grade by the other).
One no-brainer jumps out: a Goldman Sachs 6.45% issue 5/1/2036 trading at 97.5 and yielding 6.7%. Another is a 6.65% Bank of America bond maturing in 2026. It is priced at par. Since BOA and Goldman Sachs are among the magic ten U.S. banks receiving TARP funds in 2008/09, they have an implicit government guarantee. These bond have very little risk.
Other real possibilities relate to the Euro crisis. Some very big, and pretty sound banks have bonds with big yields: BBV Intl Finl Ltd 7% 12/01/2025 trades at 90 to yield 8.2%. This is Spain's second largest bank, with a present Moody's rating of A2 (S&P BBB). As a large sovereign nation, Spain will do nearly anything to shield this bank (and its mammoth sister Banco Santander) from default. The rest of Europe also has a vital stake in seeing Spain's banks survive. So, you'd also want to take a look at Abbey National PLC 7.95% 10/26/2029 trading just above par to yield 7.8%. It's a subsidiary of Banco Santander, but is backed by the company's UK assets.
In light of the fact that interest rates are due to go up sharply after 2014, why would you buy now? The best reason is that you're following a plan. You really don't know what's going to happen, you just think you know. Buying now locks in a predictable flow of money until the bonds mature. If present yields were near the lows of the 1950's, I might suggest holding off, as the odds would be stacked against you. But guess what? With inflation running somewhere around 2.5%, these present yields of 6.6 to 8.2% look fairly juicy. So, I would go ahead with the plan.
By the way, I have talked about the Moody's BAA yield so much that you might think I'm being literal about a 30 year horizon. Not at all. If you see something long-term (that could be as little as ten years, but more likely 15, 20, 30, or even 50 years) with favorable characteristics, then grab it. The maturities will even out over time.
Next, a word about ratings. One of the coolest things about the E*Trade website is that its bond research includes the Moody's report. This is a detailed discussion of the company, its outlook, and why Moody's think it deserves a given rating. Now I know you have heard about how the ratings agencies blundered big time in the mid-2000's. They assigned AAA ratings to CDOs that ultimately failed massively. So, why would you listen to them when they talk about bonds? Well, to be blunt, these guys didn't know squat about CDO's, but bonds are their business. They've been in that business for a century, and they're pretty good at it. Because they're writing for an ultra-cautious clientele, they tend to be quite cautious as well. That means that a given rating allows for quite a variety of things to go wrong. In addition, Moody's will assign an outlook to the rating: negative, positive, neutral. So, a BAA bond with a negative outlook contains a warning that certain bad things could happen. Bottom line, a Moody's rating will be a very good guide to what is likely to happen with a given issue. That guide will likely be more reliable than your personal research. There are never any guarantees, but a solid Moody's rating is usually reason enough for me to take action.
One final point. Each bond listing will show a bid/ask spread. The first is the price you would get if selling a bond, the latter what you will pay to purchase. This spread is a serious cost of doing business, as bond spreads are typically far higher than those for stocks. The trading fee charged by E*Trade is, in comparison, trivial (typically $1 a bond, or $10 for a $10,000 par position). My point? Bonds are NOT trading vehicles for folks like us. Buy and sell a few times, and you'll go broke. If you keep the bond (ideally to maturity), then that ask premium will decline in importance, particularly if you've bought at a discount to par. After all, what should interest you primarily is the yield, both now and to maturity. If it is generous enough, then you needn't worry that somebody else (the pro who's selling, for example) has snagged a better price.
So, is there NOTHING I can do for your now? Well, if I had a large lump sum, I would NOT pour it all into bonds. But if you're investing bodaciously, then this too is a year in which you will buy some bonds (remember, this is your base investment amount adjusted yearly for inflation plus any income you aren't spending). So, you would want to examine the horizon for a decently rated bond that beats present inflation by a good margin.
How would you look? My absolute favorite site for researching bonds inexpensively is E*Trade. They have a bond search function that is first-rate. Put in the your search parameters (say yields over 6.5%, ratings above junk, and maturities after 2025), and it will spit out bonds matching the parameters. I did that today, and got 18 results (excluding a number of split grade bonds rated at junk by S&P or Moodys, but investment grade by the other).
One no-brainer jumps out: a Goldman Sachs 6.45% issue 5/1/2036 trading at 97.5 and yielding 6.7%. Another is a 6.65% Bank of America bond maturing in 2026. It is priced at par. Since BOA and Goldman Sachs are among the magic ten U.S. banks receiving TARP funds in 2008/09, they have an implicit government guarantee. These bond have very little risk.
Other real possibilities relate to the Euro crisis. Some very big, and pretty sound banks have bonds with big yields: BBV Intl Finl Ltd 7% 12/01/2025 trades at 90 to yield 8.2%. This is Spain's second largest bank, with a present Moody's rating of A2 (S&P BBB). As a large sovereign nation, Spain will do nearly anything to shield this bank (and its mammoth sister Banco Santander) from default. The rest of Europe also has a vital stake in seeing Spain's banks survive. So, you'd also want to take a look at Abbey National PLC 7.95% 10/26/2029 trading just above par to yield 7.8%. It's a subsidiary of Banco Santander, but is backed by the company's UK assets.
In light of the fact that interest rates are due to go up sharply after 2014, why would you buy now? The best reason is that you're following a plan. You really don't know what's going to happen, you just think you know. Buying now locks in a predictable flow of money until the bonds mature. If present yields were near the lows of the 1950's, I might suggest holding off, as the odds would be stacked against you. But guess what? With inflation running somewhere around 2.5%, these present yields of 6.6 to 8.2% look fairly juicy. So, I would go ahead with the plan.
By the way, I have talked about the Moody's BAA yield so much that you might think I'm being literal about a 30 year horizon. Not at all. If you see something long-term (that could be as little as ten years, but more likely 15, 20, 30, or even 50 years) with favorable characteristics, then grab it. The maturities will even out over time.
Next, a word about ratings. One of the coolest things about the E*Trade website is that its bond research includes the Moody's report. This is a detailed discussion of the company, its outlook, and why Moody's think it deserves a given rating. Now I know you have heard about how the ratings agencies blundered big time in the mid-2000's. They assigned AAA ratings to CDOs that ultimately failed massively. So, why would you listen to them when they talk about bonds? Well, to be blunt, these guys didn't know squat about CDO's, but bonds are their business. They've been in that business for a century, and they're pretty good at it. Because they're writing for an ultra-cautious clientele, they tend to be quite cautious as well. That means that a given rating allows for quite a variety of things to go wrong. In addition, Moody's will assign an outlook to the rating: negative, positive, neutral. So, a BAA bond with a negative outlook contains a warning that certain bad things could happen. Bottom line, a Moody's rating will be a very good guide to what is likely to happen with a given issue. That guide will likely be more reliable than your personal research. There are never any guarantees, but a solid Moody's rating is usually reason enough for me to take action.
One final point. Each bond listing will show a bid/ask spread. The first is the price you would get if selling a bond, the latter what you will pay to purchase. This spread is a serious cost of doing business, as bond spreads are typically far higher than those for stocks. The trading fee charged by E*Trade is, in comparison, trivial (typically $1 a bond, or $10 for a $10,000 par position). My point? Bonds are NOT trading vehicles for folks like us. Buy and sell a few times, and you'll go broke. If you keep the bond (ideally to maturity), then that ask premium will decline in importance, particularly if you've bought at a discount to par. After all, what should interest you primarily is the yield, both now and to maturity. If it is generous enough, then you needn't worry that somebody else (the pro who's selling, for example) has snagged a better price.
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