Lloyds rights issue: what it means for shareholders
Lloyds Banking Group outlined details of its proposed £13.5 billion fund-raising today in what is set to be Britain's biggest ever rights issue.
Published: 2:19PM GMT 24 Nov 2009
Lloyds Banking Group
The group's 2.8 million army of private investors – the biggest shareholder base in the UK – now have to make up their mind whether to support the cash call. Our Q&A should help them decide.
Q: How is the bank proposing to raise the money?
A: Through a rights issue – the selling of new shares in the company at a discount. Existing shareholders will be offered the new shares in proportion to their holdings.
Any not taken up may be bought by other investors, or ultimately the investment banks underwriting the process, which have pledged to mop up any unwanted shares to ensure Lloyds gets its money.
This fund-raising comes in addition to an £8.8 billion debt conversion offer that did not need shareholder approval and already went through yesterday.
Q: Why is Lloyds raising this cash?
A: The bank, which is 43pc owned by the taxpayer, wants to avoid taking part in the Government's toxic asset protection scheme (APS).
Under the original terms, Lloyds would have paid £15.6 billion to insure £260 billion in loans under the scheme – raising the taxpayer stake to 62pc. Royal Bank of Scotland, which is taking part in the APS, will end up being 84pc owned by the Government after it puts risky loans up for insurance.
But Lloyds will have to pay the Government a fee of £2.5 billion in return for the protection already provided by the taxpayer since the announcement of the asset protection scheme earlier this year
Q: What is the offer on the table for shareholders?
A: Lloyds is offering 1.34 new shares for every existing share owned at a deep discount of 37p each – a 59.5pc discount to last night's closing price and a 38.6pc discount to the bank's theoretical "ex-rights" price when the extra shares will be taken into account.
Q: How much will this cost the average shareholder?
A: The typical Lloyds investor owns 740 shares and will be offered the chance to maintain their stake by buying 991 new shares at a cost of £366.67.
Q: What happens now?
A: Shareholders will attend a company general meeting at the NEC in Birmingham on Thursday to vote on 12 resolutions which enable the rights issue to go ahead.
Either 50pc or 75pc of votes cast need to be in favour, depending on the individual resolution.
Q: What happens if the rights issue gets voted down?
A: It is the second time that Lloyds has gone cap in hand to shareholders recently, after HBOS – now part of Lloyds after last autumn's rescue takeover – tried to tap them for £4 billion in 2008, although this was only taken up by 8.3pc of investors.
But the latest plan is unlikely to meet with resistance, given the unsavoury alternative of taking part in the APS and handing majority control to the Government.
The Government – the biggest stakeholder in Lloyds – has also already said it will back the move and Lloyds is likely to have canvassed other big institutional shareholders. If it is not given the go ahead then it will have to go back to the drawing board and seek alternative ways of avoiding the APS or take part in the insurance scheme.
Q: In the event of the rights issue going ahead, what options do shareholders have?
A: Investors can buy the new shares they are offered at the discount price, therefore maintaining the proportion of the bank they own.
They can let their rights lapse and receive a cheque – for an estimated £315.84 for the average investor – from the bank in return when they are sold on the open market. But in this case, the holding they own will be reduced.
Another possible manoeuvre is "tail swallowing", where investors sell enough rights to the new shares as to allow them to take up as many shares as they can without paying out extra money.
For a typical Lloyds investor, this would work by selling the rights to 529 new shares under the offer for £169.28, allowing them to take up rights to their remaining 54 shares, at a cost of around £169.46, not including any potential broker fees.
Q: What is the timetable after the meeting?
A: If the fund-raising is backed by shareholders, the "nil-paid rights" – the right to buy the new discounted shares – will begin trading on the London Stock Exchange the following day, November 27, for a period of two weeks.
There are various deadlines for shareholders, depending on whether they have share certificates or not and if they are taking up their rights in full or "tail swallowing".
The latest deadline for any shareholder to take up rights in full is December 11, but some will have earlier deadlines and Lloyds will be writing to each investor with full details after Thursday's general meeting. The new shares will start being traded on the open market on December 14.
The underwriting banks will sell rights on behalf of those investors who choose to do nothing and they will receive a cheque.
Q: How many shareholders are there?
A: There are 2.8 million smaller investors, many of whom are former HBOS savers who picked up stock when Halifax demutualised more than a decade ago. The remaining shareholders are institutions such as pension funds and investment firms and, of course, the taxpayer.
Q: What will it cost the Government to take part?
A: The Government – or taxpayer – will have to fork out £5.7 billion net of an underwriting fee to maintain its stake at 43pc, on top of the mammoth £17 billion already pumped into the group.
http://www.telegraph.co.uk/finance/personalfinance/investing/shares/6644079/Lloyds-rights-issue-what-it-means-for-shareholders.html
Friday, 27 November 2009
Dubai is just a harbinger of things to come for sovereign debt
Dubai is just a harbinger of things to come for sovereign debt
By Jeremy Warner
Economics
Last updated: November 27th, 2009
Watch out. This may be just the beginning. In the scale of things, the debt problems of Dubai are little more than a flea bite. Dubai’s sovereign debts total “just” $80bn, which counts for nothing against the trillions being raised by advanced economies to plug fiscal deficits.
Dubai has been a one-way ticket of economic expansion until recently
Small wonder, though, that this minor tremor has sent such shock waves around the wider capital markets. The fear is that threatened default in this tiny desert kingdom is just a harginger of things to come for government debt markets as a whole. According to new estimates by Moody’s, the credit rating agency, the total stock of sovereign debt worldwide will have risen by nearly 50 per cent between 2007 and 2010 to $15.3 trillion. The great bulk of this increase comes not from irrelevant little states like Dubai, but from the big advanced economies – America, Europe, and Japan.
Perversely, they are for the time being beneficiaries of the “flight to safety” that trouble in Dubai has sparked. Government bond yields in the major advanced economies have fallen in response to the crisis in the Gulf. If experience of the banking crisis, when investors removed their money from one bank only to find that the one they had put it into looked just as dodgy, is anything to go by, this effect will not last.
Up until now, markets have assumed that the ruinous fiscal cost of addressing the financial and economic crisis was probably just about affordable to the major economies. That view may be about to be challenged.
http://blogs.telegraph.co.uk/finance/jeremywarner/100002318/dubai-is-just-a-harbinger-of-things-to-come-for-sovereign-debt/
By Jeremy Warner
Economics
Last updated: November 27th, 2009
Watch out. This may be just the beginning. In the scale of things, the debt problems of Dubai are little more than a flea bite. Dubai’s sovereign debts total “just” $80bn, which counts for nothing against the trillions being raised by advanced economies to plug fiscal deficits.
