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Last week, I ran into an interesting headline: Poker Champ Phil Ivey Waiting for $11.7 Million Payout.
For those readers unfamiliar with professional poker, Phil Ivey is one of the world's best players, with eight
World Series of Poker championship bracelets, $5.9 million in tournament
winnings, and nearly twice those earnings outside official tournaments.
Here's a summary of the big story in the article: Phil Ivey was playing punto banco (a variant of
baccarat) at a London casino. He sat down with $1.6 million and finished with
$11.7 million. However, the casino is not giving him his winnings and is
instead investigating his play.
Sure, this is quite a predicament. However, I didn't
find the grand total of winnings nor the casino's reluctance to pay to be the
most interesting part of the story. Here's what gets me: one of the world's
greatest poker players sat down with nearly $2 million dollars to gamble
in a game of chance.
Of course, poker itself has elements of luck, but if
you know the probabilities, have lots of experience, and can read the other
players, the odds are in your favor. Punto banco, on the other hand, is quite literally a game of
chance. Doesn't this seem just a little crazy? Phil Ivey could sit at almost
any poker table with a near-guarantee of a return. Instead, he's toying with
his fortune over the next card in baccarat.
This isn't unique to Phil Ivey. Doyle Brunson, a poker
legend, admitted to similar failings. Brunson once wrote that he would be a
much richer man today were it not for betting on things other than poker.
Although he was one of the best players ever, he lost piles of his poker
winnings in other games of chance.
Though the poker fans among our readers might enjoy
this article, why does this matter to the rest of us? As investors, many of
us have the exact same problem as Phil Ivey and Doyle Brunson. We know there
are investments in our portfolios where the odds are in our favor. We've done
the research or at least have a strong understanding of someone else's
research on the topic, yet nonetheless, we end up basically gambling with a
part of our portfolio. Perhaps it's a hunch on the market's direction or a
hot new company on the financial news. Based on little more than intuition,
we put these things in our portfolio.
Every once in a while, these hunches will be a $11.7-million fortune, as was the case with Phil Ivey.
But more often than not, such ill-planned investments will send you to the
poor house. And if Phil Ivey continues spending more time at the baccarat
table rather than the poker table, he'll be on his way to the poor house as well,
despite his latest win.
I'm not preaching from up on high here. This happens to
all of us – I don't care if you're managing millions or a couple of
thousand. In my own portfolio, I'm doing great on everything where I've done
loads of research – like some of the picks from Dennis Miller's Money
Forever. My losses are skewed toward the side of portfolio based on the
latest hunch.
With this in mind, I'm personally rearranging my
portfolio a bit – getting rid of the short-term, spontaneous
investments and putting them into places where I've buckled down on the
research – i.e., our latest pick in Miller's Money Forever.
In case this article is ringing a familiar bell with you, I suggest taking a honest look at your portfolio and doing some rearranging
as well. What's just a hunch – er, gamble in
your portfolio –and what's a solidly researched, bedrock investment? If
you find yourself holding onto former, maybe it's time to let those
investments go.
Invest where the odds are in your favor; don't risk
your portfolio to the luck of the draw.
Should You Wait for that Dividend?
By Vedran Vuk
Here's the scenario: you're about to sell a stock which
has a nice dividend payment coming up in two weeks. Should you stick around
for that dividend?
Though it might seem like the answer depends on the
specific situation, it doesn't. The right action is to sell – with one
exception that I'll discuss later on. The main logic for selling is that the
dividend is already factored into the market price of the stock. By selling
now, you're actually not throwing away the value of the dividend. Let's see
why this is true:
Suppose we have two firms, Company A and Company B,
with the following assumptions:
1. Company A
and Company B are both worth $100 in the market.
2. The firms
are completely identical, with the same assets, earnings, growth, business
sector, etc.
3. The $100
valuation is a true reflection of the companies' underlying values. These
aren't dot-com stocks trading at forty times price to earnings.
4. The only
difference between the two is that Company A pays an enormous $10 dividend
next quarter, and Company B has no current dividend policy. Company A's
upcoming ex-dividend date is October 26.
