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SDS (Seductive Dividend Stocks)
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Sorry I hide my true identity but I'm a physicist/engineer, native contrarian and idea generator. I am an eclectic dividend investor with motto "In God We Trust, All Others Pay Cash" applied to companies I invest in. I like to read /and read a lot - did you look on my SA photo 8-)? /... More
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  • Ponzi-Like Dividend Champions? 7 comments
    Jul 21, 2012 5:31 AM

    "Ponzi scheme is a form of investment fraud. What occurs is the perpetrator of the fraud promises the victims a high return on their investment or dividends that cannot be acquired through legal and honest investments" [1].

    We know that some companies earnings are object of fraud. I read in one book on investment (sorry I do not remember title) about cases of dividends fraud in circa 1928.

    I hope such dividend fraud is in the history and never occurs nowadays but as Henry Louis Mencken said "HOPE: A pathological belief in the occurrence of the impossible" [2].

    In order to pay dividends a company must have cash. A company has different ways to obtain cash: sell goods or service, issue debt or issue equity. Sometimes a company needs to borrow money to expand it business (although recent debt of KDN company took to pay special dividend seems me too strange). Sometimes a company needs to issue new shares (small fraction of already outstanding shares) to conduct stock option policy and attract good employers (almost mandatory in Silicon Valley).

    I consider that the only the first way can be considered as a sign of good company health. So-called dividend champions (companies that consistently growth their dividends for several years) presumably sell more goods or services or charge their customers increasing price with time or at least increase payout ratio [3].

    I was surprised that some dividend champions actively issue new equity (see table below, numbers from Mergent are rounded)

    TickerCompanyIndustryCountry#shares increase in 10 years
    WPZWilliams Partners L.P.Specialty ChemicalsUSA15
    TWGPTower Group Inc.Property & Casualty InsuranceUSA8
    NSNuStar Energy L.P.Oil & Gas PipelinesUSA7
    SXLSunoco Logistics Partners L.P.Oil & Gas PipelinesUSA6
    SNHSenior Housing Properties TrustREIT - ResidentialUSA5
    SJMThe J. M. Smucker CompanyProcessed & Packaged GoodsUSA5
    MMPMagellan Midstream Partners LPOil & Gas PipelinesUSA5
    GELGenesis Energy LPOil & Gas PipelinesUSA5
    OHIOmega Healthcare Investors Inc.REIT - Healthcare FacilitiesUSA5
    PBProsperity Bancshares Inc.Regional - Southwest BanksUSA4
    EEPEnbridge Energy Partners LPOil & Gas PipelinesUSA4
    DLRDigital Realty Trust Inc.REIT - IndustrialUSA4
    PAAPlains All American Pipeline LPOil & Gas PipelinesUSA4
    TOOTeekay Offshore Partners LPShippingBermuda4
    ALTEAlterra Capital Holdings LimitedProperty & Casualty InsuranceBermuda3
    ATOAtmos Energy CorporationGas UtilitiesUSA3
    NNNNational Retail Properties, Inc.REIT - DiversifiedUSA3
    SKTTanger Factory Outlet Centers Inc.REIT - RetailUSA3

    I do not have conformation that these companies use money they obtain via selling of new shares to pay dividends to old investors from the money paid by subsequent investors. But at historically average yield 5% sell of new shares provide enough money to pay increasing dividends to old and new investors for several years without generation of earnings from produced goods or services.

    I noticed that last couple years some dividend champions also issued debt in forms of bonds, notes, preferred shares, etc… Unfortunately I don't know a good source that allows track such actions [4] but IMO investor should be aware of debt issues.

    I think the case of very active equity dilution is even worse that opposite action of shares buybacks widely discussed in press (including my SA blog).

    I do not know enough about companies listed in the table above to give any recommendation to anybody (and legally I have no such rights).

    Footnotes:

    1. I use reality-bytes.hubpages.com/hub/What-Is-A... for definition. Wikipedia also gives a good description and history of Ponzi scheme I'd encourage to read.

    2. BTW, I think this is the ideal definition of many investment approaches).

    3. David Fish maintains comprehensive list of dividend champions.

    4. I have access to Wall Street Journal and Lexis/Nexis but don't know how collect data without too much work. Help is welcome!

    July 18-21, 2012

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Comments (7)
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  • Most of those are MLPs, pass-thru entities which escape corporate taxes and which pay out distributions that are largely a return of capital. SInce they (like REITs) pay out most of retained earnings, they generally issue equities to grow and finance acquisitions.
    20 Jul 2012, 11:04 PM Reply Like
  • Debt is also issued to fund major projects or acquisitions, so it's difficult to link it to paying dividends. And some companies issue shares to acquire another company or properties. For example, SJM (Smucker) exchanged shares with Procter & Gamble when it acquired Jif and again when it acquired Folgers.
    20 Jul 2012, 11:14 PM Reply Like
  • Author’s reply » giorgiolb: you're right on MLPs.

     

    David: I agree and even consider dividends reduction as good movement if company needs to fund major project that will generate money in the future. In this case equities (not debts) were issued.
    21 Jul 2012, 12:37 AM Reply Like
  • Try using the FFO (Funds From Operations) valuation metric of F.A.S.T. Graphs. For A C corporation, FFO is very close to Operating Cash Flow, and FFO is the preferred valuation metric for REITs and MLPs. I like to see total dividends consistently less than FFO for sustainability.
    5 Jul 2013, 04:26 PM Reply Like
  • Author’s reply » Be Here Now,
    Yep, FFO is often used for REITs and MLPs. I understand that for REITs and MLPs /which must distribute almost all money/ a shares issue is probably the only way to finance expansions. For C corporations other ways are possible including debt issue in forms of bonds, notes, preferred shares, etc. which is attractive in low interest yield environment.
    My point in this blog is to remind that the classical Ponzi scheme can be executed with the shares (equity) issues.
    SDS
    6 Jul 2013, 12:00 AM Reply Like
  • I'm disappointed in you!

     

    There is no statutory requirement for an MLP to distribute anything. Some are required by the contract between the general partner and the limited partners to distribute all available cash, but it is up to the BOD to determine what that means. E&P MLPs typically have this arrangement. Others have no such arrangement; look at the ratio of DCF to distributions for EPD; it is something like 1.4:1.
    6 Jul 2013, 12:15 PM Reply Like
  • Author’s reply » I'm not MLPs expert, although own some with good reputation.
    I use new shares float as a red flag - I pass a stock if it is too high.
    SDS
    6 Jul 2013, 02:45 PM Reply Like
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