Dubai has been a one-way ticket of economic expansion until recently
Small wonder, though, that this minor tremor has sent such shock waves around the wider capital markets. The fear is that threatened default in this tiny desert kingdom is just a harginger of things to come for government debt markets as a whole. According to new estimates by Moody’s, the credit rating agency, the total stock of sovereign debt worldwide will have risen by nearly 50 per cent between 2007 and 2010 to $15.3 trillion. The great bulk of this increase comes not from irrelevant little states like Dubai, but from the big advanced economies – America, Europe, and Japan.
Perversely, they are for the time being beneficiaries of the “flight to safety” that trouble in Dubai has sparked. Government bond yields in the major advanced economies have fallen in response to the crisis in the Gulf. If experience of the banking crisis, when investors removed their money from one bank only to find that the one they had put it into looked just as dodgy, is anything to go by, this effect will not last.
Up until now, markets have assumed that the ruinous fiscal cost of addressing the financial and economic crisis was probably just about affordable to the major economies. That view may be about to be challenged.
http://blogs.telegraph.co.uk/finance/jeremywarner/100002318/dubai-is-just-a-harbinger-of-things-to-come-for-sovereign-debt/
Dubai's financial crisis: a Q&A
Dubai's financial crisis: a Q&A
Dubai, the gulf emirate that has grown explosively over the last decade, is now at the centre of markets' attention on fears that it could struggle to repay its debt.
By Richard Spencer in Dubai
Published: 8:55AM GMT 27 Nov 2009
Comments 2 | Comment on this article
Towering high above the Dubai skyline, Burj Dubai, the world's tallest man-made construction, edges closer to completion
Dubai ruling family has moved to calm investors' fear over its economic stability after stock markets tumbled around the world.
Q. Where did Dubai go wrong? I thought it was in the "oil-rich Gulf"?
A. Dubai is part of the United Arab Emirates, seven city-states which have separate ruling families, separate budgets, but security, immigration and foreign policies in common. Abu Dhabi has nearly all the UAE's oil. To keep up, Dubai from the 1950s on diversified its economy into ports, trade, services and finance, largely successfully. But its liquidity-fuelled real estate and tourism binge in the last decade may have been one step too far.
Q. What is the extent of its problems?
A. The emirate has said it has $80bn of debts, though some analysts say the true figure could be double that. Dubai World, the state-owned holding company whose bail-out plans triggered the current crisis, has liabilities of about $60bn, though only part of that is debt. The main problem is its real estate subsidiary Nakheel, which has huge bonds coming due, including an Islamic bond for $3.5bn in December. It appears to have little cash flow to meet payments - as well as relying on debt, it also sold most developments off-plan, with new developments now on hold.
Q. The big market crash after Lehman Brothers folded was more than a year ago. Why has Dubai only just been hit?
A. The property crash hit Dubai at the time - house prices fell 50 pc in six months. Nakheel was known to be in trouble. But investors assumed that as a state-owned company it would not default on its debt. The government refused to issue detailed statements of how it was to handle Dubai World's debt problems, and rounded on those who said that the crash had undermined Dubai's development model.
This encouraged a belief that a rescue package was already in place, probably funded by Abu Dhabi. The statement on Wednesday that the government was asking for a six-month standstill on repayments implied the rescue was in doubt.
Q. Why hasn't Abu Dhabi come to Dubai's aid? It has the world's largest sovereign wealth fund.
A. Abu Dhabi has, via the federal central bank, bought one $10bn bond issued by the Dubai government earlier this year, and, via its own banks, bought another $5bn bond this week. But the latter came with a rider that it was not to be used for the Dubai World bail-out. This raises two questions: what are the other debts for which it is to be used? And how is the Dubai World debt to be met, even after the six-month delay, if Abu Dhabi will not fund the rescue package?
Q. What about other Dubai companies? How are they doing?
A. Dubai World owns DP World, the successful ports operator which bought P&O. Other arms of the Dubai government, and the ruling family's directly owned holding companies, also own successful companies such as Emirates Airlines and Jumeirah Hotels, as well as stakes in buildings and businesses around the world, including the London Stock Exchange. But the emirate's lack of transparency and relatively untested financial legal system means that no-one knows if these can be demanded as collateral against Dubai World and other government debts.
Q. Nevertheless, exposure of western banks to the debt seems quite small compared to the trillions of dollars to which we have become accustomed. Why the panic?
A. At the most basic level, fears that exposed banks will have to write down losses, and that both Dubai and Abu Dhabi may have to sell worldwide assets, has hit prices everywhere. At an "animal spirits" level, the disclosure of significant unforeseen problems in Dubai has refocused attention on where else might have hidden "black holes". The health of sovereign debt worldwide, already seen as the major financial issue for the next decade, is also being reexamined.
Q. Can Dubai survive?
A. Dubai is still seen as the premier place to do business in the Middle East and beyond. It is a preferred base for not just Arab but Pakistani, Iranian and even Indian businesses, due to the wider region's political uncertainty. Its reputation for liberal attitudes helps. But events this week have damaged its reputation for economic competence, which the emirate's rulers will now have to work hard to restore.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6668281/Dubais-financial-crisis-a-QandA.html
Dubai, the gulf emirate that has grown explosively over the last decade, is now at the centre of markets' attention on fears that it could struggle to repay its debt.
By Richard Spencer in Dubai
Published: 8:55AM GMT 27 Nov 2009
Comments 2 | Comment on this article
Towering high above the Dubai skyline, Burj Dubai, the world's tallest man-made construction, edges closer to completion
Dubai ruling family has moved to calm investors' fear over its economic stability after stock markets tumbled around the world.
Q. Where did Dubai go wrong? I thought it was in the "oil-rich Gulf"?
A. Dubai is part of the United Arab Emirates, seven city-states which have separate ruling families, separate budgets, but security, immigration and foreign policies in common. Abu Dhabi has nearly all the UAE's oil. To keep up, Dubai from the 1950s on diversified its economy into ports, trade, services and finance, largely successfully. But its liquidity-fuelled real estate and tourism binge in the last decade may have been one step too far.
Q. What is the extent of its problems?
A. The emirate has said it has $80bn of debts, though some analysts say the true figure could be double that. Dubai World, the state-owned holding company whose bail-out plans triggered the current crisis, has liabilities of about $60bn, though only part of that is debt. The main problem is its real estate subsidiary Nakheel, which has huge bonds coming due, including an Islamic bond for $3.5bn in December. It appears to have little cash flow to meet payments - as well as relying on debt, it also sold most developments off-plan, with new developments now on hold.
Q. The big market crash after Lehman Brothers folded was more than a year ago. Why has Dubai only just been hit?
A. The property crash hit Dubai at the time - house prices fell 50 pc in six months. Nakheel was known to be in trouble. But investors assumed that as a state-owned company it would not default on its debt. The government refused to issue detailed statements of how it was to handle Dubai World's debt problems, and rounded on those who said that the crash had undermined Dubai's development model.
