Good News Bad News?

[Kerim]

Here is a pretty interesting review/article in the Economist about a new book arguing that while business profits are soaring, new business investment is very low. Arguably good news for dividend growth investors (though perhaps in the short-term only) is that "businesses are handing cash back to shareholders." The bad news is that the focus on buy-backs comes at the expense of long-term planning and investing in the future of the business, and results from short-term focus on quarterly EPS and share price performance. Worse still,

Quote:according to the national accounts, American companies have been paying out in cash more than 100% of their domestic profits to shareholders. If profits have been overstated, so therefore has the net worth of companies. For all the talk of deleveraging, there is barely a sign in the national accounts of a fall in the ratio of non-financial corporate debt to GDP. As a result, the dangers of high debt are underestimated. A collapse in asset prices could still provoke a crisis.

Thoughts?

[TomK]

This jibes with a thought that lurks in the back of my head all the time. While I am generally bullish on both the economy and the market, I think there are a lot of structural reasons that it is unreasonable to expect returns going forward to match historical averages of the past 20, 50, or 100 years. I am delighted to have companies sharing a larger portion of profits with me as a partial owner, but as I'm planning to hold for decades, I'd also like management to be planning well for future profitability and growth.

[hendi_alex]

That is one reason I've been looking for an ETF that focuses on small cap companies that pass a screen for both dividend growth and for sales and earnings growth. I'm skeptical as to how well mega cap companies which are often the focus of DVI will actually outperform going forward. IMO a portfolio is only likely to keep pace with inflation if it has a very solid growth component and that mostly comes from younger growth companies as they find the sweet spot in their niche. I'm not interested in pure growth companies, but would like to target businesses that pay a dividend but also which are small enough to still experience significant growth.

[Kerim]

Nice posts, both of you.

I think the same thing about the mega-caps, Alex. I still believe that KO, for example, can be a fine part of a dividend growth portfolio. But anyone who counts on the next 30 years for KO looking a lot like the last 30 has a rude awakening in their future. I'm not sure I agree about inflation, though. A well-selected basket of even older mega-caps DG stocks should be able to keep pace with inflation. But I'd like to do a little better than just keeping pace with inflation. My compromise is to add several stocks with shorter dividend histories (not focusing just on the champions), but that give me an opportunity for outsized dividend growth. I'm thinking stocks like PSX, F, and AAPL in my portfolio currently.

I haven't seriously considered venturing out in search of pure growth, other than a few extremely small "for fun" gambles. That is a foreign world to me and I have no confidence in my abilities there. Perhaps that is also why you are looking for a fund with the characteristics that you describe. Please let us know if you find one!

[hendi_alex]

Keep in mind that small caps are not generally extremely new nor particularly risky companies, and the cap is usually not as 'small' as the category would bring to mind. Investopedia for example defines small cap as a company between $200M and $2B in market cap. So this is not like looking for brand new unproven companies, but more a matter of looking for well established proven companies that are in a strong growth phase and which are nowhere close to saturation. I may just screen for one of the better yielding micro cap or small cap funds, and keep the weighting relatively small, so as to not affect the average portfolio yield too much. I guess that allocating as much as 20% to stocks with a growth emphasis might be a more productive route. After all, Buffet would say that it makes no sense for a strongly growing company to pay out dividends, as the funds are more valuable to both company and shareholder when reinvested in the company.

I'm just fumbling around with this idea for now, and will probably not act until the markets take the next really big double digit tumble.