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The Dilemma

I have a confession to make, although I classify myself as a dividend-growth investor, I have a stock on my watch list that does not pay a dividend and in fact, was in peril of going under not that long ago.

This is not the first time I have had a non-dividend paying company on my list. I have previously had non-dividend paying companies and have also had companies that paid minuscule dividends on my list. However, I have never pulled the trigger on buying any of those stocks as I always wanted to stick to my dividend-growth discipline.

In the very first article I ever wrote for Seeking Alpha, I identified discipline as one of the key ingredients for success. Here is what I said at the time about discipline:

Former British Prime Minister and author Benjamin Disraeli once said, "The secret of success is constancy of purpose." In investing, that to me is the golden rule. Successful investors have a game plan and they stick to it. They do not change their plan when the market has a bad month or jump into the latest hot sector of the market, just because it has run up lately. There is more than one way to make money in the stock market, but jumping from one investing-style to another is not one of them.

So every time I stumble upon a company that I think is a compelling value, but that does not pay a dividend, I am always faced with the same debate; do I follow the stock to see if it reaches a great buying point, or do I dismiss it? Is the must-pay-a-dividend ingredient so key to my investing discipline that I would pass on a stock that might double in three years?

Let's take this dilemma a little further. Ultimately we all are investors, our goal is to create wealth by investing some of our current money that is available in hopes of creating more money. If as dividend-growth investors we see a stock that we are confident will double in three years, but does not pay a dividend, should we avoid that stock and buy a dividend-paying company that may not grow anywhere near as fast?

I know the above example is never that cut and dried, there are no sure things in investing. However, the question remains, if a dividend-growth investor sees an outstanding opportunity in a company that does not pay a dividend, but has a compelling risk/reward ratio, should the investor take advantage?

Since becoming a dividend-growth investor, I have always disregarded any stock that did not pay a dividend. In fact, I have disregarded stocks that had low yields. However, recently I find myself wavering on that discipline.

The Company

The company I have been watching is AIG. AIG is the world's largest insurance company with clients in 130 countries. AIG was a very profitable insurance company run by Maurice "Hank" Greenberg for years before running into trouble during the 2008/2009 financial crisis due to being overlevered to the housing industry.

AIG received a Government bailout, which it has now paid back along with $22 billion in interest to the taxpayers. New CEO Robert Benmosche has sold off various divisions of the company to focus on the core insurance business. Mr. Benmosche is well regarded and has promised to return cash to shareholders, although there are no specifics at this point. The following is what he said about paying a dividend during the last quarterly conference call.

Our highest priority is to make sure that we focused on getting high costs out, reducing our expenses for interest, and improving our coverage ratio. As the year progresses, we will then begin to look at things like could we add a dividend to the stock, and also could we have some kind of a modest stock buyback.

In my opinion, the company is deeply undervalued. The company currently sells at about 65% of book value and has a P.E.G. (Price to Earnings Growth) of 0.96. While under Government watch AIG built up a huge capital reserve. According to Yahoo finance, AIG has $37.39 per share of cash on hand. That is $37.00 a share cash, for a stock that sells at approximately $40.00. S&P forecasts 2013 earnings of $4.10, which at a current stock price of approximately $40.00, is a P/E under 10.

AIG does have a significant amount of debt, but its debt-to-equity ratio of 48.99 is significantly less than Coca Cola (NYSE:KO) or McDonald's (NYSE:MCD) so I don't feel it is anything to be overly concerned about.

AIG management is aware that they have to control costs better; during the latest quarterly earnings report they stated AIG would be making investments in technology and talent in 2013, but that beginning in 2014 expenses would come down. Here is the actual quote.

Our investments in technology, talent, and infrastructure impacted the general operating expense (GOE) ratio, but we believe these initiatives will reduce losses through better claims handling and analytics. In addition, they will drive shared service efficiencies in mature markets and will also help us build scalable platforms to support our growth ambitions in emerging markets.

In the fourth quarter, we recorded approximately $100 million in severance charges. In 2013, we expect the GOE will approximate full year 2012 levels. We continue to expect a decline in GOE beginning in 2014.

Another advantage AIG will have going forward is that it is being allowed to carry-forward the massive losses suffered during the credit crisis, which should allow it to avoid paying corporate taxes for many years into the future. This "tax break" is controversial, but as an investor I make no judgment on right or wrong, I just make the assessment that this will be advantageous for AIG well into the future.

So in summary, what I see is a deeply undervalued company sitting on an exorbitant amount of cash that is back to growing the insurance business again. I also see an international company with large operations in various emerging markets, including China, that should allow it to grow for decades. It is taking solid steps to avoid investment risk going forward, so that it doesn't ever find itself in a similar situation to 2008/2009. I also see a company that will eventually pay a nice dividend and has the ability to raise that dividend for years.

What To Do?

I believe there are times in investing when a unique opportunity comes along that may provide huge rewards. I believe AIG may be that opportunity. So as I see it, I have several choices.

  1. AIG does not pay a dividend, which as part of my dividend-growth plan it must. Therefore, I avoid AIG
  2. I make an exception, based on the assumption, fairly likely I believe, that AIG will very soon pay a dividend and therefore I can buy AIG knowing an increasing dividend is on the way. Ten years from now if things turn out like I think they may, I own a stock that has doubled and pays a nice dividend that is increased every year.
  3. I buy AIG in hopes of catching some of the pop in stock price I believe is coming. Hold the stock for a 50% gain, then sell it and buy a more established dividend-growth stock.

Those are the solutions to my dilemma that I am currently considering. I have an ongoing debate in my head as to what to do, but expect to decide within the week. At that time I will buy AIG, or add to the CNI (NYSE:CNI) position I have been building. I have confidence that CNI will slowly grow through the years, but also understand AIG could explode higher. Decisions, decisions!

Source: A Dividend-Growth Investor's Dilemma

Additional disclosure: I may initiate a position in AIG within the next 72 hours.