There are numerous books devoted to the subject of dividend investing. In the coming year or so, I will offer information about many of them, though this introduction is not about a book at all.
I am embarking on an occasional series that will highlight the best books for dividend investors. I will not pull information from other articles and reprint what they have published, but will write about the books I have read and learned from them, and know will be educational to everyone with an interest in the subject.
A few years ago I was asked to be on a panel to talk about the creative process of photography. The three panel members were asked to bring a book to recommend to other photographers that would help them. My intention was to offer something that would allow the audience to learn how to go from idea to finished product, so my book was On Writing by Stephen King.
I am sure that the audience was perplexed as to why I would select a book about writing and not photography. However, I explained why the creative process was universal, and talked about how understanding a master in one discipline moves through their creative process translates to a completely different area.
That is why this introduction is not about a book, per se. If one wishes to learn then it is best to look to a master for inspiration and education. When it comes to investing it is hard to deny that Warren Buffett is one of the best, and recognizing what he does and why he does it is an insight into a path to success.
There are countless books about Warren Buffett – putting his name into Amazon's search engine returns over 1,000 results. I am sure that many of them offer excellent information, but I would rather hear from the man himself, and this can be done yearly when he offers his letter to the Berkshire Hathaway shareholders in the company's annual report.
I have been an investor in Berkshire Hathaway for the past 15 years and have read each of his letters during that time. He does talk about the company and its plans for the future, but it takes no stretch of the imagination to link how he runs the company to how one can invest prudently.
Reading his letter within the 2019 annual report offers insight into his thinking process. His initial order of business is to explain his negative view of a new GAAP rule that states that a company's earnings needs to include unrealized gains and losses of securities. This means that each quarter their reported bottom line is subject to the vagarities of the market at that particular time.
The important take-away is that one should focus on operating earnings, as they are reflective of the success or failure of the business elements of the company. Unrealized holdings may be part of the value of the company, but they may not say much about how well or poor the company’s business is performing.
I noted a similar idea when talking about National Fuel Gas, which I started to purchase in May. Oil and gas companies are required to report an impairment charge when the book value of their future reserves exceeds its current value, so the company’s bottom-line earnings are similarly driven by the whims of the price of gas. In other words, a company can be functioning successfully, but with a drop in commodity prices, their reported earnings can be forced down. So much for depending solely upon earnings when valuing a company.
How important is the issue of retained earnings to a business? Mr. Buffett tends to feel that they can be used to great advantage and offers information to support his position.
He does so initially by taking us back to 1924 when Edgar Lawrence Smith wrote Common Stocks as Long Term Investments (currently available, with a foreword by Warren Buffett). When John Maynard Keynes reviewed the book, he said that well-run companies do not distribute all earnings to shareholders but retain a portion. He emphasized the “element of compound interest (Keynes’ italics) operating in favor of a sound industrial investment.”
Warren Buffett and Charlie Munger have successfully followed this idea, and corroboration is shown in a table listing the ten largest stock-market holdings of Berkshire Hathaway, their dividends, and retained earnings. It is an important issue for them, as he ends with, "the retained earnings of our investees are certain to be of major importance in the growth of Berkshire’s value.”
As dividend investors, this rings a familiar bell. When we receive a dividend we choose to spend or retain it. By choosing the latter and converting it to additional shares in the company the magic of compounding takes place, and those who have done it for a while appreciate its power as much as does Mr. Buffett.
He continues his letter by stating something that I was glad to hear – “we group our wide array of non-insurance businesses by size of earnings, after interest, depreciation, taxes, non-cash compensation, restructuring charges – all of those pesky, but very real, costs that CEOs and Wall Street sometimes urge investors to ignore.”
EBITA has been a bugaboo of mine for quite some time. If one is seeking to evaluate a company, why would interest and taxes not be taken into account? I know the answer (it is helpful when comparing one company to another in the same line of business), but to me this is like figuring how much income one has without taking taxes and the interest payments on one’s car into account. These are real expenses, and when creating a budget they certainly better be part of the equation. Reading this snub by one of the most successful investors ever is a confirmation that the number may not be as important as some may believe.
Finishing Up
The letter continues with other items, like Mr. Buffett's expected eventual demise, how to properly select members to the Board of Directors, and under what circumstances Berkshire Hathaway will purchase their company's stock.
The letter is a glimpse into the mind of one of the world’s most successful investors. One may not initially think that the information is relevant to them but it is in a real way. We are the guardians of our own companies, as ‘twere. One may not envision themselves in charge of a multi-billion dollar corporation, but all investors are in charge of the financial wellbeing of their futures – we are CEOs of our own company.
Many of the decisions are the same – seeing what resources are available, freeing up underperforming assets and moving them to a more productive area, determining the useful lifetime of options selected and planning for future choices, understanding what is important and what is merely masked as important, and so on.
Your portfolio is your company, and the more knowledgeable and perspicacious one can be about every element within that company will lead to a more successful conclusion, and that is what investing is all about.
Sitting at the heels of the best at something and soaking in everything they have to offer is not only a proper step, but is part of the continual journey we make in an attempt to improve. Walking through Warren Buffett's letters to the shareholders is a giant step in that journey.
