Financial Uproar

Insider trading Nelson? But that’s illegal. Sure, I’m badass, but I’m not that far badass. Besides, I’m too pretty for prison, even if it’s wuss white-collar prison.

No, stupid. Not that kind of insider trading. Let me explain.

There are essentially two types of insider trading. Firstly, let me explain the bad version. A few times a year, usually right before a company releases quarterly earnings, there will be a period of time when management and board members of this company will know how earnings are going to be. This information can be used to either buy or sell shares, which would let insiders profit on information that isn’t widely available.

This gives insiders an unfair advantage, so there are rules in place to make sure insiders don’t get to profit from their special knowledge. The special term for it is material, non-public information. Most of the time, this news is just earnings, but it can also be a potential acquisition, a potential bid on the company, or even the CEO hitting the road. (Although, that last one is usually disclosed right away) Since insiders are required to let the SEC know about all their trades, they’re smart to make sure there’s nothing fishy about the timing of these trades.

Back in 2001, Martha Stewart’s broker got some good insider information on Imclone, specifically about their dumpy earnings that were coming out the next day. Stewart sold her 3,928 shares (such a nice, round number) before the bad news hit the market, booking a profit of over $41k in the process. At the time, she was worth approximately $1B. That’s the equivalent of you beating up a 9 year old for his lunch money. Of course, Stewart probably didn’t think she was doing anything wrong. After all, she was just listening to her broker.

Anyway, that’s the bad insider trading. You’re going to want to avoid that. It’s okay though, since you’re clearly not important enough to get any insider information worth trading on. If you’re a hot chick who’s an intern, you might be able to figure out the CFO likes to bang hot interns, but that’s about it.

Remember when I said the SEC keeps track of insider trading? This is perhaps the greatest overlooked resource in your investing arsenal. Let’s face it, we’re all nobodies, at least in the investing world. I’m known far and wide for having a terrific blog, ruggedly handsome good looks, and a penis the size of Vermont. But even with all those advantages, I still don’t get access to the good information. I can’t go knock on a CEO’s office door and ask him what the next year is going to bring. Even if I could somehow wrangle a phone call with somebody important, they’re still not going to be completely honest with me.

Insiders have all sorts of good information at their disposal. They know what’s going on behind the scenes. They know that Johnson from sales has a major coke habit, and because of that he’s doing a horrible job running his department. They go to the trade shows. They typically have years of experience in the industry. Insiders, even when they’re not acting on special knowledge, are a terrific source of information.

And the regulator requires they tell everybody when they buy or sell, and even how much they paid per share. This information is freely available if you’re an American investor. It’s also freely available in Canada, it’s just a little harder to find.

Let me present two hypothetical situations. Insider A is a board member of a small technology company. There is typically a requirement that all board members own at least some stock, but the number is usually just a token amount, like maybe $10k worth. (Remember, board members are usually very wealthy, oftentimes retired titans of business who serve on a few boards.) Insider A has been steadily buying shares in this company, picking up $10k here and $25k there, and before you know it he’s built up a million bucks in holdings. There’s a couple other board members who are doing the same thing.

Meanwhile, we have company B. All the directors are very wealthy, yet they all only own a token amount of stock. Once top executives are allowed to sell their stock options, they do, faster than the 15 minutes of fame of whatever nobody Kim Kardashian dates next.

Do you see the difference in these two companies? One has management and board members who are confident enough about the company’s future to put up their cash. The other has insiders who are happy to accept money for their roles, but aren’t confident enough to invest in the company’s future.

Sure, this system isn’t foolproof. Only some sort of moron would go out and blindly buy shares in every company that has heavy insider buying. Many times, insiders have continued to buy shares as a company slid down the slope into bankruptcy. Or, maybe insiders are old and lazy, and they just want to keep their portfolio safe. You shouldn’t look at this as a standalone strategy.

Just use it as one of the metrics you look at when making the decision about buying a stock. If you’re undecided between two stocks in the same industry, maybe insider buying or selling can help break the tie.

Where can you find this information? For American stocks, it’s in all sorts of places. If you want to go to the source, go to the SEC and you can search there. Or, if you’re lazy like me, just look up the information using Yahoo! Finance. (They keep the exclamation point to try and fool you into thinking they don’t suck) Just find the stock page you’re looking for, and click on the insider transactions link. That’s easier than your sister. HEY-O!

For Canadian issuers, you have to go to sedi.ca, which is the closest you’ll ever get to travelling back in time to 1998. From there, you click on ‘view summary reports’ and then just enter the company’s name where prompted when you get to the next page. You might want to enter a date range as well, unless you want to sift through the last decade of insider transactions. Every insider is assigned a number, so you don’t even need to know anyone’s name. It’s dirtier when you don’t know their name, amirite fellas?

Monitoring insider transactions can be a useful tool in any investor’s arsenal. It’s the closest thing you’re going to get to actual insider trading, so it has the plus of making you feel like a badass.

