Monday, April 30, 2007

Review: Single Best Investment - Lowell Miller

Psst ... wanna learn about dividend-based, long-term investing? Then go track down a copy of Lowell Miller's The Single Best Investment: Creating Wealth With Dividend Growth. You'll get a very solid and detailed education in the subject.

Single Best Investment was last updated in 2005, and that's the version I hold. Here's the synopsis: Find high-quality, dividend-paying stocks that exhibit moderate growth, and invest in them for the long term.

Nothing new there, to be sure. It's a strategy that, in my personal experience, is fantastic — and like most investing advice, much easier said than done. I happen to be a fan of stocks that pay dividends, but then I'm a fan of stocks that just go up, too. Given a choice, most times, I'd be content with the latter.

Miller's Money-Making Mantra

The Single Best Investment formula goes like this:

High Quality
+ High Current Dividend
+ High Growth of Dividend
= High Total Returns

Nice and simple. But the devil, as they say, is in the details, and tracking down stocks that provide all these things isn't easy to do. Take "high quality," for instance. What comprises that, exactly? And how do you measure it objectively?

What's a "high" current dividend?

What's a "high" rate of growth for a dividend?

All those are questions we have to answer, and metrics we have to determine.

Looking for Quality

"Financial strength," writes Miller, "is the key requirement of a high-quality stock." No kidding, right? He scans the investing universe for companies with low debt (debt/equity of no more than 50%), strong cash flow, annual earnings growth of at least 5-10%, and good creditworthiness (at least BBB+). He wants to see good management and strong brands.

All fine and dandy, but a whole lot of investors are searching for those very same things. Which leaves at our doorstep the problem of stock price and value: Great companies tend to trade at high multiples of earnings, and so their dividends (when present) tend to provide low yields. And that's not what Miller wants. In fact, he wants the very opposite.

Scouring the Dividends

"In a way," Miller says, "the essence of what we're about in this strategy is uncovering the high yielding stocks that aren't risky." Yeah, you and everybody else. High yield and low risk? That's a long-term investor's dream. The problem is that they're two things that rarely go together.

At the moment the S&P 500 Index offers a current yield (for the average stock) of about 1.7% — historically very low, but that's the hand an investor is dealt in 2005. ...It's not too hard to obtain a current yield of 4% — over twice the level of the stock market. And as you've already seen from our compounding numbers, that's a decent starting place (1.5 times the average is our minimum) if we can also obtain a growth of yield of 5% or better, which is also possible right now.

And here's the zinger:

In general, you want to see a dividend growth rate that is at least higher than inflation, and with a margin of safety. ...But, understanding the dynamics of an equity compounding machine built on high current yield enhanced by high growth of yield, you should really aim for a 10% growth of yield on your portfolio.

A Devil Named Valuation

Talk about things like "price/sales ratios," "book value," and "market/book ratio" all you want — and Miller spends a fair amount of time on these things — but they're all just ways we try to gauge a complex thing: stock valuation. And while Miller does a fine job explaining it all, "valuation" just isn't an easy thing to line out.

Here's a snippet where Miller touches on the ever-popular valuation metric called "P/E," or "price-to-earnings" ratio:

What you want to find, of course, is a situation where the P/E reflects skepticism that's not really well founded, reflects fear of deterioration in a company that actually has the characteristics of one that can improve. Too, sometimes you can find a P/E that's out of line because the growth or momentum constituency has abandoned a stock with expected high growth — leaving stranded a stock that has evolved into a moderate growth item priced low relative to its real and uninflated prospects. As always, though, the prospects must "come true," and cheapness is only a quality that's affirmed in hindsight.

When It's Time to Sell

Charting devotees and traders love to posit that the vast, vast majority of investors suck at selling. Sure, we can buy-and-hold 'til the cows come home, and do okay with it ... to a point. But part of the nature of buy-and-holding is, of course, "holding." Because we're humans, when we hold things, we tend to fall in love with them. So when it's time to sell, we often cling to our investments like teddy bears — teddy bears that can drop in value awfully quickly. When the market tanks, even the best stocks are going to come down with it ... eventually.

