The path to permanent wealth is paved with high-yielding dividend stocks and reinforced with gold.
With a housing market that's in tatters and an economy that's reeling, most U.S. investors see the current market as perhaps the worst ever to even think about such topics as saving, investing and wealth. Corporate profits are plunging, as unemployment soars. Investors have watched as the worst bear market since the Great Depression savaged their savings and plundered their pensions.
But Money Morning Contributing Editor Martin Hutchinson, a well-known expert on income investing, says that today's beaten-down market may represent the best opportunity in years to create real wealth â€“ in fact, permanent wealth. And Hutchinson believes that there are right now two simple secrets that can pave that pathway to permanent wealth.
One is high-yielding dividend stocks.
And the other is gold.
"Since last September's crash, it has again been possible to invest in common stocks with some solid assurance that in the long run, you're not throwing your money away," Hutchinson, a veteran international investment banker and editor of The Permanent Wealth Investor said in an interview this week. "The market is now close to a sensible long-term level; The Dow Jones Industrial Average at its historic high of 14,000 was a mirage â€“ and a very dangerous one for investors."
Hutchinson spoke with Money Morning Executive Editor William Patalon III on Monday and detailed his Permanent Wealth Investor strategy.
Here are the highlights of that interview:
Money Morning (Q): You talk about "Permanent Wealth." Thanks to the implosion of the U.S. housing market and the subsequent collapse of U.S. stock prices, American investors have lost an aggregate $12 trillion in total wealth. Against such a backdrop, is the concept of "Permanent Wealth" still a realistic concept?
Martin Hutchinson: It's actually a more realistic concept than it was between 1996 and 2007, when the stock market was so overvalued. There was a celebrated Jim Cramer tantrum last week, when somebody said retirement investors needed more Jack Bogle (the founder of The Vanguard Group, famous for index funds) and less Cramer. Cramer was right; if you'd bought an index fund Bogle-style in 1999, you'd have lost a lot of money over the last 10 years.
Investing like Cramer â€“ by picking stocks and trying to get the timing right â€“ you might well have lost your shirt, but Cramer did say in 1999-2000 that the tech sector was wildly overvalued and dangerous, and that was extremely useful information. Since last September's crash, it has again been possible to invest in common stocks with some solid assurance that in the long run, you're not throwing your money away. The market is now close to a sensible long-term level; The Dow Jones Industrial Average at a historic high of 14,000 was a mirage â€“ and a very dangerous one for investors.
(Q): Just what is "Permanent Wealth" and how does an investor pursue it?
Hutchinson: What I like to refer to as "Permanent Wealth" is the kind of wealth that you can count on over the long term, or â€“ ideally â€“ permanently. It's the kind of wealth that 18th century aristocrats left in entail for their descendents; today it's the kind of wealth that finances your dreams â€“ even fast cars and houses in the Hamptons â€“ but still leaves you with more money than you know what to do with, meaning that you can live the rest of your life in comfort, and still be sure to enjoy a safe-and-secure retirement.
Investors pursue permanent wealth by following a third investment strategy â€“ not the index fund strategy of John Bogle, nor the in-and-out speculative trading of a Cramer â€“ but something more akin to the search for value and cash flow of a Warren Buffett. I'm talking, of course, about the early-vintage Buffett, before he got so rich and famous in the 1980s, and before his track record became less special. And the best way you can be sure a company is going to give you solid and increasing cash flow is to find one that's actually doing so, quarter by quarter, by paying out high dividends.
If there's a lesson to remember, it's this: Earnings can be manipulated; dividends are cash.
(Q): That brings us to a very important point. Most experts â€“ when they outline strategies for creating wealth â€“ focus on capital gains. But you focus on income â€“ especially dividends. Why is income investing the better path to travel?
Hutchinson: The problem with going for capital growth is that you very often don't get it, and then you've got nothing â€“ the investment just sits there. As I've discussed here in Money Morning many times before, buy dividend stocks â€“ and you will at least be well paid as you wait for the market to go up.
The other reason for buying dividend stocks is that capital gains are so damnably difficult to spot. Tell me honestly: Are you really capable of telling which kind of high-tech widget is going to take off and which one will turn out to not have the "magic" features the techno-geeks want? Me neither, and I'm a Math major, so if this stuff was comprehensible, I would be able to understand it. I had a pretty good grasp on what the Wall Street whiz-kids were doing wrong during the bubble [Editor's Note: Hutchinson was recently cited by Slate magazine for "calling" the market bubble, and forecasting the stock-market decline].
Dividends are easy â€“ you can drop them on your foot, as it were. All you have to do is figure out which companies are run by sharpies â€“ and are paying dividends out of capital â€“ and which companies have genuinely solid business models that aren't going away.
(Q): Dividends â€¦ they seem so basic â€¦ why is it that they're actually so powerful? And why do so many investors fail to see this power?
