March 15th, 2013
Charlie Munger: income first capital gains later?
AIM companies to be allowed into ISA’s
Company results and dividends
Once in a while I come across an investment book that I find both instructional as well as inspirational in particular when its focus is on "income first, capital gains" later. This is also very much our mantra at Dividend Income Investor.com
As Warren Buffett’s sidekick at Berkshire Hathaway, I have always wondered whether Charlie Munger's investment style is completely aligned with those of Warren Buffett.
Now in his early 90ties, Munger was just thirty years old when he lost everything. His son died of cancer. His wife left him. His career was not advancing as he had hoped. He went broke. Yet, within the next fifty years, Munger managed to become a billionaire despite being nearly penniless.
How did Munger do it?
In Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger it transpires that during Munger's early years he had a strong appreciation and desire for both current income and capital appreciation. In practice, this led Munger towards high-quality property as well as undervalued dividend paying stocks and shares investments.
Munger's desire to get rich while he could still enjoy it – that sounds familiar - led him to selectively take on debt to back his best ideas (this decision, by the way, is supposedly in stark contrast to Buffett who publicly has stated many times his dislike to using debt as a way to become rich).
First and foremost, Munger sought immediate income to fund other investments. In fact very much in the same way that Berkshire Hathaway uses dependable sources of income – dividends - from Coca-Cola, Procter & Gamble, insurer GEICO (but also extensively using its free float), and others to fund acquisitions of companies like Heinz and shareholdings in companies like IBM, Walmart and Tesco.
Although, as far as I know, Munger has never labelled himself a ‘pure’ dividend income investor, it was his ability to always have streams of 'passive income' coming in that enabled him to buy other undervalued assets, which were often cash-generating as well while appreciating in value in time.
Buy and monitor strategy
Intriguingly, Munger did not engage in any panic selling during the bear market crash of 1973-1974, even though many of his individual and fund holdings fell by 60-75 percent. According to Munger the thought of "selling out" never crossed his mind at any point in his investing career.
What is very interesting is why Munger was able to do this. Although his stocks and shares portfolio fell dramatically during the 1973-1974 crash, he did not sell as he had monthly income coming in from various income producing assets in order to satisfy all of his personal needs.
This confirms very much with the strategy of securing passive income to fund more streams of passive income as I described in my eBook "A Little Savvy Report on 10 Secrets of Wealth Creation".
Income first, capital gains later
Munger's investment strategy, as well as Dividend Income Investor.com’s, regards income and capital gains as something that are closely related.
By finding undervalued investment opportunities that had a strong potential to generate current and future income, Munger accomplished two important things:
- he could ride out wild stock prices fluctuations because he was generating enough private income to tolerate stock market crashes, and
- he could use the regular income he received to invest in undervalued shares that would provide rapid capital accumulation, dividends or both
In this way Munger was able to build a regular 'income infrastructure' that allowed him to always have money coming in and to make the types of investments that would generate 15-20 percent annual total returns, each year.
Munger's lesson: "income first, capital gains later" is something which we very much endorse based on our own focus of investing only in high quality dividend paying companies when they are historically undervalued. Read more about Dividend Income Investor.com’s investment strategy and methodology: Here.
If you are looking for a good read that is both instructive on how to make money from dividend income investing as well as incredibly inspirational, I highly recommend that you consider buying Janet Lowe's Damn Right!: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger.
AIM companies to be allowed into ISA’s?
Earlier this week, the government announced that it has started the consultation process in order to allow AIM-listed shares in stocks and shares ISAs. Allowing stocks and shares ISAs to invest in shares on the Alternative Investment Market, as first proposed in the government's Autumn Statement, would provide ‘an important capital injection’ for small and medium-sized businesses according to the Treasury.
We at Dividend Income Investor.com welcome the possibility that stocks and shares ISA investors may in future invest in shares listed on AIM.
We have already started the process to ascertain whether there are any high quality historically undervalued AIM-listed companies that have a track record of annual dividend increases for potential inclusion in our Dividend Income Portfolio.
Company and dividend results
Several insurance companies, such as Prudential, Standard Life and legal & General have released their results the last few weeks, increasing their dividends, while Aviva and RSA Insurance Group surprised shareholders with deep cuts in their dividends.
For many people the workings of a typical insurance company is rather a mystery. However, if run properly insurance companies should be cash machines and be able to sustain increasing dividends.