This encouraged a belief that a rescue package was already in place, probably funded by Abu Dhabi. The statement on Wednesday that the government was asking for a six-month standstill on repayments implied the rescue was in doubt.
Q. Why hasn't Abu Dhabi come to Dubai's aid? It has the world's largest sovereign wealth fund.
A. Abu Dhabi has, via the federal central bank, bought one $10bn bond issued by the Dubai government earlier this year, and, via its own banks, bought another $5bn bond this week. But the latter came with a rider that it was not to be used for the Dubai World bail-out. This raises two questions: what are the other debts for which it is to be used? And how is the Dubai World debt to be met, even after the six-month delay, if Abu Dhabi will not fund the rescue package?
Q. What about other Dubai companies? How are they doing?
A. Dubai World owns DP World, the successful ports operator which bought P&O. Other arms of the Dubai government, and the ruling family's directly owned holding companies, also own successful companies such as Emirates Airlines and Jumeirah Hotels, as well as stakes in buildings and businesses around the world, including the London Stock Exchange. But the emirate's lack of transparency and relatively untested financial legal system means that no-one knows if these can be demanded as collateral against Dubai World and other government debts.
Q. Nevertheless, exposure of western banks to the debt seems quite small compared to the trillions of dollars to which we have become accustomed. Why the panic?
A. At the most basic level, fears that exposed banks will have to write down losses, and that both Dubai and Abu Dhabi may have to sell worldwide assets, has hit prices everywhere. At an "animal spirits" level, the disclosure of significant unforeseen problems in Dubai has refocused attention on where else might have hidden "black holes". The health of sovereign debt worldwide, already seen as the major financial issue for the next decade, is also being reexamined.
Q. Can Dubai survive?
A. Dubai is still seen as the premier place to do business in the Middle East and beyond. It is a preferred base for not just Arab but Pakistani, Iranian and even Indian businesses, due to the wider region's political uncertainty. Its reputation for liberal attitudes helps. But events this week have damaged its reputation for economic competence, which the emirate's rulers will now have to work hard to restore.
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6668281/Dubais-financial-crisis-a-QandA.html
Dubai debt fears: experts react
Dubai debt fears: experts react
Financial markets have been rattled on fears that Dubai could default on its debts after one of the Government's leading companies asked for a standstill on its debt.
Published: 6:41AM GMT 27 Nov 2009
Asian stocks fell for a second day on Friday, with the Nikkei 225 down almost 3pc and markets in Hong Kong and Australia all weaker. The FTSE 100 fell 3.2pc on Thursday, matching declines across European markets.
Mark Mobius, Chairman of Templeton Asset Management:
Dubai debt worries grip financial markets “If Dubai has to default, that could start a wave of defaults in other areas. This may be the trigger to allow for the market to take a rest and pull back.”
Nader Naeimi, a strategist AMP Capital Investors in Sydney:
“People are worried about the contagion effect from Dubai. Events like this bring back all the bad memories from the global financial crisis.”
Mitul Kotecha, head of global foreign-exchange strategy at Calyon in Hong Kong:
“Dubai has prompted a wave of risk aversion globally. This might prompt a short sell-off in the won but I think that’s what it will be. It’s not going to be a huge fallout because Asia looks more solid in terms of fundamentals.”
Francis Lun, general manager of Fulbright Securities in Hong Kong
"The panic button's been hit again."
Robert Rennie, strategist at Westpac Global Markets Group
"This an important reminder that the credit crisis is forgotten but not gone,"
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6667415/Dubai-debt-fears-experts-react.html
Financial markets have been rattled on fears that Dubai could default on its debts after one of the Government's leading companies asked for a standstill on its debt.
Published: 6:41AM GMT 27 Nov 2009
Asian stocks fell for a second day on Friday, with the Nikkei 225 down almost 3pc and markets in Hong Kong and Australia all weaker. The FTSE 100 fell 3.2pc on Thursday, matching declines across European markets.
Mark Mobius, Chairman of Templeton Asset Management:
Dubai debt worries grip financial markets “If Dubai has to default, that could start a wave of defaults in other areas. This may be the trigger to allow for the market to take a rest and pull back.”
Nader Naeimi, a strategist AMP Capital Investors in Sydney:
“People are worried about the contagion effect from Dubai. Events like this bring back all the bad memories from the global financial crisis.”
Mitul Kotecha, head of global foreign-exchange strategy at Calyon in Hong Kong:
“Dubai has prompted a wave of risk aversion globally. This might prompt a short sell-off in the won but I think that’s what it will be. It’s not going to be a huge fallout because Asia looks more solid in terms of fundamentals.”
Francis Lun, general manager of Fulbright Securities in Hong Kong
"The panic button's been hit again."
Robert Rennie, strategist at Westpac Global Markets Group
"This an important reminder that the credit crisis is forgotten but not gone,"
http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6667415/Dubai-debt-fears-experts-react.html
Dubai default fears rock markets
Dubai default fears rock markets
Global markets had their biggest collective fright since the chaos of the financial crisis as fears that Dubai could default on its debt gripped investors.
By Louise Armitstead
Published: 8:59PM GMT 26 Nov 2009
A metro train passes by Jumairah Lake Towers in Dubai.
Investors are worried that the state could default on its debt
Photo: AP Photo/Kamran Jebreili)
The FTSE 100 suffered its worst one-day fall since March closing down 3.2pc. Companies with big Middle Eastern shareholders led the rout, on the back of concerns that the high-rolling emirate would be forced to sell stakes to raise capital. Barclays Bank tumbled 7.9pc and the London Stock Exchange fell 7.4pc.
There were similar scenes across European stock markets with the French CAC-40 down 3.4pc and the German DAX index down 3.3pc. In America, markets were closed for the Thanksgiving holiday, but electronic trading of the benchmark S&P 500 equity futures contract showed a potential drop on Wall Street of 2.2pc.
On Wednesday, Dubai World, the government investment company behind some of the emirate's most ambitious projects, said it was seeking to delay repayment on a tranche of its debt.
The company has $60bn (£35.9bn) of liabilities from its various companies including Nakheel, the property firm behind the Palm Jumeirah, the world's biggest artificial island, and the Nakheel Tower, the world's tallest building at 1km high. It also owns DP World, the ports operator that bought P&O Ferries. Nakheel is due to make a $3.52bn Islamic bond repayment, plus charges, on December 14. The company also unveiled a restructuring programme, to be headed by Aidan Birkett, Deloitte's managing partner for corporate finance.
Traders feared that the request for a six-month standstill was a sign that the Dubai Government was struggling with its other debts – and that the full impact of the financial crisis globally may not yet be over.
