Value, dividends and liquidity – what are my thoughts?
Another viewer question I would like to share…
A few questions (assume for all questions below that I am referring to stocks with low debt and high return on equity):
1) If you see the market as overvalued and most stocks you look at above their intrinsic value, do you just stay in cash until they become cheaper, even if you could be waiting years (like the 2003-2007 period)?
RM – I look at individual companies rather than the market. If there are no individual companies that are cheap, the answer is yes.
2) I know you like stocks that pay no dividends, but what happens if management does something stupid and the stock price plummets? At least you have got something from your investment if you have received dividends.
RM – You have misunderstood my stance on dividends, which is quite a common misunderstanding. My position is that all things being equal, a company with a high ROE that can retain its profits and compound them at a high rate is worth more than a company with the same ROE but paying some proportion of its earnings out as a dividend.
I am quite happy to buy companies that pay dividends – I bought Fleetwood earlier this year on a dividend yield of more than 20% – but the price I must pay for them is lower.
On the second part of your question, you are right. The assumption is that if management is going to retain profits they must generate high returns on those retained earnings. The track record of management doing stupid things however is long so I can understand shareholder reticence towards management hanging onto the cash.
3) Do you have any concerns about buying a stock that has low liquidity (as it could be difficult to sell if something goes wrong)
RM – Even when managing more than $100 million I bought shares with low liquidity, but I was right in those cases and their superior performance eventually attracted increased liquidity. Had I been wrong then yes, the illiquidity would have been a problem. They key is to worry more about being right, then you don’t have to worry about the liquidity.
Posted by Roger Montgomery, 3 December 2009
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