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Thanks to jkm929 on the Deranged Monkey Criticism Board for this link:
Morningstar Course 408: The Case for Dividends
http://news.morningstar.com/classroom2/course.asp?docId=1452...

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. What was the best-performing stock?

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: cigarette maker Philip Morris, now known as Altria Group (MO). Over Siegel's 46-year time frame, Philip Morris posted total returns of an incredible 19.75% per year.

What was the secret? Credit a one-two punch of high dividends and profitable, moat-protected growth. Philip Morris made some acquisitions over the years, which were generally successful--but the overwhelming majority of its free cash flow was paid out as dividends or used to repurchase shares.

Amazingly, by maximizing boring old dividends and share buybacks, a low-growth business can turn out to be the highest total return investment of all time. As Siegel makes abundantly clear, "growth does not equal return." Only profitable growth--in businesses protected by an economic moat--can do that.
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No. of Recommendations: 8
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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What is important here is that Siegel is telling investors not to chase after hot new IPO's or try to find the next great thing, instead they should look for companies with a moat, pricing power and repeat customers. Companies that buy back shares and pay dividends can be rewarding for shareholders.

Philip Morris is not the only company that can raise prices. You don't have to be addicted to a product to keep buying it after prices are raised. The trick is to find companies that can charge high prices and raise their prices.
Buffett discovered that See's Candies could raise their prices and people kept buying them. Hershey's can raise prices, people keep buying their chocolate.
Starbucks can raise their prices, people keep coming back for their coffee.
Apple keeps inventing new products that people want and are willing to pay up for.
Colgate keeps developing new toothpastes that people want and are willing to pay up for.

I really don't care what Munger thinks of Siegel. Munger has a way with words doesn't he?
Siegel's predictions are not under discussion here.
Whether or not the investor reinvested the dividends is not the point here.
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No. of Recommendations: 7
Forget trying to find the next big thing. Find a proven company with pricing power that generates a lot of cash. Then follow the cash. There are several possibilities:

1. The company generates a lot of cash and reinvests its cash back in its own business. This is OK as long as they can generate a lot of cash on the cash they reinvest in themselves. The cash is spent wisely and the business grows. This is the early growth phase of a great company. This can be great for shareholders, as long as the growth lasts, and if the company doesn't try to grow too fast.

2. The company generates a lot of cash but does not reinvest its cash in its own business. It cannot generate a lot of cash on the cash if it reinvests in itself. So it lets the cash build up on the balance sheet. This describes Apple today. The growth is great for shareholders, as long as it lasts, but the cash on the balance sheet is doing anything for them.

3. The company generates a lot of cash but does not reinvest its cash in its own business. It cannot generate a lot of cash on the cash if it reinvests in itself. Instead of letting cash build up on the balance sheet, it returns the cash to shareholders in buybacks and dividends. This describes the Philip Morris approach. This is great for shareholders, that is the point of the article. If the shareholder reinvests his dividends, his returns will increase, but that's not the point.

3 The company generates a lot of cash but does not reinvest its cash in its own business. Instead of letting cash build up on the balance sheet it reinvests its cash in other businesses, but it does a lousy job of it. Peter Lynch calls this de-worsifying. Microsoft generates a lot of cash but blows some of it by de-worsifying in companies like Skype. Many corporate leaders don't deploy cash wisely, or they just deploy cash to build up their own empires and their salaries. This is not good for the shareholders.

4. The company reinvests a lot of its cash in other businesses and does a great job of it. Berkshire Hathaway invests its cash wisely in other good businesses. This is great for shareholders, no dividends or stock buybacks needed. However, most corporate leaders cannot allocate capital like Warren Buffett and Charlie Munger.
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I really don't care what Munger thinks of Siegel. Munger has a way with words doesn't he?
Siegel's predictions are not under discussion here.


Why don't you care what Munger thinks of Siegel? Munger is one of the most astute investors out there and without him Warren Buffett and Berkshire Hathaway wouldn't have the stature and success they enjoy today. I think long and hard about anything Charlie Munger has to say. He's much smarter (and richer) than I'll ever be.

