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URL:  http://boards.fool.com/the-best-of-the-best-hails-not-from-a-hot-30534201.aspx

Subject:  Re: The Case for Dividends Date:  2/9/2013  6:23 PM
Author:  kelbon Number:  7821 of 8743

The best of the best hails not from a hot, rapidly growing industry, but instead from a field that was actually surrendering customers the entire time

A company that is losing customers can only prosper if they are able to charge their remaining customers more for their products or services, and, to an extent that more than compensates for the revenue lost from a shrinking customer base, and then some. Philip Morris was, and is, able to do this because they sell an addictive product that customers are prepared to keep paying more for because that is an easier option for them than trying to kick their habit.

Philip Morris, was, and still is to an extent, the exception to the rule. Most businesses that are losing customers, even if they are paying a dividend and buying some shares back, are likely in decline. Companies must have deep and wide moats to be able to continually raise prices for their goods or services in the face of a stagnant, or shrinking, customer base. They are few and far between. The caveat being that because a company pays dividends and buys back shares doesn't necessarily mean that you would be wise to buy their shares.

Warren Buffett's largest stock purchase for Berkshire Hathaway in a very long time was IBM. In its present incarnation, it has some of the same characteristics as Philip Morris. They pay a dividend; though not a large one, but more importantly they are committed to, and have been, buying back a considerable number of their own shares. They have a deep and wide moat because of the service contracts that their customers are committed to because they have little or no option.

Back to Philip Morris: What was the secret? Credit a one-two punch of high dividends and profitable, moat-protected growth.

In the article the author doesn't mention if the great returns for Philip Morris's shareholders was contingent on them reinvesting the dividend. Presumably this is the case. If an investor receives dividends from a company that is returning the lion's share of their earning to investors as dividends, and spends them rather than reinvests them, then he's (obviously) not going to see the kind of potential capital appreciation that those who reinvest dividends see. It's worth considering that it's not so much that a company with a moat pays you dividends, but what you choose to do with those dividends that makes the difference.

Reinvesting dividends and share buy-backs work in similar ways in maximizing an investors chance of above average capital appreciation. If an investor reinvests dividends in a company he is purchasing a larger percentage of that company; that is, accumulating more shares: he has a bigger piece of the pie. With buy-backs, a company—by buying back shares—reduces the number of shares outstanding (let's assume there are no stock options for the sake of simplicity). Therefore, each share represents a larger percentage of the company: a bigger piece of the pie. The rocket fuel that propels an investor to superior returns is getting a bigger piece of the pie. If a company is paying dividends and buying back shares a stock holder has two routes by which to grow his holdings in the company and his own profits.

A lot of investors chose dividend yielding companies because they want, or need, the money the dividend provide as income. As these investors are not going to reinvest the dividends this leaves them only one route, not two, with which to get a bigger piece of the pie. That is buybacks. It makes sense, if you are looking at stocks for income to consider companies that have a history of buying back their shares in addition to paying dividends. Also, it makes sense to consider stocks that are relatively cheap, or at least fairly valued, because when a company pays $1.50 to buy-back a dollar's worth of value everybody loses.

No body wants a piece of stale and moldy pie. It does an investor no good to reinvest his dividends in a company that is a bad business, whether management buys back stock or not. This is the rub. All companies should be considered on an individual basis in spite of the fact that they may have similar characteristics.

In Jeremy Siegel's The Future for Investors, the market's top professor analyzed the returns of the original S&P 500 companies from the formation of the index in 1957 through the end of 2003.

Siegel is mentioned twice in this article and I think it's worth mentioning that there isn't universal agreement about his conclusions and predictions. Referencing Warren Buffett again, his business partner Charlie Munger had this to say about him:

http://www.valuewalk.com/2012/02/charlie-munger-i-think-jere...

In a Q&A session at the 2006 Berkshire Hathaway annual meeting, Charlie Munger, Berkshire’s vice chairman, was asked about Jeremy Siegel’s perma-bull theories, which are constantly reinforced by Siegel on TV and are laid out in his book, Stocks for the Long Run.

Munger said, “I think Jeremy Siegel is demented.”

Buffett, was embarrassed and in his usual diplomatic sense stated, “Well he’s a very nice guy.”

Charlie Munger then continued, “He may well be a very nice guy, but he’s comparing apples to elephants in trying to make accurate projections about the future.”

kelbon

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