Tuesday, November 15, 2011

Buying Companies, Not Stocks

Let’s go back to what I started out in reviewing Finning International (TSX-FTT) yesterday. This was the book review by The Loonie Bin Blogger on Saturday. See this blog.

My comment had to do with how you view your purchases in the stock market. Are you buying a company or a stock (and, of course are you gambling)? I still think that your view of the stock market determines very much how you look at the stocks you buy. But today, what I want to discuss is between buying a company and buying a stock.

When looking at the current price of Finning International yesterday, I commented on the fact that it passed two of my tests regarding whether or not the current stock price is a good one. What I found was that the stock price was reasonable considering the current Price/Earnings Ratios and the Graham Price.

When I looked my other two tests, the results were different. The dividend yield was currently higher than the 5 year median dividend yield. Looking further, I could see that the dividend yields have been unusually high over the past 5 years. The 10 year median high dividend yield was lower at just 1.56%, than the current dividend yield of 2.32%, so this put the current yield in a more favorable light. So, really this test is fine.

However, you cannot say the same thing about the Price/Book Value Ratio test. Here I got a 10 year median P/B Ratio of 2.37 which is 23% lower than the current P/B Ratio of 2.92. This suggests that the current stock price is not low. I probably just hinted at the problem rather than really stating it with talking about the book value going down and the Dividend Payout Ratios for earnings going up.

The problem is that they are not only maintaining their dividends but are continuing to increase them when they are not doing well in earnings. Yes, I know, companies are reluctant to stop dividend increases, and heaven forbid, reduce dividends. The main reason for this is that investors tend to punish them heavily as far as stock price is concerned, when this occurs. But, I believe that this has a great deal to do with the lack of foresight with dividend investors. Also, I believe it also has to do with the fact that they are buying a stock, rather than a company.

I dislike my companies to muck around with my dividend payments as much as the next person. However, I do like the companies I invest in to act prudently. The question, to me, is Finning International acting prudently? Or, are they gambling, that business will improve and future earnings will once again be good coverage for their dividend payments?

Far be it for me to criticize a relatively good company. However, I do think that Finning International is not acting prudently. It is not that I think their gamble will not work, because it probably will. If I had stock in this company, I would be holding rather than selling. However, I do think that they are not acting prudently and they that their action might well delay the recovery of Finning International when the economic climate changes for the better.

As a dividend investor, I expect that from a diversified portfolio investing in dividend paying companies that my dividend income will go up over the long term. My experience has been for this to happen. My dividend income has never decreased, but the increases have slowed down when we have recessions. Some companies lower their increases, some stop increases and some decrease or suspend their dividends.

I, of course, review companies when they stop increases or decrease or suspend dividends. But what I ask myself is do I buy, sell or hold. Is a company doing the prudent thing for the long term viability of the company? I will sell if I think a company has difficulties that they cannot or cannot easily overcome.

However, if a company cuts or suspends dividends prudently in an obviously viable company, I will not sell. I have even been known to buy when I company has been unfairly punished for acting prudently. I want companies I invest in to act prudently. I am investing in a company and I am investing for the long term.

So getting back to Finning International as I said above, if I held the stock, I would probably not be selling as I think that it will recover just fine. However, I personally would not be buying this stock either.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my website for stocks followed and investment notes. Follow me on twitter.

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