British bank stocks, that are among the most exposed in the world to the Middle East, were hard-hit. Royal Bank of Scotland slumped 7.75pc, Lloyds Banking Group lost 5.75pc and HSBC fell 4.4pc – all three are among nine banks who were bookrunners on an outstanding $5.5bn syndicated loan to Dubai World in June 2008.
HSBC's interim accounts showed that the bank had a $15.9bn exposure to the whole of the United Arab Emirates.
The concerns for UK banks also hit sterling, which fell to its weakest point in a month against the euro and a basket of currencies, while gilt futures leapt to a six-week high, propelled by renewed fears about credit quality.
Property shares fell sharply amid concerns of a fire sale of Dubai's UK assets, which include the Grand Buildings in London. Dubai has also been a major buyer of UK property.
Land Securities and British Land both shed over 3pc. Similarly construction companies were down including Balfour Beatty and WS Atkins, who are involved in key projects in the Middle East, including the Dubai Metro.
The confidence in emerging markets was hit. Analysts at Merrill Lynch said: "The risk of corporate default in Dubai clearly shows that contagion risks have not disappeared and that perhaps the market has turned a little complacent about risk.
http://www.telegraph.co.uk/finance/businesslatestnews/6664913/Dubai-default-fears-rock-markets.html
Global markets had their biggest collective fright since the chaos of the financial crisis as fears that Dubai could default on its debt gripped investors.
By Louise Armitstead
Published: 8:59PM GMT 26 Nov 2009
A metro train passes by Jumairah Lake Towers in Dubai.
Investors are worried that the state could default on its debt
Photo: AP Photo/Kamran Jebreili)
The FTSE 100 suffered its worst one-day fall since March closing down 3.2pc. Companies with big Middle Eastern shareholders led the rout, on the back of concerns that the high-rolling emirate would be forced to sell stakes to raise capital. Barclays Bank tumbled 7.9pc and the London Stock Exchange fell 7.4pc.
There were similar scenes across European stock markets with the French CAC-40 down 3.4pc and the German DAX index down 3.3pc. In America, markets were closed for the Thanksgiving holiday, but electronic trading of the benchmark S&P 500 equity futures contract showed a potential drop on Wall Street of 2.2pc.
On Wednesday, Dubai World, the government investment company behind some of the emirate's most ambitious projects, said it was seeking to delay repayment on a tranche of its debt.
The company has $60bn (£35.9bn) of liabilities from its various companies including Nakheel, the property firm behind the Palm Jumeirah, the world's biggest artificial island, and the Nakheel Tower, the world's tallest building at 1km high. It also owns DP World, the ports operator that bought P&O Ferries. Nakheel is due to make a $3.52bn Islamic bond repayment, plus charges, on December 14. The company also unveiled a restructuring programme, to be headed by Aidan Birkett, Deloitte's managing partner for corporate finance.
Traders feared that the request for a six-month standstill was a sign that the Dubai Government was struggling with its other debts – and that the full impact of the financial crisis globally may not yet be over.
British bank stocks, that are among the most exposed in the world to the Middle East, were hard-hit. Royal Bank of Scotland slumped 7.75pc, Lloyds Banking Group lost 5.75pc and HSBC fell 4.4pc – all three are among nine banks who were bookrunners on an outstanding $5.5bn syndicated loan to Dubai World in June 2008.
HSBC's interim accounts showed that the bank had a $15.9bn exposure to the whole of the United Arab Emirates.
The concerns for UK banks also hit sterling, which fell to its weakest point in a month against the euro and a basket of currencies, while gilt futures leapt to a six-week high, propelled by renewed fears about credit quality.
Property shares fell sharply amid concerns of a fire sale of Dubai's UK assets, which include the Grand Buildings in London. Dubai has also been a major buyer of UK property.
Land Securities and British Land both shed over 3pc. Similarly construction companies were down including Balfour Beatty and WS Atkins, who are involved in key projects in the Middle East, including the Dubai Metro.
The confidence in emerging markets was hit. Analysts at Merrill Lynch said: "The risk of corporate default in Dubai clearly shows that contagion risks have not disappeared and that perhaps the market has turned a little complacent about risk.
http://www.telegraph.co.uk/finance/businesslatestnews/6664913/Dubai-default-fears-rock-markets.html
Is this bye-bye Dubai?
Is this bye-bye Dubai?
Dubai dazzled the world with its extravagance and excess. Now it wants to defer its debts. What went wrong, asks Richard Spencer.
By Richard Spencer
Published: 7:52AM GMT 27 Nov 2009
The brief statement was short but, in the words of one banker, desperate. "Dubai World intends to ask all providers of financing to Dubai World and Nakheel to 'standstill' and extend maturities until at least 30 May 2010."
In a nutshell, the government was asking banks to let two of Dubai's most famous companies hold off on their mortgage payments. Since they are state-owned, the announcement suggested the city itself was in trouble: governments aren't supposed to default on their debts, and when they do – as Argentina did in 2001 – it causes chaos around the world.
Yesterday, the creditors didn't know whether to laugh or cry. On the one hand, this is an undoubtedly serious situation. Western banks, and the construction firms that built those castles in the sand, are exposed to serious amounts of money. Dubai's total government owings are officially $80 billion, unofficially twice that, and the cash flow to pay that back is a mystery.
More to the point, confidence had returned to the city's dealings, its companies were rehiring, precisely on the same assumptions that have seen rising property prices in London and rising stock markets everywhere. The crisis was over, meltdown averted, and growth was back.
But if Dubai's revival turns out to be fake, perhaps the rest is, too?
Yesterday, share prices around the world fell as the news was absorbed. One analyst asked whether this was the "new Lehman brothers".
http://www.telegraph.co.uk/news/worldnews/middleeast/dubai/6667851/Is-this-bye-bye-Dubai.html
Dubai dazzled the world with its extravagance and excess. Now it wants to defer its debts. What went wrong, asks Richard Spencer.
By Richard Spencer
Published: 7:52AM GMT 27 Nov 2009
The brief statement was short but, in the words of one banker, desperate. "Dubai World intends to ask all providers of financing to Dubai World and Nakheel to 'standstill' and extend maturities until at least 30 May 2010."
In a nutshell, the government was asking banks to let two of Dubai's most famous companies hold off on their mortgage payments. Since they are state-owned, the announcement suggested the city itself was in trouble: governments aren't supposed to default on their debts, and when they do – as Argentina did in 2001 – it causes chaos around the world.
Yesterday, the creditors didn't know whether to laugh or cry. On the one hand, this is an undoubtedly serious situation. Western banks, and the construction firms that built those castles in the sand, are exposed to serious amounts of money. Dubai's total government owings are officially $80 billion, unofficially twice that, and the cash flow to pay that back is a mystery.
More to the point, confidence had returned to the city's dealings, its companies were rehiring, precisely on the same assumptions that have seen rising property prices in London and rising stock markets everywhere. The crisis was over, meltdown averted, and growth was back.
