There are several obvious cases that would cause us to sell. The easy one is that we'll almost certainly sell if a company suspends its dividend. That would cause the holding to unequivocally violate our fundamental requirement for ownership. Similarly, we'd be very likely to sell if a company cuts its dividend, as we'd consider that to be a very ominous sign. Another catalyst that could go hand in hand with a negative dividend change would be a material breakdown in the business case that motivated us to buy the company. This could mean that we simply were wrong and have finally come around to that position, or that there was a material change. An example of such a change would be BP's recent oil spill troubles. Certainly, there are arguments for and against investing in BP over the last few months; what is inarguable is that the financial picture for the company changed drastically in a short period of time. That would clearly be cause for re-evaluation on our part.

The final reason that we would consider selling a significant position is a run up in the price of the stock. This is a pretty standard consideration in straight value investing: if a stock is trading for considerably more than one's calculated intrinsic value, it may be time to pare down the position. Many value investors bail out at or even prior to the point when market prices match intrinsic value. We view things a bit differently in the case of the Camelback Fund. If we've been able to buy a strong, dividend-paying company for a lot less than its intrinsic value, and the market has subsequently recognized the mispricing and closed the gap, we'll probably hold on a bit longer than a strict value investor because we like fortified companies that pay a healthy dividend. However, there comes a time when the prospect of a significant price decline and the likelihood of more attractive investment opportunities make a sell decision obvious. An example of this is a fertilizer company that dropped approximately 45% between March and June, when I bought it for myself and earmarked it for the Camelback Fund. Before the fund launched, it had already gained back more than 50%, and was right around intrinsic value. It consequently didn't make it into the fund's portfolio, but would now be a candidate for sale if it had.

Recently, I ran across an article from the May issue of Kiplinger Personal Finance discussing the wisdom of investing in dividend-paying stocks.  The information in the article is pretty well-covered territory at Foothills Financial Planning, but a sub-article covering Why Dividends Matter almost sounded like an advertisement for the Camelback Fund, so I decided to summarize the high points.


The article points to five reasons to favor dividend paying companies, using Procter & Gamble as a representative stock.  For purposes of full disclosure, P&G is not currently a holding of the Camelback Fund, but it is a significant holding in Warren Buffett’s Berkshire Hathaway portfolio, and it has a lot of the characteristics we look for in evaluating candidates for the Camelback Fund.

The high points:

Dividends are big drivers of stock returns

Although the S&P 500 is currently yielding less than 2%, dividends have accounted for 43% of the market’s long-term return of nearly 10% annually.  At the time of the article the yield for the S&P 500 was 1.9%, and we’re not far off of that right now.

Dividends can grow

Many companies make it a practice to increase their dividend on a regular basis, typically annually or every other year.  Owning these shares on a long-term basis not only ensures that the investor receives the dividend income he or she signed up for, but also that the income will grow over time as the dividend grows.  In contrast, the interest payment on bonds - which are another place income-seekers look for a steady paycheck - will never increase.  This is a particularly important issue when inflation is factored into the equation.  The fact that P&G has raised its dividend an average of 10% per year for a very long time provides reassurance that the income provided from such an investment will outpace inflation in most economic environments.

Dividend-paying stocks enjoy a tax advantage

At least through the end of 2010, dividends are taxed at a 15% rate for taxpayers in most tax brackets, while ordinary income can be taxed at a rate as high as 39.6%.  Those in the 10% and 15% brackets pay no tax on qualified dividends.

To be clear, the current favorable tax treatment for dividends is set to expire at the end of 2010.  Lately, there has been a lot more indication that they may be extended for a year or two, at least for most taxpayers, but that is far from a done deal.  If the tax treatment does expire, rates will return to the rates paid on ordinary income.

It’s worth noting that the out-performance that has been attributed to dividend stocks has mostly occurred during times when they were taxed at ordinary income rates, rather than the current lower dividend rate.  Nonetheless, the more that goes to taxes, the less the investor keeps.

Dividend-paying stocks tend to be less volatile than non-dividend stocks

While the stock market as a whole has been very volatile in recent times, and dividend payers have not been entirely exempt from that volatility, they tend to move up and down less than the overall market.  One backward-looking measure of volatility is beta, which in this case typically refers to how closely a stock tracks with the S&P 500.  The article points out that dividend-paying stocks as a whole (i.e. those that pay dividends, big or small) tracked pretty closely over the past 5 years, with a beta of .98.  However, Proctor and Gamble’s beta was only .55.

Bad markets treat dividend-paying stocks more kindly

Dividend-paying stocks tend to maintain their value in down markets more than their non-dividend paying brethren.  Perhaps the most eye-opening bit of data offered in the article is the fact that dividend-paying stocks lost only 10.9% in 2002, just after the bursting of the dot com bubble.  By contrast, non-payers dropped 30.3%!  In fact, P&G actually gained 9.4% in 2002.  

It comes as little surprise that the contribution limits for Health Savings Accounts in 2011 have not changed from 2010. A summary of the limits is included in the below table.

Source: IRS - http://www.irs.gov/formspubs/article/0,,id=207296,00.html

Cale Smith, godfather of the Spoke Fund and portfolio manager at Islamorada Investment Management, maintains a blog that I highly recommend that goes by the moniker of Cale in the Keys.  Whether or not you choose to take me up on that recommendation, if you own actively-managed mutual funds I implore you to at least review a recent post on the topic of closet indexing.  In it, Cale plainly articulates the reality of most actively-managed mutual funds today:  they have way too many holdings to know a lot about each of them, and even if they do have precise knowledge of each and every one, it doesn't matter.  That is because the sheer number of holdings ensures that the fund will approximate the index that it most closely resembles, while charging significantly more in expenses than the average index fund.  In other words, it will likely underperform the index, especially when fees are considered.  (Side rant: not all index funds are cheap.  Check out the B shares of State Farm's S&P 500 index fund - SNPBX:  1.5% expense ratio plus a deferred load of up to 5%.  Ouch!)

Check it out.

Great sketch from BehaviorGap.com that depicts how quickly you should run from the big financial services/mutual fund companies as a function of how many pictures of the beach show up in their ads.  Go to BehaviorGap to check out this and other sketches that simplify sometimes complex topics.