Hutchinson: Investing for high dividend payouts is a type of "value investing" â€“ investing in stocks with low Price/Earnings (P/E) ratios, or in companies whose stock prices are low relative to the firm's asset values.
With this focus on dividends, you reap all the benefits (the higher returns) of the value-investing strategy. However, by investing in stocks with high dividend yields, you also are getting paid to wait. And you're also defending yourself against a corporate management that wants to throw away your value through unwise investments: Once you have the cash, it's no longer locked up inside the company; it's yours to keep.
Investors don't see this because they buy stocks through brokers and read about stocks in the financial media. A 100% capital gain is much more exciting than a 10% dividend yield, and a new tech concept that turns out to work is more exciting than a business that just keeps on turning out good profits and paying those profits out to shareholders as dividends.
What's more, high-yield stocks lend themselves well to a "buy-and-hold" strategy that maximizes returns for the investor but not for the broker. If a growth stock doesn't go up, the investor has nothing; but the broker can then make another commission by making the investor switch to a different "growth" stock, playing on the investor's boredom and feeding him a new "concept."
Corporate management teams, Wall Street stock brokers, and even the mainstream news media all have a vested interest in promoting "growth" stocks to investors; it's not surprising that most investors buy mostly what is sold to them.
(Q): How do dividends create wealth?
Hutchinson: Dividends create wealth in two ways.
First, they provide cash flow that you can either use for living expenses or to reinvest: That means there's no more having to sell shares, often at a depressed price, to meet your monthly bills, or to finance a vacation or home remodeling.
Second, if you buy shares with high dividend yields, there's a good chance that the market will eventually notice the superior [dividend] payouts, and revalue the shares so that their dividend yield is back down around the market's average. For a dividend yield to go down in this manner, the stock price has to go up. Once that happens, you have received dividends and capital gains.
(Q): You talk about the three key steps of permanent wealth creation? What are those three steps? How do they work?
Hutchinson: The first step is to invest in stocks with high, stable dividend yields â€“ yields, in fact, for which there's a good chance of an increase.
The second step is this: When the high-yield stocks you've invested in revert to normal market dividend yields (because the share price has risen, pushing the dividend yields down), sell those shares for a nice capital gain, and invest the newly increase proceeds in newly selected high-yield stocks. By following this part of the strategy, you've increased your capital and your income.
The third step is to increase your capital still further: Invest small portions of your capital, or perhaps some of your higher income, in options, the currency markets, or in other income-related or gold-related investments.
In fact, let's make sure to return to the topic of gold in just a moment.
(Q): A central piece of your high-yield investing strategy is something called the "Alpha Bulldog." What are "Alpha Bulldogs?" What defines them â€¦ what parameters do they share â€¦ and how do they contribute to your overall strategy of permanent wealth creation
Hutchinson: An Alpha Bulldog is a publicly traded company that displays the share with the following five characteristics:
- A stock with a high dividend yield â€“ at least 7.5%-8%, but preferably higher.
- A "permanent" (sustainable) business model, with operations solid enough to allow dividends to be maintained ad infinitum â€“ meaning the corporate business plan has no "self-liquidating" feature.
- A pro-shareholder management team that welcomes paying high dividends â€“ and that doesn't embark upon dividend-sapping, management-aggrandizing schemes.
- A business that offers dividend-growth potential once the global economy resumes its expansion.
- The first dividend is "locked in" â€“ having been declared â€“ but there is still time to invest before the "ex-dividend" date.
Only a small percentage of high-yield stocks are actually Alpha Bulldogs, making them suitable for permanent wealth investment. Some high-yield stocks have dividend payouts that are much greater than actual earnings, an unsustainable gambit designed to make the companies appear more solid than they actually are. Others have been beaten down by declines in profitability, and are unlikely to maintain their current high-yield payouts. Still others â€“ such as many real estate companies, or Canadian royalty trusts â€“ are "self-liquidating," in that they have a finite life. These entities will pay dividends for maybe 10 years, but at the end of that time there will be nothing left: 10% a year for 10 years and nothing at the end is, needless to say, not a particularly great investment!
In fact, I refer to these "non-Alpha Bulldogs" as "mangy curs."
(Q): How much does the overall market have to do with the success or failure of your strategy? Or is "Permanent Wealth" somewhat divorced from the swings of the market?
Hutchinson: The Permanent Wealth strategy is not suited to long periods of market overvaluation â€“ essentially, what we had from 1996-2007 â€“ because during those periods it is impossible to find quality companies with dividend yields of more than 5% or so.
On the other hand, Alpha Bulldog stock prices will rise if the market goes back into bubble mode. In that situation, the problem then will be finding new Alpha Bulldogs. In other words, where will you invest new money, or where will you invest the proceeds of the Alpha Bulldogs that you have sold.