But if Dubai's revival turns out to be fake, perhaps the rest is, too?
Yesterday, share prices around the world fell as the news was absorbed. One analyst asked whether this was the "new Lehman brothers".
http://www.telegraph.co.uk/news/worldnews/middleeast/dubai/6667851/Is-this-bye-bye-Dubai.html
Statement of Retained Earnings
-----
SAMPLE Consolidated Statement of Retained Earnings
For the Year Ending December 31, 2002
December 31, 2002
$2,185,000 Retained Earnings Beginning of Year
$2,188,000 Net Income
$ 700,000 Less Cash Dividends
$3,673,000 Balanced Retained Earnings End of Year
-----
The statement of retained earnings indicates the amount of the company's earnings (net income from the current income statement) and adds this amount to the previous retained earnings from the balance sheet. When a company earns a profit, management must decide either to:
1. Pay out all or part of the earnings to shareholders as dividends; or
2. Retain the earnings to
The statement of retained earnings indicates the amount of retained earnings accumulated at the beginning of the year, and then adds the net income for the period. If management declares a cash dividend, it is deducted from retained earnings to arrive at the balance of retained earnings for the end of the year, which is carried forward to the balance sheet.
The statement of retained earnings shows you how much net income the company will retain or pay out in dividends for the year - an important factor when you are focusing on dividend-paying stocks.
SAMPLE Consolidated Statement of Retained Earnings
For the Year Ending December 31, 2002
December 31, 2002
$2,185,000 Retained Earnings Beginning of Year
$2,188,000 Net Income
$ 700,000 Less Cash Dividends
$3,673,000 Balanced Retained Earnings End of Year
-----
The statement of retained earnings indicates the amount of the company's earnings (net income from the current income statement) and adds this amount to the previous retained earnings from the balance sheet. When a company earns a profit, management must decide either to:
1. Pay out all or part of the earnings to shareholders as dividends; or
2. Retain the earnings to
- finance the purchase of assets,
- retire debt, or
- grow the other resources of the company.
The statement of retained earnings indicates the amount of retained earnings accumulated at the beginning of the year, and then adds the net income for the period. If management declares a cash dividend, it is deducted from retained earnings to arrive at the balance of retained earnings for the end of the year, which is carried forward to the balance sheet.
The statement of retained earnings shows you how much net income the company will retain or pay out in dividends for the year - an important factor when you are focusing on dividend-paying stocks.
Three distinct yield categories of stocks
Income investors should focus their search on dividend stocks that have yields high enough to generate the income they require. If you need an income stream equal to 4 percent of invested capital, then you should look for stocks with yields int he 4 percent range.
There are thousands of stocks, so to make your job of finding the right dividend stocks easier, we suggest you mentally group them into three distinct yield categories:
Category 1: Low-yielding stocks
These are issues that have a dividend yield of less thant he yield of the S&P 500 Index. The yield on the S&P 500 Index is about 1.5%.
These are issues with dividend yields that are equivalent to the index's yield or higher and tend to be companies focusing on providing a balanced return from both dividends and price appreciation.
These are issues with yields today in the 4 to 5 percent range or higher and are companies that are generally in mature industries that focus on providing investors with returns through dividends.
There are thousands of stocks, so to make your job of finding the right dividend stocks easier, we suggest you mentally group them into three distinct yield categories:
Category 1: Low-yielding stocks
These are issues that have a dividend yield of less thant he yield of the S&P 500 Index. The yield on the S&P 500 Index is about 1.5%.
- Although they do pay a dividend, they tend to reinvest most of their earnings to foster growth in value through price appreciation.
- These stocks are very appropriate for growth investors, but they may fail to meet your income requirement.
These are issues with dividend yields that are equivalent to the index's yield or higher and tend to be companies focusing on providing a balanced return from both dividends and price appreciation.
- When screening for stocks, we target stocks with yields that are at least 150 percent of the index's yield. They are committed to their dividend program and pay out from 30 to 50 percent of earnings in dividends.
- You can shop in this group for income, but remember that the object of your search is to find stocks that meet your income requirement, so you should concentrate on stocks with higher yields.
These are issues with yields today in the 4 to 5 percent range or higher and are companies that are generally in mature industries that focus on providing investors with returns through dividends.
- They pay out 50 percent or more of their earnings to attract investors to their high dividend yield.
- Mature industries that fit this category are utilities, banks, pharmaceuticals, energy and real estate investment trusts (REITS). The high yields of REIT stocks can be compelling.
- You will be able to find a fair supply of high-yielding stocks with dividend yields equivalent to most bonds' yields. It just depends on where you look.
- You can find stocks with yields in excess of 4 percent from mature companies in certain industries like utilities that focus on attracting investors to their high dividend yields.
- You can also find undervalued stocks with juicy yields that have fallen out of favour with investors. In many cases, their price has declined while their dividend has remained stable, increasing the stock's yield in the process. Analyse these situations carefully to determine why the stock has declined in price and if its dividend is secure. There is often a fundamental business reason why the stock price is declining: failing to meet earnings expectations, declining revenue, increasing debt levels, etc. Your job is to determine if the price decline is a temporary setback or part of a larger negative trend. If you're confident that the pricing adjustment is based on temporary conditions that you see improving, then you may have found a nugget of gold!
Stock versus Cash Dividends
Some firms pay stock dividends in addition to or in lieu of cash dividends. Stock dividends are a form of recapitalization and do not affect the assets and liabilities of the firm.
There is a misconception that stock dividends increase the ability of the firm to grow. Many investors believe that stock dividends preserve cash and actually allow the firm to reinvest more for growth. Because of this belief many stocks trade higher after paying a stock dividend. However, stock dividends do not increase the earning power of the company.
In the US, if an investor receives additional shares from a stock dividend (and the investor does not have the option to take the dividend in cash), there is no tax consequence until the investor sells the stock.
There is a misconception that stock dividends increase the ability of the firm to grow. Many investors believe that stock dividends preserve cash and actually allow the firm to reinvest more for growth. Because of this belief many stocks trade higher after paying a stock dividend. However, stock dividends do not increase the earning power of the company.
In the US, if an investor receives additional shares from a stock dividend (and the investor does not have the option to take the dividend in cash), there is no tax consequence until the investor sells the stock.
Evaluating Dividend-Paying Companies
A company should be evaluated on three dividend attributes:
1. Reliable dividend payment history
2. A record of increasing dividends
3. A relatively high dividend yield
A company's dividend history is factored into the company's stock price.
But beware of company with a high dividend yield that has an eroding earnings outlook. Remember, a company can only pay dividends from current or accumulated earnings. Without good earnings, there is good chance that the high dividend you covet may be cut.
1. Reliable dividend payment history
2. A record of increasing dividends
3. A relatively high dividend yield
A company's dividend history is factored into the company's stock price.