So how does Miller propose we counter this obstacle? Well, he mentions a few items, but this one caught my attention:

However, as a shareholder you do need to be especially alert to the state of the dividend. As you surely know by now, we consider the dividend to be the litmus test for a dividend-paying company. It is like a cardiogram image of the heartbeat, or breath on the mirror. No matter what the earnings picture may look like, no matter what Wall Street analysts or talking heads on TV may say, the dividend is the tell-tale. If the company has a history of raising dividends and the dividend doesn't rise within about a year when it should (and there's no excuse such as a big capital expenditure), something's wrong.

I'd agree with that — and add that by the time you're a year into a state of "something's wrong" with a stock (as evidenced by its dividend), then you're probably already down a hefty percentage, price-wise, from wherever the stock's price was a year ago. So this "litmus test" isn't exactly foolproof. But then what is?

Not much, in the world of investing. That's why they call it "risk."

What? He Talks About Charting?

To say that a book like Single Best Investment, which seems to focus entirely on fundamental analysis of stocks, shocked me by actually discussing technical analysis (that is, using stock-price charts to guide in buying/selling decisions) and not just dismissing it outright, would be an understatement.

...I'll propose that charts can help you with SBI investing, no matter what the Old Testament may claim to the contrary. ...Charts help, but they're only one more tool: useful when employed as part of an array of analytic tools which include, primarily, fundamental factors affecting each individual stock. Charts can help you more quickly if it's time to sell. Charts can help you wait for the prime buying moment if you're eyeing a candidate for your portfolio. As a timing device, charts can help you make decisions regarding adding to positions or lightening up. What charts can't do, all by themselves, is tell you what to buy and sell.

Miller focuses not on "moving averages" or "support and resistance" in his technical musings, but on price trends and "relative strength" — a stock's price performance relative to that of the market as a whole. I'm okay with that, I suppose, although I do come from the school of thought that says price support and resistance do matter, and matter big.

Bearing in mind that the fundamental formula of high quality, high current yield, and high growth of yield, is far more important than any technical pattern could ever be, and that technical "maps" are useful but not near as useful as a well-tuned analytic brain ...

Well, I dunno. All the fundamental analysis in the world isn't going to help you when you've just bought Hershey (HSY, an SBI-qualified stock) at $34 in 1998, only to watch it slide to $20 by early 2000. (See page 112 of SBI for a chart and brief discussion of this "low volatility" cruncher.)

Who'd have wanted to hold stocks like HSY through that? Especially given what was happening in the tech-stock world at the time? The answer: not many people, and that's why HSY investors likely choked on their Kisses as it all unfolded. By 2003 and 2004 they'd been rewarded for holding, of course, as HSY reached toward new highs. Still, I'd have to ask what was gained by holding through that forty percent haircut.

"As has often been said," writes Miller, "quality is always a bargain."

It'd be nice if that were true, but I just can't play along. From what I've seen since I started paying attention to stocks and the market — say, 1997 or so — there is a right time to buy, and a right time to sell.


I thought Single Best Investment was good — really good if you're new to the tenets it espouses regarding fundamental analysis of stocks. SBI's 246 pages covered a lot of investing ground, and Miller did his level best to make the book's language and terminology accessible to everyone. He did a fine job of educating the reader on some very basic investing points, and I appreciate that.

Page 123 of my copy starts what Miller calls "A Gallery of Single Best Investment Stocks." This, in some ways, was the best part of the book for me. Here I could look through examples of stocks that provided exactly what Miller was looking for, SBI-wise, at the time. It's enlightening. If you pick up a copy of the book, be sure to spend some time in the Gallery. You'll get some nice insights into the investing decisions of a guy who's done very well in the market over a long period of time.

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— Posted by Michael @ 9:35 AM

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My financial life began turning around when I took responsibility for it.
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