{"id":66126,"date":"2015-01-07T05:14:25","date_gmt":"2015-01-07T10:14:25","guid":{"rendered":"http:\/\/countingpips.com\/?p=66126"},"modified":"2015-01-07T07:31:52","modified_gmt":"2015-01-07T12:31:52","slug":"why-income-investing-beats-value-investing","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2015\/01\/why-income-investing-beats-value-investing\/","title":{"rendered":"Why Income Investing Beats Value Investing"},"content":{"rendered":"
January 7, 2015<\/div>
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By WallStreetDaily.com<\/span><\/a> \"Dividends:<\/p>\n

By Martin Hutchinson<\/a>, World Banking Analyst <\/em><\/p>\n

When it comes to stocks, income investors are mostly interested in dividends.<\/p>\n

Earnings and valuation don\u2019t matter much, unless they impact the sustainability of a company\u2019s dividend. For instance, an income stock that cuts its dividend is a killer to our portfolio value.<\/p>\n

Value investors often sneer at us, claiming that dividends are irrelevant to the true long-term valuation of their investments. Yet in a world of funny accounting and high P\/E ratios, the solid virtue of our income streams may give us the last laugh\u2026<\/p>\n

Funny Accounting and Spurious Profits<\/h2>\n

Value investors traditionally look for companies selling at low P\/E ratios and discounts to their net asset values. Unfortunately, modern derivatives techniques and accounting conventions make this approach much less useful than in days past.<\/p>

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This is especially true for natural resource companies. You see, technically speaking, these companies should hedge their product sales price forward. The problem is that, unless the hedges all expire each quarter, a period of declining prices could produce an immense (and spurious) profit that reflects nothing in cash and occurs even as the company\u2019s value has declined.<\/p>\n

The oil production master limited partnership (MLP), Linn Energy<\/strong> (LINE<\/a>), for example, showed a huge profit in the final quarter of 1988, even though the value of its reserves had declined with the price of oil. A similar outcome is likely in the first quarter of 2015.<\/p>\n

In reality, declining oil prices are very damaging to LINE\u2019s business \u2013 so much so that the company recently slashed its dividend payout from a forecast $2.90 per unit to just $1.25 in 2015. Of course, Wall Street Daily <\/em>readers weren\u2019t surprised, as my colleague, Alan Gula, had predicted the dividend cut in his Dividend Death Watch<\/a>.<\/p>\n

Finally, it\u2019s the dividend cut \u2013 not the company\u2019s quarterly earnings \u2013 that will be the best indicator of LINE\u2019s fortunes. The quarterly earnings report will likely only reflect the success of LINE\u2019s price hedging. Meanwhile, the stock has halved in the last six months, which mirrors the declining value of the company\u2019s oil reserves.<\/p>\n

The Problem With Net Asset Values<\/h2>\n

Net asset values are an ever-worse indicator of a company\u2019s true economic value.<\/p>\n

As shareholders in Barrick Gold Corporation<\/strong> (ABX<\/a>) discovered early last year, the net asset value of a mining company is a very uncertain statistic. If market conditions are poor or, as in Barrick\u2019s case, if bureaucratic delays hold up an $8.5-billion gold mine, the accountants can arbitrarily force the company to write off billions of dollars of irreplaceable assets.<\/p>\n

Since mineral prices fluctuate widely, mining companies will often suffer huge write-offs of assets they\u2019ve only recently developed, making their net asset values artificially low. In those cases, value investors may miss companies that, on an operating basis, are highly attractive, simply because phony write-offs have given them the appearance of low, or even negative, shareholder equity.<\/p>\n

Barrick\u2019s tangible book value declined from $12.7 billion to $7.4 billion in 2013, knocking the company\u2019s leverage ratios and causing a $10-billion reported loss \u2013 yet the company continues reporting a modest profit on an operating basis, even at today\u2019s lower mineral prices.<\/p>\n

As in the derivatives cases, silly accounting has distorted the true picture.<\/p>\n

Rely on Sustainable Dividends<\/h2>\n

Of course, dividends can be deceptive, too \u2013 particularly companies with very high dividend yields, whose managements sometimes pay out dividends that exceed earnings.<\/p>\n

In fact, LINE has done this for several years, though it would argue that an energy MLP has large non-cash charges of depletion and depreciation that don\u2019t affect cash flow, allowing it to safely pay more than it earns. Still, this week\u2019s announcement that LINE cut its dividend and<\/em> halved its exploration budget suggests that this approach is dangerous.<\/p>\n

Even more dangerous is the possibility that the dividends are being paid out of cash flow from an asset with limited life. Unfortunately, this is a real issue for many MLPs that don\u2019t replenish their asset bases. Great Northern Iron Ore Properties <\/strong>(GNI<\/a>), for example, has a concession in the Mesabi Iron Range that expires in June. Hence, its seemingly magnificent dividend yield (46.8%) doesn\u2019t actually represent a useful opportunity!<\/p>\n

Still, even in the beleaguered mining sector, there\u2019s a certain comfort that comes from a steady dividend. After all, a sustainable dividend signals management\u2019s long-term commitment to the business.<\/p>\n

A more attractive long-term investment for income seekers is copper and gold miner, Freeport-McMoRan<\/strong> (FCX<\/a>). FCX rewards shareholders with a $0.3125 quarterly dividend, giving the stock a current yield of 5.2%. Still, there\u2019s one caveat: FCX hasn\u2019t had any big asset write-offs yet, and I wouldn\u2019t be at all surprised if it had one this quarter, since it recently bought a substantial oil producer.<\/p>\n

Thus, I\u2019d wait to buy until either the fourth-quarter earnings statement or the next dividend announcement, which is due in early March.<\/p>\n

Here\u2019s the bottom line: Dividends represent real cash, and, if they\u2019re sustainable, can provide money to live and rely on, at least for the medium term. That\u2019s a lot more useful than possibly distorted \u201cvalue investment\u201d earnings, which, when it comes down to it, may pay the company\u2019s bills but won\u2019t pay yours.<\/p>\n

Good investing,<\/p>\n

Martin Hutchinson<\/p>\n

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The post Why Income Investing Beats Value Investing<\/a> appeared first on Wall Street Daily<\/a>.<\/p>\n

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 <\/p>\n","protected":false},"excerpt":{"rendered":"

By WallStreetDaily.com By Martin Hutchinson, World Banking Analyst When it comes to stocks, income investors are mostly interested in dividends. Earnings and valuation don\u2019t matter much, unless they impact the sustainability of a company\u2019s dividend. For instance, an income stock that cuts its dividend is a killer to our portfolio value. Value investors often sneer […]<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-66126","post","type-post","status-publish","format-standard","hentry","no-post-thumbnail"],"_links":{"self":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/66126","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/users\/3"}],"replies":[{"embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/comments?post=66126"}],"version-history":[{"count":0,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/posts\/66126\/revisions"}],"wp:attachment":[{"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/media?parent=66126"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/categories?post=66126"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.investmacro.com\/forex\/wp-json\/wp\/v2\/tags?post=66126"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}