The Ignorant Investor

From the AP comes this little nugget:

NEW YORK - Although companies have amassed record stockpiles of cash, their dividend yields remain anemic. Some dividend-loving investors say it's time for that to change — and companies may be paying attention.

As companies have cut dividends, they've increased stock buybacks. But investors say the buybacks are no substitute for dividends.

This news increases my confidence in the investing community. After years of the S&P 500 trading in a range, are investors finally understanding that total return in equities is not based on massive capital gains alone? One hopes so. It would be a sign that rational expectations have returned to the market place. The kicker is here:

Corporate management had sold institutional investors on the idea that buybacks, or stock repurchases, by a company are as good as or better than dividends. "Managers have really successfully convinced institutional investors that $1 of buyback equals $1 of dividends," said Douglas C. Eby, president of Robert E. Torray & Co. Inc. and a manager of the $1.5 billion Torray Fund. . . . But that argument became unconvincing while corporations were issuing millions of shares of stock options to their executives, diluting the worth of outstanding shares.

I may be wrong, but the need to pay cash out of the corporate treasury seems like a decent rein on the modern greedy CEO. Whatever accounting tricks used on the balance sheet, having to pay out a couple of billion a year to shareholders keeps at least something out of the hands of the board and executives, who often seem too tempted to use it instead on worthless acquisitions or increasing their benefit packages.

One of the things that has struck me as funny recently is the way every quarter the economy appears to turn in good numbers, and yet the Dow is still stuck in the same range. It's as though every time we have another strong quarter on GDP, people say "that's okay for now, but what about next year?"

That's the nature of Wall Street, on which the price of securities has less to do with the current numbers than where corporate profits will be in six months or a year. The failure of the republicans to control spending, the trade deficit, the concurrent outsourcing of high-wage manufacturing jobs to China and other low-wage countries, and the dual wars in Iraq and Afghanistan have got everyone a little confused as to the future direction of the economy. Are these problems we need to worry about, or are they mere bumps in the road that the muscular American economy will plow through on the way to higher growth?

The economists seem mixed on the question. I'm pessimistic, but then again, I'm always pessimistic. It's a characteristic that I constantly have to guard against in investing, since being too pessimistic is just as bad as being too optimistic. It leads to a lack of risk taking, which typically hurts returns down the road. I honestly don't know. This doesn't feel like a boom time even though the government's numbers are good and Alan Greenspan is smiling.

Anyone who missed out on the heyday of the dot com boom of the late 1990s can catch the replay by following the performance of Bidu.com, an internet search engine that apparently is big in the Chinese market. The IPO price was $27, but after only a few hours of trading on the open market on Friday the stock was running above $150. It's fallen significantly over the past couple of days, trading now in the $100 range, so it's worth asking whether it's a good buy at the current price.

The frenzied trading is understandable. Google's ability to turn its dominent position as a search engine into a cash cow by creating a new market in search advertising- to draw huge profits out of an internet that has left so many investors in tears- stunned people like me some months ago. Back in 1999, I bought into Hewlett-Packard on my broker's advice and can still remember the almost physical euphoria of watching it shoot upwards day after day (my current grim, Calvinist distrust of share prices that shoot upwards with effortless rapidity came only later, after the stock's price fell by 80% along with most of the other companies that suffered when the tech boom went bust). Google was a tech company that seemed to deliver on what it had promised. Big profits now. Not promises of future growth, but real live cash in hand. So people went gaga over google.

So now along comes Bidu.com with its strong position in the Chinese market. People can't look at the stock without thinking of that verticle rise in Google's price. There's a kind of mania that takes over at a time like this. You see a country that's teeming with a billion people, you look at the popularity of the internet works here, and you think about half a billion Chinese men just waiting to type in searches like "pictures+American+girls+lesbians". Who can resist owning the next Google?

I'm sure sympathetic to this argument, but look at the negatives involved: At $100 a share, the stock is running about four times what the company's own management and bankers thought the stock was worth only a week or so ago. And there's no guarantee that Bidu.com will dominate the Chinese market the way Google dominates this one. Google itself just might turn out to be the Chinese google with the addition of a couple of Chinese programmers and a sales office in Hong Kong. Further, there's a good chance that Google is itself overvalued. The internet advertising market is new, after all, and its potential for growth may be wildly overestimated.

