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Posted 10/31/2002

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"Disappearing Dividends," by Eugene Fama and Kenneth French

The Speculator

Recent articles:
• 5 genuine buys on a Street of impostors, 10/24/2002
• Higher dividends are no magic bullet, 10/17/2002
• What dividends say about a stock, 10/10/2002

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The Speculator
Nothing pays dividends like a new dividend
Investors would do well to look for cash up front. Few companies are launching dividends anymore, but those that do often follow up with market-beating performance.
By Victor Niederhoffer and Laurel Kenner

Our articles on dividends have elicited thousands of responses from investors who see dividends as the best way out of Wall Street's fog. Inspired, we continued our studies and have come up with a new idea for dividend aficionados.

Money Plus.
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and free Bill Pay, too.

We reported Oct. 17 that S&P 500 ($INX) companies that increased dividends this year outperformed those that cut or stopped them by about 6 percentage points.

Unfortunately, companies that increase dividends are as rare as the rhinoceros these days. Only 21% of companies pay dividends at all, down from 67% in 1978. Given that dividends are double-taxed in the United States, it's no wonder that this is so.

Moreover, companies are more likely to stop paying dividends than to initiate them. Between 1978 and 1999, an average of 5% of dividend payers stopped the payouts each year, according to Eugene F. Fama and Kenneth R. French in their paper "Disappearing Dividends." (To read the article, see the link at left under "Related Sites.")

On the other hand, the chances were just 1.8% that a company would start paying dividends. In 1999, only 0.7% of companies initiated dividend payouts. (Fama and French used the comprehensive Center for Securities Prices database, which has since 1973 included all stocks listed on the NYSE, Amex and Nasdaq.)

Those are the companies we wanted to investigate. The initiation of a dividend seems like a quantum type of event. Going from zero-ness to something is even more important than an increase from one positive level to another. We reasoned it might lead to superior performance. Furthermore, a company that initiates a dividend may be signaling that it intends to increase it in the future, or at least doesn’t fear that it will lack the profits to maintain it.

We found just 14 companies in the S&P 500 that have initiated a dividend since the end of 1998. With the exceptions of FedEx (FDX, news, msgs) and Qwest Communications (Q, news, msgs), all the new dividends were declared after spin-offs, mergers and initial public offerings or by mutual companies that had gone public.

As the table shows, they did very well as a group:

 New dividends and stock returns*
Company Ticker           Dividend initiated % chg 12 mos. later Difference vs. S&P 500 12 mos. later
AmerisourceBergen ABC 10/31/2001 N/A N/A
FedEx FDX 5/31/2002 N/A N/A
Goldman Sachs GS 6/24/1999 32% 22%
John Hancock Financial Services JHF 11/13/2000 32% 49%
MeadWestvaco MWV 1/13/2002 N/A N/A
Metropolitan Life MET 10/24/2000 10% 29%
Monsanto MON 10/18/2000 49% 72%
Pepsi Bottling PBG 4/29/1999 7% -3%
Principal Financial PFG 10/25/2002 N/A N/A
Qwest Q 5/2/2001 -87% -73%
R.J. Reynolds Tobacco Holdings RJR 7/28/1999 5% -2%
Rockwell Collins COL 7/2/2001 6% 29%
United Parcel Service UPS 11/18/1999 -9% -9%
Visteon VC 7/14/2000 24% 43%
*Returns don't include reinvested dividends

The dividend initiators rose 7%, on average, in the 12 months beginning the day after declaring the dividend. The average performance for the S&P 500 was -9%, so the new-dividend companies had an advantage of some 16 percentage points. (Without Qwest, the outperformance increases to 25 percentage points, but these things are so easy in hindsight.)

Considering the intrinsic variability of stocks, bearing in mind that this is a sample of generally good corporate citizens and noting the 40% standard deviation of the differential performance, the results are on the borderline of statistical significance -- say a 1-in-10 shot by chance variations alone. But it’s a good start.

3 to speculate about
Just three S&P 500 companies announced initial dividends in 2002: Principal Financial, the big Iowa insurer; MeadWestvaco, the paper products company; and FedEx, the delivery giant. We don’t know enough about them to opine. However, they would seem to be worth a speculation as part of a basket of the next 15 or 20 companies that initiate dividends.

We’re continuing our research on fundamental analysis by looking at many combinations of the indicators we’ve studied separately. We will send readers who write to us at with comments, compliments or critiques about our column a list of Dow companies fitted with regressions for their performance over the past three years versus inventory changes, accounts receivables changes and book-to-pay ratio (that's the ratio of EBIDTA, or earnings before interest, taxes, depreciation and amortization, to cash taxes paid).