- One with a superior history of paying and increasing dividends will usually command a higher price than a company that has a poor record.
- A high dividend yield will often attract more investors to a stock, and this can translate into higher prices as investors buy up shares to lock in a generous stream of dividends.
- A track record of dividend growth is an important indication of the company's ability to grow earnings.
But beware of company with a high dividend yield that has an eroding earnings outlook. Remember, a company can only pay dividends from current or accumulated earnings. Without good earnings, there is good chance that the high dividend you covet may be cut.
What dictates dividend policy?
Management determines if it is going to distribute earnings in the form of a dividend or reinvest all earnings to further the business plan of the company. The ratio of dividends paid out to investors versus the amount of earnings retained is called the payout ratio. Changes in tax law and investor preference can influence decisions in the corporate boardroom regarding how much profit to retain or to pay out to investors in the form of dividends. However, dividend increases often lag behind an increase in earnings because management will want to be certain that a new higher dividend payment will be sustainable going forward.
Looking back over market history, we can see that dividend policy and payouts have remained relatively steady and that any change in dividend yield has had a lot more to do with the change in stock prices than with changes to dividend policy made by corporate directors. (Note: You can 'price' your stocks by looking at historical dividend yields.)
Management is usually very reluctant to reduce dividends because a cut is often perceived as a sign of financial weakness. Even during the Great Depression, companies were loath to cut dividends. From 1929 to 1932, dividend yields soared because most companies maintained their dividends as stock prices collapsed in the crash. But, as stock prices rose from 1933 to 1936, dividend yields fell - even though companies were actually increasing the dividends they paid.
This inverse relationship between dividend yield and price was really evident during the huge bull market run from 1982 to 1999. Companies increased dividends steadily over the period, actually increasing dividends paid by almost 400 percent. Yet the dividend yield collapsed to historic lows because stock prices increased by 1,500 per cent.
Some companies do run into trouble and cut or omit their dividend payments, but this is the exception rather than the rule.
Many established public companies pay cash dividends and have a dividend policy that is well known to their investors. Some of them have been paying cash dividends for a very long time.
Twelve of the companies in the S&P 500 today started paying dividends more than a century ago.
S&P 500 Century Dividend Payers
Company ---- Cash Dividends Paid Each Year Since
Stanley Works ----1877
Consolidated Edison ---- 1885
Lilly (Eli) ---- 1885
Johnson Controls ---- 1887
Procter & Gamble ----1891
Coca-Cola Co ---- 1893
First Tennessee National ---- 1895
General Electric ---- 1899
PPG Industries ---- 1899
TECO Energy ---- 1900
Pfizer. Inc. ---- 1901
Chubb Corp ---- 1902
Bank of America ---- 1903
Looking back over market history, we can see that dividend policy and payouts have remained relatively steady and that any change in dividend yield has had a lot more to do with the change in stock prices than with changes to dividend policy made by corporate directors. (Note: You can 'price' your stocks by looking at historical dividend yields.)
Management is usually very reluctant to reduce dividends because a cut is often perceived as a sign of financial weakness. Even during the Great Depression, companies were loath to cut dividends. From 1929 to 1932, dividend yields soared because most companies maintained their dividends as stock prices collapsed in the crash. But, as stock prices rose from 1933 to 1936, dividend yields fell - even though companies were actually increasing the dividends they paid.
This inverse relationship between dividend yield and price was really evident during the huge bull market run from 1982 to 1999. Companies increased dividends steadily over the period, actually increasing dividends paid by almost 400 percent. Yet the dividend yield collapsed to historic lows because stock prices increased by 1,500 per cent.
Some companies do run into trouble and cut or omit their dividend payments, but this is the exception rather than the rule.
- The typical dividend-paying company not only maintains the dividend payout it establishes, but follows a policy of steadily increasing its dividend as earnings increase.
- Some companies increase their dividend payments every quarter, some once per year, and others only as profits allow.
- Some companies will even pay extra or special dividends if earnings have been quite good for a number of years.
Many established public companies pay cash dividends and have a dividend policy that is well known to their investors. Some of them have been paying cash dividends for a very long time.
Twelve of the companies in the S&P 500 today started paying dividends more than a century ago.
S&P 500 Century Dividend Payers
Company ---- Cash Dividends Paid Each Year Since
Stanley Works ----1877
Consolidated Edison ---- 1885
Lilly (Eli) ---- 1885
Johnson Controls ---- 1887
Procter & Gamble ----1891
Coca-Cola Co ---- 1893
First Tennessee National ---- 1895
General Electric ---- 1899
PPG Industries ---- 1899
TECO Energy ---- 1900
Pfizer. Inc. ---- 1901
Chubb Corp ---- 1902
Bank of America ---- 1903
Business and Dividend Life Cycles
Business life cycles are most influenced by access to resources and capital.
A company's success and development are also affected by a host of outside factors - competition from companies in the same industry, economic conditions, even changing consumer preferences.
There are 6 phases in a company's development that influence its dividend policy:
1. The Start-Up Phase: In the start-up phase, someone invest cash for stock in the business to develop products, hire employees, pay for equipment, and rent space. It is not unusual for a company to raise seed money from professional investors and enter the start-up phase with a hundred or more employees. A small company needs to plow all profits back into growing and perfecting its business model to survive.
2. The Early Growth Phase: If the company launch is successful, it will enter the early growth phase. As the demand for its products and services increases, sales and profits increase. The company will need to reinvest all cash flow and profit to achieve competitive scale.
3. The Late Stage Growth Phase: In the late stage growth phase, the company continues to grow and may begin to pay a small dividend, usually 10 to 15% of earnings. This is a clear signal to investors that the company has reached a level of stability in profits and cash flow necessary to support a dividend.
4. The Expansion Phase: If the company is well run, it will enter the expansion phase. Its rate of growth may slow as competitors take some of the company's market share. Companies at this stage generally increase their dividend payout ratio to approximately 30 to 40% of earnings.
5. The Maturity Phase: Companies can continue to expand even as they reach their maturity phase, but their growth rate usually slows measurably. Well-run mature companies can continue to be a competitive force in their respective industries for decades or even several generations. Many of the companies in this group are mature companies, a few over a century old. It is during this stage that companies tend to increase their dividend payout ratios to 50 to 60% of earnings, which provides investors with generous dividend income.
6. The Decline Phase: In the later stages, many companies fail to innovate - to keep their competitive advantage. These companies will enter the decline phase, and unless they reinvent themselves, they will eventually cease to exist. In this phase, as sales and profits decline, they will eventually reduce or eliminate their dividend payouts.
Beware of attempting to buy or hold the stock of a company in the final stages of its business life cycle.
