Wednesday, December 10, 2008
(Cont'd from above)...

Jim (cont'd):    Still... we need to see if these cuts coming... well, we've got to figure them out ahead of time, if we are going to keep praising our accidentally high yielders...

Sometimes I like to draw on the critical things that I learned when I audited classes at Harvard business school... about options... and, what I always go back to... the text... I was go back to the Canon... Remember the 1976 movie, the Marathon Man... When it comes to your dividend, you've got to ask yourself the same question... "take your time... tell me... is it safe?" (Soundbite that Jim played from the movie)...

That's right... Is it safe?...

Lucky for you, I've got the answers!...

You need to measure the safety of your dividends... So, tonight, I'm going to teach you how the Freeport-McMoRan (FCX*) experience could have been avoided... how you can know if your dividend is safe, or if it can't be protected, and you need to sell, sell, sell...

First, we have to figure out how we ended up in a world where the most exciting page in the Wall Street Journal this morning is the darn dividend declaration page. This market has high yielders galore but, unlike hips, dividends sometimes dissemble...

The page has become a tale of ratiocination, to quote Cramer-fave, Edgar Allan Poe...

Before 2003, when the feds decided to cut the tax rate on dividends to 15%... something I, along with my former partner, Larry Kudlow, like to take full credit and responsibility for... dividends were just for widows and orphans... most companies just didn't pay them... and only people interested in utilities, some of the banks, and some of the old-time industrials... bought stocks for their dividends...

But then we got that dividend cut... making it so that you don't have to give that much to the taxman... and everything changed!...

By 2007, the companies in the S&P 500 collectively paid out $247 billion in dividends... more than double the payout a decade ago... and the number of dividend payers in the S&P reached 390... up 11% from before the dividend tax cut...

Now, courtesy of the credit crisis... and the global recession... those bountiful dividends are now in danger... In the fourth quarter, the S&P is predicting that dividends in the S&P 500 will decline by 10%... the worst performance in 50 years... and these dividends matter...

From January of 1926 through March of 2008, dividends made up 41% of the S&P 500's total return... That's right, almost half of your return is from dividends...

Now that were seen dividends fall by the wayside, we need to know which ones can be defended and which ones can't...

The first rule of thumb...

Make sure a company can cover its dividend payout two times over with its annual earnings... You look at the annual earnings... you multiply by four, the quarterly dividend... If one is much more than the other... like the dividend... then we're in a little trouble...

See, that could have saved you from owning Freeport-McMoran... for the dividend. See, the consensus estimate for next year is $.94 (a share)... less than half the dividend payout performance... and they decided to suspend it...

You wouldn't have known that dividend had to go, okay... because Freeport-McMoRan (FCX*)'s projected 2009 earnings didn't come close... It was spottable... Now, of course, the problem was... if you got out ahead of the dividend cut or, if you anticipated it, and then sold on the dividend cut, that was the bottom... and that sometimes happens with the commodity plays...

The most reliable dividend payers... you know, those who have raised their annual dividend for 40 or 50 consecutive years... and have been able to do so in the up cycles and down cycles... when the economy is weak and when it's strong... that's what I'm looking for. These are the dividends that might look skimpy now... but, if you look at where the stock prices were five years ago, you can see that the dividend that is constantly raised, ultimately turns out to be huge compared to where the stock was back then...

Which leads us to another indicator of whether or not a dividend can be defended...

As the ranks of new dividend paying stocks swelled since 2003, it meant that more and more companies from nontraditional dividend-paying industries... cyclical growers... were paying their investors just to own their stocks...

Now, cyclical companies like FCX, with volatile earnings that depend on a strong economy, got into the dividend game...

Many of the companies that have slashed their dividends recently... Freeport-McMoRan (FCX*), Lennar Corp. (LEN), Boyd Gaming Corp. (BYD)... were stocks with limited payout histories... that's right, they hadn't done it for a long time... that needed a decent economy to be able to defend the dividend...

So, here's rule number two...

It's hard to depend on cyclical plays like commodity companies, like homebuilders... They may not be able to defend their dividends... when their earnings are so volatile... and not depending on their own businesses, but on the economy at large.

We also have to be wary when it comes to the financials... but you know that already... In the third quarter, banks and insurers accounted for 93% of the dollar decline in dividend payouts in the overall market. The financials make up 15% of the S&P 500's market cap, but still contribute 20% of the dividends... Uh oh... right... you got to wonder if these companies can defend their dividends...

The worst may be coming to an end in terms of mortgage damage... but the people running the financials that took the TARP money this year... I think they're going to have a hard enough time justifying their own bonus checks... let alone justifying their dividend payouts on the common stock, when Obama moves into the White House...

Then there are companies that have what I regard as a "beau jest" attitude toward dividends... everybody does his duty, dead or alive... So, who is a "beau jest" dividend?... Masco (MAS), a cabinet and faucet maker that just declared its dividend today, and seems committed to defending it to the death... and beyond.

We talked about how this 9.2% yielder was too good to be true a couple of months ago, and I still think Masco will have to cut its dividend within the next year... because the company will earn enough money to cover its annual payout next year. Its balance sheet is loaded with debt... it has 108% debt to equity ratio... and management has been managing receivables and payables, just to post a decent cash flow figure...

Nah, this dividend... it doesn't look like it can be defended... and, believe me, it pains me to say that...

You want faucets and cabinets?... No... not Masco... I want you to buy Cramer fave, Fortune Brands (FO)... and I'll throw in some Master Lock, Jim Beam, and some golf shoes...

Masco was once a dividend Titan... a company that raised its payout every year for the last 49 years... but Masco is dependent on housing... and, even though I think housing prices will bottom by June 30, 2009... something Wells Fargo said today on its call... it just doesn't have the business or the balance sheet, at this point, to justify paying its dividend.

The fact that a company has been able to raise its dividend for nearly 50 straight years doesn't mean it won't cut the dividend next year, if it has to.

Here's the bottom line...

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The Bottom Line!:     Look, we all want the extra return from big dividends, especially in this market, where upside is hard to come by. But remember what great granddaddy, Vladimir Lenin, said... "No company is worth anything, unless it can be defended with a dividend." Or... as friend, buddy, pal, Trotsky, would say, "it's better than a sharp ice pick in the eye!"

[verbatim recap]

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