Siegel's predictions about the future are based on his interpretation of the past. Most predictions are. What Munger was saying was that his premise is flawed because not only does he not compare apple to apples, he doesn't even compare apples to oranges. He compare apples to elephants. I wish Munger would have elaborated and got into specifics.


Whether or not the investor reinvested the dividends is not the point here.

On the contrary.

Reinvested dividends are very much the point as far as Siegel is concerned. It's curious that the author of the article that you provided a link to doesn't mention reinvesting dividends because he references Siegel and his finding throughout. Siegel's premise is based unequivocally on dividends being reinvested. The compounded rate of return for Philip Morris that the author quotes assumes the reinvestment of dividends.


Philip Morris is not the only company that can raise prices. You don't have to be addicted to a product to keep buying it after prices are raised.

Of course Philip Morris isn't the only company that can raise prices!

Apart from the author curiously not mentioning the cornerstone of Siegel's argument, that is, reinvesting dividends, he muddied the waters further by this (which is what my remarks about Philip Morris were in response to):

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: cigarette maker Philip Morris

It's irrelevant to the argument that Philip Morris was losing customers. What I said was: there are very few companies who are surrendering customers that are likely to be good investments and that Philip Morris was an exception to this rule. What I did not say was companies that can successfully raise prices are the exception to the rule. Most successful companies don't have a shrinking customer base.

It's noteworthy that a simple omission by an author can so easily lead his readers down the garden path. Siegel's message is, without a shadow of a doubt: for superior returns, it's not the dividends, it's reinvesting them that counts.

kelbon
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kelborn

I'm afraid I have to disagree with you on companies buying back stock. There are a few good reasons to do it such as get stock to give to deserving employees and decreasing the amount of stock a large amount might enable an increase in the dividend. However, most buybacks are a waste of money. Yes, it is true that it improves the P/E, but it is PROFITS that count, not P/E.* Buybacks are a phony way of "giving" something back to the stock holders and are a waste of money. It means that the company can't think of a profitable way of investing that money to increase profits.

If you give me a case of a company that has declining profits but buying back stock to improve the RPS and the stock price is improving, then I'll grant it is possible that buying back stock may do some good in an exceptional case. I know of no such example, and I spent years looking for an example but I gave up looking.

So far as I am concerned, the companies would do better to give the repurchase money back to investors as a special dividend.

* Incidentally, at least on the NASDAQ, companies losing money are just counted as zero in the NASDAQ 100 whereas if there are no profits the P/E should go to infinity. And companies with loses are also counted as zero, whereas the P/E should be negative. Thus in the ballon period around the end of the 20th century, the NASDAQ was allowed to show a rational, if large, P/E whereas a rational accounting might have shown the P/E to even have been negative. It was a strange period in which it was claimed that it was revenues and not PROFITS that were important. Well, we found out that the Greater Fool Theory applied and that PROFITS were important after all. REITs, incidentally, were murdered in that period,and it was a good time to buy them which I did.

brucedoe
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I'm afraid I have to disagree with you on companies buying back stock. There are a few good reasons to do it such as get stock to give to deserving employees and decreasing the amount of stock a large amount might enable an increase in the dividend. However, most buybacks are a waste of money. Yes, it is true that it improves the P/E, but it is PROFITS that count, not P/E.* Buybacks are a phony way of "giving" something back to the stock holders and are a waste of money. It means that the company can't think of a profitable way of investing that money to increase profits.

Well, you could say that a company paying a dividend can't think of a profitable way of investing that money to increase profits too. And, in a lot of cases you wouldn't be far off on either count.

Yes, for the company, it's profits that count, but not necessarily to the same extent for investors. For investors it's the size of the pie that's more important; the percentage of the company they own. If that percentage rises because of buy-backs and reinvested dividends then they are likely better off. Some buy-backs are a waste of money simply because a company pays too much per share to buy 'em back.

kelbon
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There is also something to be said for being in a dying but profitable business. It keeps new entrants from entering the market. Who wants to start a business in a dying industry? Plus there are advertising restrictions which favor current tobacco players. This grants big tobacco a huge advantage.

Smoking rates are decreasing in America but not globally. Lorillard, part pf PM's competition has been increasing market share for years.
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