Unfortunately, not all insurance companies are the same as I report in this article.
RSA Insurance Group
RSA Insurance Group announced a rather unexpected dividend cut of 33 percent, with the final dividend of 3.90 pence going ex-dividend on 3 April and payable on 24 May. Last year the final dividend was 5.82 pence. The total for the year is 7.31 pence which is down 20.2 percent on last year’s 9.16 pence. The new ‘rebased’ 2013 dividend forecast is 6.3 pence
As it swung into the red in 2012, following a £3.3bn write-down on a disposal in the USA, Aviva slashed its final dividends by almost 44 percent to 9 pence per share (2011: 16 pence), going ex-dividend on 20 March and payable on 17 May. This makes for a full-year dividend 19 pence per share compared to 26 pence a year earlier. The new rebased dividend 2013 forecast is 16 pence.
The dividend has been rebased to reduce leverage and increase retained earnings, ensuring dividend distribution is covered by earnings and cashflows, while the company is also removing the dilutive scrip dividend in the hope that this will improve earnings per share.
Just days after the firm disappointed the City with its results for 2012, Mark Wilson, Aviva’s newly-appointed CEO, bought his first stake in the. Wilson acquired 150,000 ordinary shares at 321.1113p each for a total of £481,667, his total holding since joining Aviva on January 1st.
One final bit of good news: in the first major announcement since his appointment, Wilson said that the company's overall situation did not warrant bonuses for executive directors for 2012 or pay rises for 2013.
Britain's biggest insurer, Prudential raised its final dividend by a bigger-than-expected 16 percent as net profits surged 55 percent last year after continued strong growth at its flagship Asian operations. Final dividend is 20.79 pence, going ex-dividend 27 March and is payable 23 May. The dividend 2013 forecast is 28.5 pence
The bigger dividend payout, reflected a 25 percent jump in Prudential's 2012 operating profit to 2.53 billion pounds. Prudential has avoided the economic turbulence afflicting its European competitors thanks to a strong focus on fast-growing Asia, the source of nearly half its sales these days.
British American Tobacco
British American Tobacco released its 2012/13 results including a final dividend of 92.7 pence going ex-dividend on 13 March and payable on 8 May. This makes a total for the year of 134.9 pence, up an inflation beating 6.6 percent on the 126.5 pence paid last year. The 2013/14 dividend forecast is for a further increase to 147.2 pence.
Unfortunately, group debt rose £600m to £8.5bn partially due its £1.25bn share buyback programme during the year. Uncomfortably, gearing rose from an already high 97 percent to an even higher 113 percent due also to a decline in net assets. The group’s intention for this year is to spend another £1.5bn in 2013 on share buybacks likely to increase gearing even further.
how using shares in British American Tobacco you could have exponentially have grown your returns.
BAE Systems issued annual figures disclosing a final dividend of 11.7 pence going ex-dividend on 17 April and payable on 3 June. For the year that makes a total of 19.5 pence modestly up on last year’s 18.8 pence. Analysts' 2013 dividend forecast is 20.4 pence. We are not so sure about that.
While sales were down 7 percent, BAE Systems surprised with holding net cash of £387m by the year end - a remarkable turn round from the net debt position of £1,439m and 34% gearing of a year earlier.
While the group is expecting significant cash expenditure in 2013, principally for the production costs of various aircraft contracts, BAE Systems also announced that it intend to spend up to £1bn in the next three years on share buybacks, a process that increases both the absolute level of debt and the gearing ratio, thereby increasing risk to the business and its shareholders.
BHP Billiton, having released its half year accounts in US dollars, reported an interim dividend of US 57¢, having gone ex-dividend on 6 March, while 36.9 pence is payable on 28 March. The dividend payout is up on last year’s interim 55¢ (34.5 pence) - both ahead of inflation in dollar and sterling terms. Analysts' 2013 dividend forecast in sterling is 76.5 pence.
First half year was a difficult one for BHP Billiton with revenues falling by 14 percent and operating cash flow down 48 percent. Net debt rose to $30.4bn from $23.6bn at the 30 June 2012 year end with a rise in gearing to 45 percent from 36 percent.
Earlier in December, I released an article on BHP Billiton stating that its diversity, in comparison to its competitors, guarantees future dividend increase. You can access the article Here.
However that diversity may now be somewhat under threat as BHP Billiton has decided on a major divestment program as I explained, earlier today, in this article.
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