I don’t know if you guys have noticed, but dividend growth investing is kind of a big deal these days. How big? Jason Segel temporarily took a break from making crappy movies to complain how dividend growth investing was stealing his thunder. Dividend growth investing was the actual sponsor of Taylor Swift’s tour last summer. Apple briefly considered calling the New iPad the DGI iPad, before the ghost of Steve Jobs appeared and talked some sense into everyone.

So, yeah, I think dividend growth investing is kind of a big deal.

These days, in the PF-o-net (which is totally a word, thanks to the magic of dashes) there seem to be two distinct camps. In one, we have the dividend growth guys. They love about 30 different stocks, and they love the HELL out of them. We all know they’ve pleasured themselves thinking of Johnson and Johnson shares at least once, probably while using a product from that particular company as lube. They have a simple criteria: find stocks that have consistently raised dividends for a certain period of time, and make sure they aren’t paying out all their money to sustain this dividend.

Meanwhile, we have their opponents, the passive investors. You shouldn’t even try to beat the market, see, since a moron like you has no chance. They’re content to just buy the ETFs that mimic the performance of the major indices and just call it a day. They have a valid argument, especially if you know nothing about investing, but for the purposes of this blog post, we’ll ignore indexers. They’re boring and I’m pretty sure they smell like they forgot their deodorant today.

As you can probably figure out, I’ve got a bit of a problem with dividend growth investing. I don’t think it’s the worst system of investing in the world – after all, some moron I know actually buys stocks when they’re out of favor and beaten down. Generally, the stocks they buy are, at least from a P/E perspective, somewhat fairly valued. They’re also generally the bluest of blue chips, their favorite stocks generally have market caps bigger than my gigantic penis. FINALLY, A PENIS JOKE ON FINANCIAL UPROAR.

So, what’s my problem again? Dividend growth investors are buying stocks that are growing the dividend, usually at a level higher than inflation, and are buying them at reasonable valuations. That seems reasonable. And there, lies the first problem with the system – the reasonableness of it. If an investor buys McDonalds (after a 502% gain in the past 9 years) or Johnson and Johnson, their chances of a large capital gain is virtually non-existent. McDonalds isn’t going up another 100% anytime soon. Neither is Johnson and Johnson or Pepsi or any of the other dividend growth favorites. They’re just too large. Yes, I realize McDonalds has just completed a hell of a run, and Apple is the largest company in the world after their epic run. But, these companies are the exception, not the rule.

Secondly, we have the obsession with the dividend. I can get that. I like dividends too. The problem is with the almost singular focus on it. As long as a company is growing the bottom line and their investors get that yearly dividend hike, dividend growth investors are happy to buy, all other metrics be damned. Paying $10 for every $1 in assets? THAT’S ALL GOODWILL BABY! Buying at a 52 week high? WHO CARES, DADDY LIKES DIVIDENDS.

Dividend growth investing has such a focus on the past that I bet it was invented by a bunch of fat housewives who used to be hot. Look at how good this company has been. It has grown revenues and profits and dividends SO MUCH over the past decade/quarter century/millennium that they’re just bound to do it again. Ignore the fact it’s a giant behemoth. Ignore the fact that past performance is not indicative of future results. Ignore the fact that you’re resigning yourself to small capital gains by buying a company that’s been successful for decades.

Anyway, what’s the solution? What would I rather you do? It’s simple: create your own dividend growth. It’s easy. All you need to do it reinvest your dividends.

Say you buy $20,000 worth of preferred shares giving you an average yield of 6.5%. After the first year, you’d make $1300 in dividends. If you take that $1300 and buy another preferred share yielding 6.5%, you’ve increased your earnings by $34.50 in year 2. To match your success, a dividend growth investor would need a stock yielding 3% to grow the dividend by 11.5% in year 2 to match your 6.5% growth rate, and they still won’t have as much, since their dividend was smaller to begin with.

Fast forward to year 3, where our preferred share investor is enjoying yearly dividends of $1474.49 off his compounding returns. It’s too late for me to figure out exactly how much growth our dividend growth investor needs to keep up, but it’s definitely a pace that’s difficult for most companies to maintain.

The math on this is fairly simple. If you start with a much higher dividend offered by a preferred share, (or a bond if you’re so inclined) and reinvest the payout in a similar preferred share, you’ll beat all but the golden boys of dividend growth investing, at least when it comes to yield.

Want some capital gains exposure in there too? Hey, there are all sorts of stocks out there they pay generous dividends, you’re just missing the growth. Rogers Sugar is a great example. God, I love that stock. Thanks to Canada’s income trust boom of 2002-2006, I bought a stock that paid a 10% distribution for years, with only a slight amount of growth over that time. I will take a steady 10% dividend over a 3% dividend that’s growing any day of the week, and so should you.