Sunday, June 21, 2009

No dividends? What worth?

1999 saw my first entry into the stock market. It's the first time we had funds sufficient to invest in anything more than a couple CDs. I was married in 1997. My wife had been employed as an engineer for a couple years. I was teaching as an adjunct professor at a community college, performing, and running my own voice studio. Come 1999 we had some disposable income, and enough things that we were able and eager to set some of it aside.

That was the height of the bubble. We didn't lose our shirts, but we did have some surprises. I remember buying some B2B stock that I had read about, having not the slightest idea what they did. I can't even remember the name of the company (though last I looked them up the stock was selling for pennies). At the time however, the roulette wheel landed on red: what we bought for about $100/share, sold for twice that. I was foolish but lucky. I walked away, and have so far avoided roulette again.

We also had luck buying Ben & Jerry's several months before Unilever bought them. Another double. But I remember selling Janus Worldwide about 40% off my average purchase price, probably 75% off its top. That's common enough this recession, but it was my entrée into the world of stock investing. In hindsight it was just too broad a market to be handled by even the smartest of fund managers. They were lucky (for a time), but it didn't last. I made the decision then to avoid overly wide investment strategies.

And I made the choice to buy only companies I had some knowledge of, mostly ones whose products or services I used or had used in the past and valued. I've added some because I believed the product or service was worthwhile, met a real need, and had a good shot at success, like for example Intuitive Surgical (ISRG) which I first bought June 2006, after having read about them and watched them for months.

Intuitive Surgical is a good example. Their surgical robotics tools are innovative, they've had great success in the market, they offer something uncommon well, they've identified a need, and created a niche. But... I've been on a rollercoaster. I bought the shares just under $100. Just over a year later, I sold half of what I had at a 50% profit. I thought that was remarkably steep, but I still had confidence in the company. A week after I sold, in July 2007, the shares had gone up another 50%! But why? What could justify such exuberance? Virtually nothing about the market or the product or the company had changed. Some good news perhaps: big deal!

AT $320 and $330 a share I sold some more, but still hold about 1/3 of my investment. It went down from those lofty heights below where I bought it, and back up to where I first sold it two years ago. The big issue for me is not whether the company has lasting power. I believe it does. But what am I investing for? What am I investing in?

The odd thing about the stock market the past decade or so, is that the value of a share has increasingly become removed from any real value, in ways akin to the Credit Default Swaps and Mortgage-backed Securities that we have heard so much about. What do I mean? Look: ISRG is trading at about 35 times it's annual earnings per share (P/E). That means, every share of stock costs about $35 for every $1 that the company will earn this year. If 100% of the company's earnings were doled out in dividends to investors, it would take 35 years for my investment today to be repaid in full.

Put that in perspective: let's say I put $100 into a CD, in hopes that my money will grow. I have them pay out the interest in cash, so my principal remains the same. That'd mean, every month I'd receive about 24 cents in interest for 35 years, then I'd have doubled my money: the principal of $100, plus $100 in earned interest. Wow!

Ah... but we don't purchase shares like we buy CDs now do we? Here's a quote from the article "Slash and burn" from the March 7th issue of The Economist:

A share's value must be the present value of all future dividends--otherwise stockmarkets would be a giant Ponzi scheme.

I'd like to believe that they are not... but I don't. When I buy a stock, if it's not priced at "the present value of all future dividends" then it's priced on the basis of my assumption that someone at some later date will pay me a higher price than I paid the last owner to purchase my shares. On what basis? If I argue it's the present value of all future dividends, the assumption is that the company does now, or sometime will, pay dividends. (ISRG at present does not.) But the assumption as well is likely that those dividends will be much higher than today's value.

Why would I buy a CD that takes 35 years to double my principal? I would do so only if I believe that next year the rates will go up, and the year after that, so much that I might double my principal in say 5 years or less. If so, that P/E ratio needs to come down, way down. (Even in the deepest trough of late, P/E ratios remained at or above historic averages.) If values are not determined on the basis of the current value of future dividends... in the words of our columnist it's just "a giant Ponzi scheme". And, sadly, I believe for the most part, it is.

The conclusion I come to, as an entrepreneur, is that the best company to invest in, is my own! As much as I can take non-retirement money out of stocks, and invest them directly in my company, I will. This might not be the safest bet, or the wisest move for everyone, but my dreams are worth investing in!

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