However, if the market crashes, Alpha Bulldog stock prices will be somewhat protected because of their solid yield. Another very important consideration: Due to the high income they are receiving, Alpha Bulldog investors will not be forced to sell shares if they need money at the bottom of the market.
If the market stays flattish for several years, capital-gains investors will find it tough to make money, but Alpha Bulldog investors will continue pulling in their hefty dividends.
Lastly, as I mentioned earlier, Alpha Bulldog investors also will make money by selling Alpha Bulldog stocks that have risen enough so that the yield on the shares is only average â€“ using the proceeds to seek out new, higher-yielding Alpha Bulldog opportunities.
(Q): Are Alpha bulldogs mostly U.S. stocks, or are there Alpha Bulldog opportunities internationally also?
Hutchinson: Global markets can offer particularly attractive opportunities for Alpha Bulldog investment. For one thing, non-U.S. companies typically have smaller stock-option schemes for their management teams than U.S. companies; so foreign company management teams tend to be more "pro-dividend."
The explanation for that difference in dividend viewpoints is actually a pretty simple one. Dividends take cash out of a company, and therefore reduce the value of a management team's stock options â€“ that's why the U.S. tech sector, in particular, hates the payouts. Indeed, some countries â€“ such as Taiwan â€“ levy extra taxes on retained earnings, thus encouraging higher dividends.
Then there are the advantages of diversification. Global investments present an opportunity to invest in markets that may well be growing at a faster pace than the U.S. economy, or whose currencies may be strong against the U.S. dollar, or whose stock markets may be cheaper than the U.S. market.
Purely domestic investors are missing out on a lot.
(Q): Is gold also part of this strategy? Why so? What do you see that makes gold such a powerful part of "Permanent Wealth?"
Hutchinson: Gold and gold-based investment â€“ such as gold-mining companies â€“ are an important part of a permanent-wealth-investment strategy because of gold's historic function as a store of value that is impervious to inflation. At the moment, when inflation is low but there is a big danger of it rising, gold investments are an essential protection for permanent wealth investors.
(Q): Having closely studied the Obama administration stimulus and bailout programs, why do you feel that inflation is an almost-certain part of our future?
Hutchinson: Two factors in government policy make me expect a big resurgence in inflation: fiscal policy and monetary policy. Fiscally, U.S. President Barack Obama is running the biggest deficits in U.S. history, which will push up yields in the U.S. Treasury market, cause the dollar to decline and cause inflation to surge because of the debt burden. Monetarily, broad money [M2, Money of Zero Maturity (MZM) or M3, take your pick] has been rising at an annual 15% clip since September â€“ which will feed through to inflation once the economy bottoms out.
Finally, there's the combination of the two: [U.S. Federal Reserve Chairman] Ben S. Bernanke buying $300 billion of U.S. Treasury bonds over the next six months, and printing money to do so. That means printing money is being used to finance 15% of the $2 trillion in government spending during those six months. Germany's Weimar Republic used printing money to finance 50% of government spending in 1919-1923, and ended up with 1 trillion percent inflation.Â We're not quite there â€“ yet. But we're headed in that direction.
(Q): What's your overall outlook for the U.S. and global economies? In the near term? The long term? What should investors watch for? How will that outlook affect "Permanent Wealth?"
Hutchinson: I'm quite optimistic about the short-term; I think this recession will reach bottom in about the third quarter of 2009. However, after that the huge budget deficits and rapid money-supply growth will make early recovery impossible. Instead, for several years, we'll have persistent quite high inflation, sluggish growth and probably a weak dollar.
That means the U.S. stock market won't go anywhere for some time â€“ but "Permanent Wealth" investors will get dividends and inflation protection, meaning they needn't fear such a scenario.
Internationally, those countries without the big fiscal deficits and monetary expansions will recover quickly, as in a normal recession. In Europe, that's Germany and possibly France. In Asia, that's Korea, Taiwan and China (which has had "stimulus" â€“ but had a surplus, beforehand â€“ so can afford it). In Latin America, that's the well-run countries â€“ Brazil, Chile and Colombia.
[Editor's Note: When Slate magazine recently set out to identify the stock-market guru who most correctly predicted the stock-market decline that accompanied the current financial crisis, the respected online publication concluded it was Martin Hutchinson, a veteran international investment banker who is one of Money Morning's top forecasters.
It was no surprise to our readers: After all, Hutchinson warned investors about the evils of credit default swaps six months before the complex derivatives did in insurer American International Group Inc. Then last fall, Hutchinson "called" the market bottom.
Now Hutchinson has developed a strategy for investors to invest their way to "Permanent Wealth" using high-yielding dividend stocks. Indeed, he's currently detailing a strategy that will enable investors to make $4,201 in cash in just 12 days. Just click here to find out about this strategy - or Hutchinson's new service, The Permanent Wealth Investor.]
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