Yes, I too cannot help but think about all those Chinese men searching for all those pictures of lesbians. Or amateur guides to all the episodes of Star Trek. Or chat rooms on whatever reality shows Chinese people like. If I had to be honest here, I'd say that the only reason I didn't buy into Bidu.com at $150 a share last Friday is because I happened to be on vacation, and the only reason I'm not buying in right now is because it fell from $150 to $100 in a couple of days, which is too much volatility for me. Whatever value is in a share of Bidu, and there may be a lot of it, it's probably not worth a hundred bucks. At least for now I'm going to pass on this one.

Perhaps in a few months we'll have another search engine IPO. Something in India, maybe. I hear they like Star Trek, too.

Here are seven ways to get started as an investor, even if all you can spare is $20 or $50 a month.

So begins this week's column by the usually solid Jonathan Clements of the Wall Street Journal. He goes on to give the reader several options for investing these tiny sums, for the most part in low-cost no-load mutual funds.

I don't mean to be a snob, but what's the point? Twenty bucks a month is $240 a year. With a real rate of return of 6-7% or so per year (in effect, the annual nominal rate of return minus the annual rate of inflation), a historically generous estimate, what you're going to have in 30 years or so is enough cash to . . . well, not buy much.

Point is, the stock market is not some magic machine that takes little acorns and builds them into huge oaks. If you put just a little money in, chances are you're going to come out with just a little more money on the other end, even with the magic of compound interest.

The whole "at least put a little into the market" has the smell of mutual fund community hype to me. A way for the industry to capture revenue by aggregating lots of small accounts that don't have much utility to investors.

If there is one quality that every blog should possess - and every other piece of writing, too- that quality is originality. I usually forgive writers who can't avoid being long-winded or dull. Most of us can't shut up about our own ideas and manage to be at all engaging only occasionally, and awkward and mediocre writing may still contain insights missing from more smoothly written and professional prose. But simply repeating what other people have written elsewhere, or worse, what one has already written before, is a literary crime that deserves the severest form of punishment a reader can inflict on a writer: to stop reading and go watch television.

When it comes to blogs on investing, having an original thought isn't easy. After a hundred or so years of investment commentary by thousands of writers, there is nothing that I can say about investing that hasn't been said before. The three basic rules of investing I listed below are not profound. Yes, they would earn the rapt attention only of those readers who know only two basic rules of investing. But since everyone already knows the one about buying low and selling high, the chance of finding someone who doesn't know at least a couple of other rules is very small.

The standard test of originality is to ask whether anyone has ever written the same thing at any time in the past, but as an alternative measure we could think of originality subjectively from the position of the reader. In other words, if the reader hasn't read the same thing elsewhere, the piece will seem original to that reader. Thus, my writing about such well-worn concepts as diversification, the buy-and-hold strategy, the merits of index funds, realistic expectations of return, and simple prudence may appear original if only the reader doesn't know anything about investing at all.

Yet where does one find such ignorant readers?* Americans are all very sophisticated investors. We know this because if you ask most people whether they are capable of managing their money, they will say quite confidently that they know all about investing. Some of them have even taken seminars with people who tell them how to day-trade or buy real estate with no money down or pick stocks better than the pros with all their so-called experience and knowledge. Many of them, if the frequency with which I receive a certain secret e-mail from a certain banker in Nigeria, know how to smuggle millions in cash from third world nations. In fact, one of the most humbling experiences I had during the last ten years was watching in 2000 when all those people who held shares in tech stocks sold them right at the top of the market, which they timed with extraordinary and widespread prescience. Who would have done that except someone who thought that the NASDAQ wouldn't grow 50% or so a year indefinitely?

So I am going keep writing this blog even as if I remain one of the few ignorant investors in the market. Yes, I admit that I do not know where the DOW will be in 2006, or even at the end of 2005. I do not know what will happen to corporate profits in the next twelve months. Or whether interest rates will soon rise, or if the yield curve will invert. If anyone does, will they please tell me?


*The more significant question is how one finds a reader, since so far this blog doesn't have even that many, but as not having any readers saves me from having to proofread, that's one question I refuse to ask.