5. After the
dividend is paid, both company A and Company B will be worth $100.
(The ex-dividend date is the day on which buying the
stock no longer entitles you to the next dividend. If you bought the stock on
the October 25 and held it until the record date, you would receive the
dividend.)
Given our five assumptions, does the first assumption
make sense on the day prior to the ex-dividend day? No. If I hold Company A,
I will soon have a share worth $100 and a $10 dividend. If I hold Company B,
I would only have a share worth $100. If one stock will pay $10 while
retaining its value, it can't possibly worth the same as the stock with no
yield and the same price. As a result, market participants would bid up the
value of Company A to near $110, perhaps $109.98.
Hence, assumption one would be a strange market anomaly
given our other assumptions.
Why not $110 fully? A dollar today is always worth more
than a dollar tomorrow. So there's still a tiny difference between the value
of $110 today or $110 tomorrow.
But what if there's a whole month left before the
ex-dividend date? The same principle applies. However, the market won't be
close to the entire dividend. For example, the stock might be worth $107. As
one gets closer to the ex-dividend date, the price will keep climbing to
$110.
If you sell early, part of your dividend is implied in
the price. You're not throwing away your whole dividend by selling prior to
the record date.
A More Realistic Example
That was one way of looking at it, but let's makes
things more realistic by throwing out assumption five. In reality, both
companies wouldn't be worth the same after a dividend. If Company A and
Company B are both worth $100 prior to the dividend,
they cannot be worth the same afterward. Think about it. Since Company A just
paid $10, it has $10 less on its balance sheet than Company B. Since Company
A has fewer assets than Company B, it must be worth less as well.
In theory, Company A should be worth $90 on the day
after paying out $10. Company B should still be worth $100. After the
dividend is paid, the stock should drop by the amount of the dividend.
Now, I know what you're thinking, "That doesn't
really happen in the real world. I bought Coca-Cola stock and when its
dividend was paid out, the price actually went up." Remember that our
example is in a vacuum. In the real world, there are a million things
happening at once. If the ex-dividend date happens when the S&P 500 is up
over 1% and Coca-Cola is surging with it, you probably wouldn't notice the
downward pressure from the dividend being paid out.
However, if the dividend wasn't paid, this good day for
Coca-Cola might have been a great day instead. If this wasn't true, any
dimwit with a brokerage account could become a millionaire. One could just
buy the stock before the ex-dividend date and sell it a few days later after
the record date for a nearly riskless dividend return.
The Exception to the Rule
This all holds up, with one exception –
short-term capital gains versus dividend taxes. If you've held the stock for
less than a year, you're going to pay a higher tax on your capital gains than
dividends. As a result, if your dividends are already reflected in the stock
price, you would make slightly less after taxes by selling the stock before
the dividend.
If you were in the 35% tax bracket, a $10 short-term
capital gain would be only $6.50 after taxes. However, if the company pays
out $10 and the stock drops back to $100, then the tax would be only 15% on
the $10 dividend for an after-tax gain of $8.50. In this situation, it might
be worth it to wait for the dividend and save a little bit of money.
However, there are still a few additional things to
consider here. In the majority of cases, we won't be getting a huge 10%
dividend each quarter – we'll be lucky to get half a percent. As a
result, you will need to weigh the benefit of staying in the stock a little
longer for the tiny tax benefit versus the risk of the stock going sour. In
the worst-case scenario, your stock could plummet by several percentage
points while chasing a tax saving of a meager 0.2%. If you really think it's
time to get out of the stock, the savings are usually not worth the risk of
waiting.
The Bottom Line
Much of this article has been a proof of the theory
behind dividends. However, the whole issue can be summed up in one sentence
extending far beyond dividends: If something about a stock is obvious to
almost every market participant, it has already been reflected in the stock
price. Dividends and their pay dates – which are available at the
click of a mouse – definitely fall into this category. In the current
issue of our newest advisory, Miller's Money Forever, our
latest recommendation is a stock with a projected dividend yield of 5.2%. If
securing consistent dividends is part of your long-term investment strategy, you should check it out.
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