Business and Dividend Life Cycles
Start Up
Growth Rate 20%
Dividend Payout Ratio 0%
Early Growth
Growth Rate 30%
Dividend Payout Ratio 0%
Late Stage Growth
Growth Rate 35%
Dividend Payout Ratio 15%
Expansion
Growth Rate 25%
Dividend Payout Ratio 30%
Maturity
Growth Rate 20%
Dividend Payout Ratio 55%
Decline
Growth Rate < 5% and declining
Dividend Payout Ratio < 20%
AT&T is a great example of a company currently in decline, possibly on its way to extinction.
Beware of attempting to buy or hold the stock of a company in the final stages of its business life cycle.
At one time, AT&T was the most widely held stock in America. The company paid its first dividend in 1893 and became known as the widows and orphans stock because it was such a consistent source of dividend payments for investors. AT&T's history dates back to 1875. The company's founder, Alexander Graham Bell, invented the telphone and together with several investors started the American Telephone and Telegraph Corporation. As a telephone company, AT&T was so successful it achieved regulated monopoly status. In 1984, the US Department of Justice broke the AT&T monopoly into eight companies: seven regional operating "Bells" and AT&T.
For most of its history, AT&T had been largely insulated from market pressures and competitive forces. After the break up, smaller and leaner communication companies stole AT&T's market share, first through price competition and later by becoming product innovators. For the new AT&T to successfully compete in an unregulated environment, it would require a drastic change in corporate culture. Over the past few years, operations and profits have continued to decline, and AT&T is now struggling to survive.
AT&T's story of dominance and decline highlights the constant need for you to follow up your initial purchase analysis with a routine review to see if the companies you hold are performing as expected.
Start Up
Growth Rate 20%
Dividend Payout Ratio 0%
Early Growth
Growth Rate 30%
Dividend Payout Ratio 0%
Growth Rate 35%
Dividend Payout Ratio 15%
Growth Rate 25%
Dividend Payout Ratio 30%
Growth Rate 20%
Dividend Payout Ratio 55%
Growth Rate < 5% and declining
Dividend Payout Ratio < 20%
AT&T is a great example of a company currently in decline, possibly on its way to extinction.
Beware of attempting to buy or hold the stock of a company in the final stages of its business life cycle.
At one time, AT&T was the most widely held stock in America. The company paid its first dividend in 1893 and became known as the widows and orphans stock because it was such a consistent source of dividend payments for investors. AT&T's history dates back to 1875. The company's founder, Alexander Graham Bell, invented the telphone and together with several investors started the American Telephone and Telegraph Corporation. As a telephone company, AT&T was so successful it achieved regulated monopoly status. In 1984, the US Department of Justice broke the AT&T monopoly into eight companies: seven regional operating "Bells" and AT&T.
For most of its history, AT&T had been largely insulated from market pressures and competitive forces. After the break up, smaller and leaner communication companies stole AT&T's market share, first through price competition and later by becoming product innovators. For the new AT&T to successfully compete in an unregulated environment, it would require a drastic change in corporate culture. Over the past few years, operations and profits have continued to decline, and AT&T is now struggling to survive.
AT&T's story of dominance and decline highlights the constant need for you to follow up your initial purchase analysis with a routine review to see if the companies you hold are performing as expected.
- Each time you decide to continue to hold a stock, you are in fact making a new buying decision.
- Understanding the business life cycle outlined above will enable you to identify companies that are about to emerge as great dividend payers, as well as help you to spot the mature companies headed down the road to extinction.
"Make Hay While the Sun Shines": When Greed leads to Heavy Losses
An illustrative story.
Rick found out the hard way that greed leads to heavy losses, not gains.
At age 40, Rick had been in an unfortunate accident that would prevent him from ever working agin. To compensate for his loss of future earnings, he was awarded a lump sum of approximately $4 million. In 1996, Rick's attorney recommended that he seek out a financial planner to manage his money. Rick's goals were to set up an investment portfolio that would provide him with current income of $8,000 per month, and an income that would keep pace with inflation over the balance of his lifetime. Because he depended on income from his assets for his sole support, he wanted to be very careful with his money.
Lump sum: $4 million
Current income: $8,000 per month
As the stock market advanced unabated, Rick started to listen to the siren's song of the easy money to be made. He told his planners that he wanted to get more aggressive with his accounts. The high returns and easy money that the markets were offering were just too good to pass up. He acknowledged that he had told his planners that he needed to be conservative before, but now he felt that he should "make hay while the sun shines!" In other words, he perceived that there was little risk involved in getting more aggressive.
Rick did not need to chase high returns because his asset base was sufficient to allow him to pursue a lower risk and return strategy. Most important, he would always be okay so long as he kept his capital base intact to produce the income he required. His planners counseled Rick to stick with his conservative income and growth plan because he could not earn back the money he might lose. But by 1999, the siren song proved too much for him. He abandoned his investment strategies and moved his entire portfolio into high-flying tech stocks just before the speculative bubble burst.
The ensuing "Tech Wreck" shattered Rick's financial security along with that of millions of other investors. Greed had won again. Rick's more aggressive investment strategy that had looked like a sure path to untold wealth became the wrecking ball that destroyed his financial security. With losses that averaged in excess of 70 percent, Rick's capital base was decimated, and with it, the engine of his income production.
To add insult to injury, the income strategies Rick abandoned actually increased in value. With the huge stock market declines, investors fled to the relative safety that income-producing investments provided. Bond prices increased as did the prices of many high-yielding dividend-paying stocks.
Rick found out the hard way that greed leads to heavy losses, not gains.
At age 40, Rick had been in an unfortunate accident that would prevent him from ever working agin. To compensate for his loss of future earnings, he was awarded a lump sum of approximately $4 million. In 1996, Rick's attorney recommended that he seek out a financial planner to manage his money. Rick's goals were to set up an investment portfolio that would provide him with current income of $8,000 per month, and an income that would keep pace with inflation over the balance of his lifetime. Because he depended on income from his assets for his sole support, he wanted to be very careful with his money.
Lump sum: $4 million
Current income: $8,000 per month
As the stock market advanced unabated, Rick started to listen to the siren's song of the easy money to be made. He told his planners that he wanted to get more aggressive with his accounts. The high returns and easy money that the markets were offering were just too good to pass up. He acknowledged that he had told his planners that he needed to be conservative before, but now he felt that he should "make hay while the sun shines!" In other words, he perceived that there was little risk involved in getting more aggressive.
Rick did not need to chase high returns because his asset base was sufficient to allow him to pursue a lower risk and return strategy. Most important, he would always be okay so long as he kept his capital base intact to produce the income he required. His planners counseled Rick to stick with his conservative income and growth plan because he could not earn back the money he might lose. But by 1999, the siren song proved too much for him. He abandoned his investment strategies and moved his entire portfolio into high-flying tech stocks just before the speculative bubble burst.
