Are You Playing Baccarat with Your Portfolio?
Vedran Vuk here, filling in for David Galland. First today, I’ll touch on controlling our urge to gamble in the market. Then I’ll discuss whether it’s worth it to wait for the next dividend when you’re about to sell a stock. And last, I’ll share some short thoughts on the divergence of thought about free markets in the political world versus the investment world.
By Vedran Vuk
Last week, I ran into an interesting headline: Poker Champ Phil Ivey Waiting for $11.7 Million Payout. For those readers unfamiliar with professional poker, Phil Ivey is one of the world’s best players, with eight World Series of Poker championship bracelets, $5.9 million in tournament winnings, and nearly twice those earnings outside official tournaments. Here’s a summary of the big story in the article: Phil Ivey was playing punto banco (a variant of baccarat) at a London casino. He sat down with $1.6 million and finished with $11.7 million. However, the casino is not giving him his winnings and is instead investigating his pla y.
Sure, this is quite a predicament. However, I didn’t find the grand total of winnings nor the casino’s reluctance to pay to be the most interesting part of the story. Here’s what gets me: one of the world’s greatest poker players sat down with nearly $2 million dollars to gamble in a game of chance.
Of course, poker itself has elements of luck, but if you know the probabilities, have lots of experience, and can read the other players, the odds are in your favor. Punto banco, on the other hand, is quite literally a game of chance. Doesn’t this seem just a little crazy? Phil Ivey could sit at almost any poker table with a near-guarantee of a return. Instead, he’s toying with his fortune over the next card in baccarat.
This isn’t unique to Phil Ivey. Doyle Brunson, a poker legend, admitted to similar failings. Brunson once wrote that he would be a much richer man today were it not for betting on things other than poker. Although he was one of the best players ever, he lost piles of his poker winnings in other games of chance.
Though the poker fans among our readers might enjoy this article, why does this matter to the rest of us? As investors, many of us have the exact same problem as Phil Ivey and Doyle Brunson. We know there are investments in our portfolios where the odds are in our favor. We’ve done the research or at least have a strong understanding of someone else’s research on the topic, yet nonetheless, we end up basically gambling with a part of our portfolio. Perhaps it’s a hunch on the market’s direction or a hot new company on the financial news. Based on little more than intuition, we put these things in our portfolio.
Every once in a while, these hunches will be a $11.7-million fortune, as was the case with Phil Ivey. But more often than not, such ill-planned investments will send you to the poor house. And if Phil Ivey continues spending more time at the baccarat table rather than the poker table, he’ll be on his way to the poor house as well, despite his latest win.
I’m not preaching from up on high here. This happens to all of us – I don’t care if you’re managing millions or a couple of thousand. In my own portfolio, I’m doing great on everything where I’ve done loads of research – like some of the picks from Dennis Miller’s Money Forever. My losses are skewed toward the side of portfolio based on the latest hunch.
With this in mind, I’m personally rearranging my portfolio a bit – getting rid of the short-term, spontaneous investments and putting them into places where I’ve buckled down on the research – i.e., our latest pick in Miller’s Money Forever. In case this article is ringing a familiar bell with you, I suggest taking a honest look at your portfolio and doing some rearranging as well. What’s just a hunch – er, gamble in your portfolio -and what’s a solidly researched, bedrock investment? If you find yourself holding onto former, maybe it’s time to let those investments go.
Invest where the odds are in your favor; don’t risk your portfolio to the luck of the draw.
By Vedran Vuk
Here’s the scenario: you’re about to sell a stock which has a nice dividend payment coming up in two weeks. Should you stick around for that dividend?
Though it might seem like the answer depends on the specific situation, it doesn’t. The right action is to sell – with one exception that I’ll discuss later on. The main logic for selling is that the dividend is already factored into the market price of the stock. By selling now, you’re actually not throwing away the value of the dividend. Let’s see why this is true:
Suppose we have two firms, Company A and Company B, with the following assumptions:
1. Company A and Company B are both worth $100 in the market.
2. The firms are completely identical, with the same assets, earnings, growth, business sector, etc.
3. The $100 valuation is a true reflection of the companies’ underlying values. These aren’t dot-com stocks trading at forty times price to earnings.
4. The only difference between the two is that Company A pays an enormous $10 dividend next quarter, and Company B has no current dividend policy. Company A’s upcoming ex-dividend date is October 26.
5. After the dividend is paid, both company A and Company B will be worth $100.
(The ex-dividend date is the day on which buying the stock no longer entitles you to the next dividend. If you bought the stock on the October 25 and held it until the record date, you would receive the dividend.)
Given our five assumptions, does the first assumption make sense on the day prior to the ex-dividend day? No. If I hold Company A, I will soon have a share worth $100 and a $10 dividend. If I hold Company B, I would only have a share worth $100. If one stock will pay $10 while retaining its value, it can’t possibly worth the same as the stock with no yield and the same price. As a result, market participants would bid up the value of Company A to near $110, perhaps $109.98.
Hence, assumption one would be a strange market anomaly given our other assumptions.
Why not $110 fully? A dollar today is always worth more than a dollar tomorrow. So there’s still a tiny difference between the value of $110 today or $110 tomorrow.
But what if there’s a whole month left before the ex-dividend date? The same principle applies. However, the market won’t be close to the entire dividend. For example, the stock might be worth $107. As one gets closer to the ex-dividend date, the price will keep climbing to $110.
If you sell early, part of your dividend is implied in the price. You’re not throwing away your whole dividend by selling prior to the record date.