Nonimpostor stocks
Last week, we combined three fundamental indicators -- a buyback announcement, a big decrease in accounts receivable and a big decrease in inventory -- to find five companies we think will collectively beat the market. We’re still waiting for a nice down day to buy them, but here is their performance from the close on Oct. 23, our publication date, through the close on Oct. 28:

 5 real buys
Company Ticker Performance
Albertson’s ABS 0.6%
Analog Devices ADI 0.3%
Dell Computer DELL 0.1%
Paccar PCAR 2.6%
Xerox XRX -2.8
S&P 500 $INX -0.7%

Readers share impostor tales
The collective common sense of people is astonishing.
-- Dave Barry

The response to our column on impostors proved Dave Barry’s point. We received dozens of tips and erudite essays on how to spot cheats, phonies, quacks and manipulators. Here are two out of many dozens.

Kate Donnelly Schneider had two brilliant additions to the four impostor characteristics that trader David Rosen wrote about in our column last week: unrelentingly trendy, always on the make, unwilling to discuss risk and your instant “best friend."
    5) A toxic person/con artist/impostor also has a history of failed relationships, of which he/she is the innocent victim. Their “friends” are only new acquaintances; the test of time has stripped their veneer. First wives were “nuts” and turned the children against them, so there's no contact with them. The family of origin is dead (probably not true) or did some dastardly deed to the impostor (usually around money) that led to estrangement. Prior business associates “screwed “ them, thus no contact with them.

    6) There's another kind of impostor -- the Genetic Impostor -- a bit harder to discern. He or she is in a bunch of deals with Daddy. He wants to do business or get close to you -- but only to see what you can do for this two-headed monolith. He's very interested in your success, and interested in you being impressed by him -- but his “story” doesn't quite add up. He has no real success of his own, only what has been fed to him by Daddy, and Daddy has sent him out in search of fresh blood. He seems to have sprung directly from the loins of Daddy/Predator #1. You possess the life force on which they exist, so his purpose is to take all you have to benefit their common good. You are a means of survival for them.

'We’re excited!'
We haven’t tested the following hypothesis from Jack Tierney, a Tennessee philosopher who spent many years in newspapers, but it sure rings true.
    A good number of years ago the gentleman who first hired me was suddenly replaced by a” young Turk" who was obviously on a career path to the top. The newcomer's knowledge and interest in our functions was superficial at best; my former boss's life had been spent in the creative end of advertising so, following generally accepted business practices, he was made Assistant Purchasing Manager. In his farewell address to us he stated that he was “excited about his new position.” The word “excited” struck me as so inappropriate and inaccurate, and its dissonance has never left me.

    Yet in the years that followed, I've discovered it has become the accepted way of spinning a disastrous occurrence. Whenever I hear an executive say that he's excited about recent negative developments, it's time to walk away from that stock . . . chances are he is neither excited nor optimistic.
Tierney sent several examples of “excited” companies from among 15,600 he found on Google. Suffice it to say that all of them drastically underperformed the S&P 500 after the effusion.

Who’s the dumb money now?
James Altucher, a partner in Subway Capital, writes that market gurus who use sentiment measures as a contrary indicator belong on our list of imposters.
    First, a review of the primary sentiment indicators:

    A. The put/call ratio. When this is greater than 1, supposedly the "dumb money" is bearish.
    B. Investors Intelligence survey of bullish vs. bearish newsletters. When more newsletters are bullish then it’s bearish and vice versa.

    I always get bothered by the guys who primarily use sentiment indicators. It’s as if there is an exclusive club where the secret handshake is a shared assumption that everyone who is not in the club is dumb money.

    For example, there was a big uptick of the “the bulls” in the latest Investors Intelligence survey. So a lot of analysts are saying this is a bear market rally until that sentiment gets a lot lower, and many of the big financial Web sites have been recommending shorting into this rally.

    I think, though, that there is a resource issue. The question is, who is actually fueling this stage of the “bear market rally”?

    A. It’s not the newsletter writers that are surveyed by (Investors Intelligence). They make a decent living writing newsletters! Why flush hard-earned money down the toilet?
    B. It’s not the customers of the newsletter writers. Since the newsletter writers are all “dumb money,” the customers are broke by now.
    C. It’s not the mutual funds at this point. Money is barely trickling in now and mutual funds are standing at 4% cash, a low for a market bottom. Maybe that's enough to propel the market on week 1 but probably not week 3.

    The bottom line is, all the “smart money” that’s been going short because of sentiment indicators is now buying in a huge squeeze.
For the full compilation of readers’ impostor tales, see

At the time of publication, Victor Niederhoffer and Laurel Kenner owned or controlled shares in the following securities mentioned in this article: Dell, Albertson’s, Analog Devices, Paccar and Xerox.

MSN Money's editorial goal is to provide a forum for personal finance and investment ideas. Our articles, columns, message board posts and other features should not be construed as investment advice, nor does their appearance imply an endorsement by Microsoft of any specific security or trading strategy. An investor's best course of action must be based on individual circumstances.