Example: a few short months after RadioShack doubled its lofty dividend (hooray 25% yield) it cut its dividend altogether and has no plans to return it. You can’t pay a dividend when you’re losing money.
Result: pick six. The “Short’s” win.
The Biography
I’m not only here to heckle, you get to laugh at me too! Yes, regional bank (and quasi-bane of my existence) First Niagara Financial Group Inc. (NASDAQ:FNFG) was kind enough to teach me two dividend lessons through one scary story.
The story is the biography of First Niagara‘s CEO John Koelmel. Koelmel, who started at First Niagara in 2006, was on an acquisition spree (New Alliance, Harleysville, HSBC) from day one and had used increased EPS to pump up the dividend from .40 to .64 in four short years.
Sound good? I thought so too, yet soon after I decided to jump aboard the story quickly deteriorated. The red flag that went ignored: at the time of their HSBC branch acquisition in 2010, FNFG’s pay-out ratio was a ridiculous 75%.
Surprisingly FNFG decided to issue new stock and dilute shareholders to fund the acquisition. If that move weren’t curious enough the next was startling; with bank stocks (including FNFG) slumping, Koelmel & Co. decided to slash the dividend 50% and take on pricey debt, just to fund the acquisition.
The truth is that the company couldn’t grow organically, and it needed acquisitions to grow EPS in order to pay its unsustainable dividend. The lesson from this is to stick to organic growth stories with payout ratios under 50%; both alternatives are screeching red flags
Dividend All-American
I’m certainly not opposed to dividend payers–far from it. But like Mr. Manning, I want to know the story behind them. Based on what we’ve learned, it’s clear that Apple Inc. (NASDAQ:AAPL) is a true dividend champion.
1. Apple is growing: Q1 revenues were up 18%, while EPS increased 7%
2. Apple also has a ridiculously low pay-out ratio of just 20%. The company holds about a third of its value in cash–suffice to say the dividend is safe.
3. Apple carries very little short interest–just 1.89%.
Unlike our “interceptions,” we can trust that Apple is paying dividends for the right reasons. Like all “Dividend Champs,” Apple’s dividend is the cherry atop its return Sundae, not its central investment thesis.
We can buy Apple now and hope for growth, but should the market slump the yield will rise and we can buy more. Wouldn’t you rather “back in” to a 3.5% yield of a company you adore than buy a company you fear, just for its yield?
Of course you would. Thank you Mr. Manning, for the lesson.
The article The Super Bowl’s Over! Here’s What Peyton Manning Can Teach You About Investing. originally appeared on Fool.com and is written by Adem Tahiri.
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