A More Realistic Example
That was one way of looking at it, but let’s makes things more realistic by throwing out assumption five. In reality, both companies wouldn’t be worth the same after a dividend. If Company A and Company B are both worth $100 prior to the dividend, they cannot be worth the same afterward. Think about it. Since Company A just paid $10, it has $10 less on its balance sheet than Company B. Since Company A has fewer assets than Company B, it must be worth less as well.
In theory, Company A should be worth $90 on the day after paying out $10. Company B should still be worth $100. After the dividend is paid, the stock should drop by the amount of the dividend.
Now, I know what you’re thinking, “That doesn’t really happen in the real world. I bought Coca-Cola stock and when its dividend was paid out, the price actually went up.” Remember that our example is in a vacuum. In the real world, there are a million things happening at once. If the ex-dividend date happens when the S&P 500 is up over 1% and Coca-Cola is surging with it, you probably wouldn’t notice the downward pressure from the dividend being paid out.
However, if the dividend wasn’t paid, this good day for Coca-Cola might have been a great day instead. If this wasn’t true, any dimwit with a brokerage account could become a millionaire. One could just buy the stock before the ex-dividend date and sell it a few days later after the record date for a nearly riskless dividend return.
The Exception to the Rule
This all holds up, with one exception – short-term capital gains versus dividend taxes. If you’ve held the stock for less than a year, you’re going to pay a higher tax on your capital gains than dividends. As a result, if your dividends are already reflected in the stock price, you would make slightly less after taxes by selling the stock before the dividend.
If you were in the 35% tax bracket, a $10 short-term capital gain would be only $6.50 after taxes. However, if the company pays out $10 and the stock drops back to $100, then the tax would be only 15% on the $10 dividend for an after-tax gain of $8.50. In this situation, it might be worth it to wait for the dividend and save a little bit of money.
However, there are still a few additional things to consider here. In the majority of cases, we won’t be getting a huge 10% dividend each quarter – we’ll be lucky to get half a percent. As a result, you will need to weigh the benefit of staying in the stock a little longer for the tiny tax benefit versus the risk of the stock going sour. In the worst-case scenario, your stock could plummet by several percentage points while chasing a tax saving of a meager 0.2%. If you really think it’s time to get out of the stock, the savings are usually not worth the risk of waiting.
The Bottom Line
Much of this article has been a proof of the theory behind dividends. However, the whole issue can be summed up in one sentence extending far beyond dividends: If something about a stock is obvious to almost every market participant, it has already been reflected in the stock price. Dividends and their pay dates – which are available at the click of a mouse – definitely fall into this category. In the current issue of our newest advisory, Miller’s Money Forever, our latest recommendation is a stock with a projected dividend yield of 5.2%. If securing consistent dividends is part of your long-term investment strategy, you should check it out.
By Vedran Vuk
Plenty of publications cover investments and the financial news. However, have you noticed that pretty much all of them have one thing in common: an appreciation for the free market? Certainly, most of them aren’t as appreciative as Casey Research, but there really are no far-left financial sites out there. In a way, it’s a bit strange, given people’s political views. After all, one could make a financial website or newsletter dedicated to companies tied to governments such the state oil companies, firms funded almost solely by subsidies, and government contractors. What could we call the newsletter… perhaps Casey Marxist Investor. For some reason, I don’t think that it would be a big hit. When it comes to politics, people are extremely split on their economic views, but in the investment world, everyone is much closer to being on the same page.
Sure, in the short term, there are intense debates on what’s best for the market. Some analysts feel QE3 or another short-term stimulus is just what the economy needs. However, almost no one disagrees on the big-picture items.
For example, think about China. Have you ever heard anyone say, “China keeps making itself more and more open to markets. That’s a bad thing. You should short Chinese stocks.” I’ve never heard that anywhere. Or what about, “Europe has a lot more regulation than US, so it’s a better investment.” Can’t say that I’ve heard that either. Or what about, “Greece and Spain are less fiscally responsible. They love providing their citizens with all sorts of limitless government programs. As a result, they will be amazing investments for the future.” Sure, there’s a case for investing in Europe, but greater regulations and unsustainable spending aren’t part of the investment thesis.
But there’s more to it than that. What about stocks with government ownership? Does the government’s share of AIG make you more or less likely to invest? Has anyone ever said, “Wow, now that the government owns AIG, this firm is just going to be amazing!” Or what about Dodd-Frank or other regulations? Has anyone argued that Dodd-Frank is going to make things so much better in the financial sector that it’s clearly a case for investing in the financials? Quite the opposite. It’s feared to destroy the sector.
On the big-picture items, investors are generally on the same page for the long term, if not the short term. They get it: free markets are good for economic growth. Even the people who push for more stimulus and more printing by the Fed understand that there’s a certain point where one has spent too much or printed too much. However, what’s widely understood in the financial world somehow never transcends to the realm of politics. Politicians still pretend that increasing regulation, greater taxes, and large government expenditures will somehow lead to prosperity. If investors realize that these things don’t lead to greater prosperity, isn’t it about time for everyone else to get the hint?
And now for a few funny cartoons on the intersection of technology and one’s golden years. If some of these cartoons aren’t already true for today’s retirees, they’re certain to be true for the next generation.
That’s it for today. Thank you for reading Casey Daily Dispatch. David Galland is going to be out for the next couple of weeks, so I’ll see you again next Friday!
Casey Research Senior Analyst