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Of Dating and Dividend Yields

It is my belief that most markets operate on similar principles, except for detail. Thus, the dating/marriage market is not so different from financial markets. This could be the topic of a long series of discussions, but I wanted to focus on one financial topic, high dividend yields.

It is a truism of dating that the most successful daters (the one with the most "scores") are not the best dates in the long run. That's because they put all of their efforts into the initial approach. Often, they sweep their "mark" off their feet, at least initially. Nothing could be better than this, right?

Wrong. That's because the heavy front-loaded pace is not one that can be sustained. The "romance" starts to fizzle, and usually comes to an early end, because initial expectations were set too high, at a level that reality can't sustain.

Much the same is true with dividend yields, especially one that is overly high relative to its industry. (We would consider double-digits to be overly high for companies like REITS and MLPs that pay inherently high dividends, and 7%-8% to be overly high for other types of dividend producers.) The highest yielder is a "royalty trust," best represented by an oil well, or a group of oil wells. The best flows (and resulting yields) are those of the first or second year. Thereafter, the yields decline, and become a trickle in later years. Just like romances too often do.

It's not necessarily a bad idea to invest in a royalty trust, but one often has to do net present value calculations using a steep decline rate. Although Exxon Mobil is in the oil and gas business, it is not considered a royalty trust (although some analysts would put it in that category). That's because it takes those hefty front end cash flows, and instead of paying most of them out as dividends, reinvests them in more producing wells.

The likely best formula for dividend investment, is not a high dividend, but rather a pretty good dividend, growing at a hopefully rapid rate; e,.g., a 4%-5% yield on a dividend growing at a 10%-12% annual rate. That's usually a better proposition than a 6%-7% yield from a dividend that is more satisfying up front, but is so high that it probably has nowhere to go but down. A similar story could be told in dating situations.

Investment is a marathon, not a sprint. So is dating. The whole point of either should not be how much you can get up front, but whether the relationship can continue at a lasting pace. Unless, of course, you are strictly a trader.