Dividends Define Success
Of course, a company can elect to do nothing with its free cash flow. Barron's recently listed 20 firms with the highest FCF to market cap. Many of these firms pay little or no dividend. From an investment perspective, firms with significant free cash flow that distribute some portion of it as a dividend are preferable. It just makes good business sense to let shareholders enjoy the fruits of their "capital labor."
Companies with solid free cash flow also generally enjoy better business prospects than those without. The value of the company is real and, just as important, it's current. It is measurable by the dividend just paid. Investors can cash dividend checks. They are not fungible. They are not accounting gimmicks, nor can they be disguised or hidden by a creative executive. They are an actual measure of a company's worth.
Dividend checks do not come, usually, from exciting companies. Once paid, dividends tend to continue each quarter, and afterward, senior management becomes reluctant to stop the flow of shared wealth to the shareholders.
A Value Example
Look at the company CenturyTel (CTL). It has paid dividends since 1974. For 36 years, it has come up with virtually everything an astute investor wants to see in a company: a good product; a well-maintained market share; excellent service; strong relationships with employees, management and stakeholders; meaningful controls on debt and capital; and consistent behavior in a variety of markets and economic conditions.
As a result, the company's share price does not radically gyrate up or down. It dances to its own drummer. CTL is trading at essentially the same price it has for more than a decade while paying dividends at a gradually increasing pace. It is a classic example of a value stock-boringly beautiful.
When exogenous events do occur, such as the 2008 and 2009 meltdown, value stocks get hit, just like other stocks. When a storm hits, all ships are in danger, even those in safe harbor. When the storm subsides, the value merchant remains afloat because it is more watertight. It has a wider "moat."
An investment in a company should be based on the worth of that firm. Its worth is best understood as the sum total of its products, services, employees and goodwill. Left to its own devices, a value stock's price will more closely reflect the actual worth of the company.
When investing, does it make sense to own a company or a stock? If you prefer to make investment decisions based on today's value rather than tomorrow's projections, buy companies with free cash flow, not stocks.
John Graves, ChFC, CLU, is a principal of the Renaissance Group LLC, a Registered Investment Advisor based in Ventura, Calif. He can be reached at [email protected] or 805.652.6930.