How to read an Annual Report part 2: Dividend

Tweet

This is part of my series on The Annual Report. Please read the other posts for other perspectives on the matter:

How to read an Annual Report part 1: Management
How to read an Annual Report part 2: Dividend

Introduction

So, we have had a look at the management teams of the companies and what to look at there. The question is still, how do we differentiate long term, solid companies from junk companies in an easy way that doesn't require a lot of time. The answer might be dividends. Lets look at the details.

Companies that don't pay divided

The are numerous reasons for a company not to pay out any dividends, maybe they are in an expansion phase, researching a new product, acquiring businesses etc.  This is all well and good, the question we should ask as long term investors is:

Is the management team creating more value for us by keeping the cash in the books instead of paying it out in dividends?

For me, to answer this question would take too long to analyse and research. I.e. going back in reports and looking at the returns over a longer period of time. And that is basically the one reason why I don't invest in them.
Other reasons why I keep away is because when my money making machine build phase is over, I would like to be able to live on the returns. If the companies I own don't pay out dividends I would have to sell my shares, bit by bit to be able to make a living and that just feels wrong.

Companies that pay dividend

So, we have now filtered out a big chunk of companies that don't pay dividends. Lets look at the ones that do.
For a company to be able to pay a dividend it requires that it must have a revenue stream that is higher than the cost of operations. The management team must be confident that they will be able to continue with operations even after the dividend is paid. To be able to pay dividends, year after year the companies must adapt to all sorts of challenges that the world throws at them, from financial crisis to acquisitions. Everything the company does, must pay itself. The company can't afford to throw away money.

So, companies that pay dividend are good. How do we know that they will continue to do so? As with mutual funds, we can't predict the future by looking at past performance. There is always a risk. But dividend companies have one thing that stands out: Shareholders don't tend to like them if they mess with the dividend policy.
And that is why so many companies make an extraordinary effort to pay the dividend. If they don't do it one year, it sends out strong signals that things are not in order and many larger institutional owners tend to sell when it happens, making the share drop.

If the company has paid dividends for a decade, we should be interested.

Companies that raise dividend

So dividend payers are great companies, but what makes companies stand out even more from the competition? Companies that raise their dividend year after year. To be able to raise a dividend year after year, the operations must be optimized. And just like with the dividend payout itself, shareholders tend to not like it if a company changes its dividend payout plan and doesn't raise it for one year.
There is even a name for companies that have raised their dividends for 25 consecutive years, they are called Dividend Aristocrats.  Its a thing, it is part of the company's image. The company is a dividend raiser and most of them are quite proud of that and it takes something out of the ordinary to change that. For example the financial crisis in 2009, the list of S&P500 Aristocrats dropped 10 companies. From 52 to 42. Keep in mind that the whole financial sector was on the edge of collapse and still 42 companies managed to raise their payouts to shareholders. If you reinvested that cash during that year, you got a lot of shares for a bargain as the markets plummeted at the same time. I feel that I can trust a dividend raiser, they go the extra mile.

Conclusions

Of course there are companies that for various reasons stop or change their dividend payouts. Maybe that should be the signal for you to go somewhere else instead of the quarterly noise with missed expectations. If the company is still able to raise its dividend even after a 'failure', it is still a great company to own and most likely things will sort themselves out.

I'm not that into numbers as you might have noticed on this blog, I'm happy to leave them out most of the time. But one thing that should be kept in mind when looking at companies that pay dividend is that if you re-invest the dividend payout, and the payout is higher each year. You will get some awesome compounding effects on your investment. The numbers go crazy after some years. I'll let you find the numbers on google yourself. :)

A great place to start searching for dividend paying companies: The DRiP Investing Resource Center
They have lists for various markets, US, Canada, UK and Sweden to name a few.


Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.

How to read an Annual Report part 1: Management

Tweet

The one key indicator of how well your business is performing is The Annual Report.

Before putting your hard earned money into a business, make sure that you read up on the annual reports for the at least the last 5 years, preferably the last decade. This may sound like a lot of work, but you want to get a picture of the business before handing over your cash. In the end, it is better to discard one too many companies than invest in a rotten one.

This is part of my series on The Annual Report. Please read the other posts for other perspectives on the matter:

How to read an Annual Report part 1: Management
How to read an Annual Report part 2: Dividend

Management perspective

Let's start with the part that usually comes in the beginning of most reports. This is the part where the chairman of the board and CEO (chief executive officer) make tell you their view of the business. They should go over major events of the past year and tell their plans for the future.
By reading up on the past decade of reports, you should get a pretty good view of how trustworthy the top management is in what they tell their shareholders.

Is there passion?

Do you want the management team to passionate about the company, or only their own careers? Passionate people take the extra step and put in the time that is needed to get things going.

Do they include not only the positive side of the story but also the negative? 

All years are not success stories, that's the way of life. If it is a trend that every year is only described in positive terms in the report then maybe there is something left out.

In my mind this should be a deal breaker if the chairman and CEO leave things out in the communication to the shareholders, then maybe you should go find another business to invest in.

Are they focusing on the share price or on the value generating streams in their business?

If the main goal for the top management is the market price of the company, maybe it does not suite your long term investment plans. In other words, if you try to ignore the whims of Mr Market, shouldn't the businesses that you invest in do the same?

Management Turnaround

Is there a continued red line in the management? Does the CEO change every year?
You should be able to trust the management in your investment and trust is hard to build up.
Is the top management invested in the business (this may not be clear in a report, check the Insider Trading lists of your market to find out more)
Of course you cannot expect that a CEO stays a decade in the same company, there are numerous legitimate reasons to change the CEO and even the Chairman but in the long run, it should not require detective work to figure out the red line in the management structure.

Fulfillment of goals

Goals that are set one year, are they followed up and in the end fulfilled?

Here's the reason you should read back on annual reports over a longer period of time. You get the backstory. If the management is new, look up what other companies they have worked on and if they got things done there.

Conclusions

In the end the question to ask is:
Do you trust these people to operate your business on a daily basis.


Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.