The ensuing "Tech Wreck" shattered Rick's financial security along with that of millions of other investors. Greed had won again. Rick's more aggressive investment strategy that had looked like a sure path to untold wealth became the wrecking ball that destroyed his financial security. With losses that averaged in excess of 70 percent, Rick's capital base was decimated, and with it, the engine of his income production.
To add insult to injury, the income strategies Rick abandoned actually increased in value. With the huge stock market declines, investors fled to the relative safety that income-producing investments provided. Bond prices increased as did the prices of many high-yielding dividend-paying stocks.
People are risk takers or risk avoiders by nature.
As market rises, investors tend to forget that risk is a four letter word, greed takes over, and those who once thought themselves in the conservative camp abandon caution in search of higher returns and what looks to be easy money to be made.
But an investor's tolerance for risk is part of his or her basic personality, and tolerance for risk rarely changes. People are risk takers or risk avoiders by nature.
Investors and the markets are said to be rational, but most people are heavily influenced by their emotions. The primal emotions of fear or greed often cause investors to play the loser's game of buying high and selling low.
But an investor's tolerance for risk is part of his or her basic personality, and tolerance for risk rarely changes. People are risk takers or risk avoiders by nature.
Investors and the markets are said to be rational, but most people are heavily influenced by their emotions. The primal emotions of fear or greed often cause investors to play the loser's game of buying high and selling low.
Cash: The real enemy of investors is not fluctuation of principal, it is inflation!
Many investors confuse safety of principal with a "sure thing investment." Cash accounts provide investors with peace of mind because their principal does not fluctuate in value and because interest is added to the account on a periodic basis. The institution providing the savings vehicle invests the money deposited by the investor in loans and bonds. They take the dual risks of volatility and loss of capital - not the investor. Unfortunately, investor peace of mind is an illusion, because the real enemy is not fluctuation of principal, it is inflation! And "cash" investments do not keep pace with inflation! As inflation robs investors of their purchasing power they must invade principal to buy the goods and services they need to live. As the years go by, the investors' peace of mind is replaced by fear as they continually dip into their principal to pay for lifestyle expenses that rise with inflation.
In fact, cash flunks one of the most important tests we set for our perfect income investment. In exchange for safety of principal and liquidity, the returns on cash are generally very low. In fact, at current rates, the return on most cash alternatives isn't even as high as the rate of inflation, as measured by the Consumer Price Index (CPI).
On December 31, 2003, the average yield on a 30-day Treasury bill was a paltry 0.85 percent while the annual rate of change in the CPI was 1.88 percent. In other words, the interest on your money, would not be sufficient to replace the purchasing power you're losing to inflation.
Even if you think cash passes the safety of principal test because your principal does not fluctuate in value, it fails three other important safety tests.
The more you study the inflation problem, the more you realize how important it is to a successful retirement plan. Inflation has been pretty tame over the past 10 years, averaging only 2.75 percent per year. Don't be lulled into a false sense of security and allow yourself to think that inflation is not going to be a big problem for you in the future.
In the 1970s inflation averaged just over 7.4%. By the 1990s inflation had moderated to an average of just over 2.9%. Still, the average inflation rate for the entire 30-year period from 1972 through 2002 was 5.12%.
Just a small increase can be crushing to retirees. You would need to invest a lot more money initially in a cash investment to provide enough interest to be reinvested against the day when you need to take more income to keep up with rising costs.
Inflation is the Retired Person's Greatest Enemy
1972-2002 (30 years) Average inflation rate 5.12%
1982-2002 (20 years) Average inflation rate 3.36%
1992-2002 (10 years) Average inflation rate 2.75%
Example:
Let's say you had an income need of $3,000 per month and you noticed that you could buy a five-year CD with a current yield of 4% (a generous assumption based on current yields). To generate an income of $3,000 per month or $36,000 per year, you would need to deposit $900,000 in the bank.
The first year everything seems to work well, but in the second year you notice two problems:
1. You had to pay taxes on your interest income, and you had not factored that into the question. Where do you get the tax money?
2. Your living costs are rising, and you forgot to factor in inflation. If inflation averages just 3% for the first year, your annual expenses would increase by an additional $1,080, compounding your income need. After only the first year, you would have to start liquidating principal to buy the same goods, and services you enjoyed the year before.
Safe but Sorry
Over the years we have seen many people make the same big mistake - they opt for the safety of principal that cash investments offer and ignore inflation risk. Inflation robs them of the purchasing power of cash; this illusion of safety would cost dearly. When interest rates drop, they maybe forced to dip into their original capital. The more principal taken out, the less income will be produced putting them on a slippery slope.
The classic problems of:
Bonds start out with a little more income for each dollar invested, but suffer the same defects that cash investments do. And, although it may not be widely understood by most investors, bonds can also suffer from high volatility and risk under the right circumstances.
Is there another option to meet your income needs without impairing the capital base? We shall take a look at the difference dividend paying stocks can make. As an investor in dividend-paying stocks, you not only get to keep more of what you earn from dividends becasue of lower taxes, but it's likely your dividend income and value will increase over time to keep you with inflation. These exciting fundamental benefits are also available in dividend-paying stocks for growth.
- First, the safety of cash begins to look suspect if you're losing the true value of your money - the ability to buy the things you need - because of inflation.
- Second, since the yield is so low, the income generated by cash is not sufficient to buy the goods and services you need, which will force you to liquidate your principal.
- Finally, the false illusion of safety is compounded because the low yield on cash is further reduced by taxes. Worst yet, you will pay tax at your highest marginal rate. Unfortunately the combination of a high tax rate and a low yield only increase your need to liquidate assets.
1982-2002 (20 years) Average inflation rate 3.36%
1992-2002 (10 years) Average inflation rate 2.75%
2. Your living costs are rising, and you forgot to factor in inflation. If inflation averages just 3% for the first year, your annual expenses would increase by an additional $1,080, compounding your income need. After only the first year, you would have to start liquidating principal to buy the same goods, and services you enjoyed the year before.
Safe but Sorry
Over the years we have seen many people make the same big mistake - they opt for the safety of principal that cash investments offer and ignore inflation risk. Inflation robs them of the purchasing power of cash; this illusion of safety would cost dearly. When interest rates drop, they maybe forced to dip into their original capital. The more principal taken out, the less income will be produced putting them on a slippery slope.
The classic problems of:
- low yield,
- high taxes and
- no inflation protection
Bonds start out with a little more income for each dollar invested, but suffer the same defects that cash investments do. And, although it may not be widely understood by most investors, bonds can also suffer from high volatility and risk under the right circumstances.
Is there another option to meet your income needs without impairing the capital base? We shall take a look at the difference dividend paying stocks can make. As an investor in dividend-paying stocks, you not only get to keep more of what you earn from dividends becasue of lower taxes, but it's likely your dividend income and value will increase over time to keep you with inflation. These exciting fundamental benefits are also available in dividend-paying stocks for growth.
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