Published On: Tue, May 4th, 2010

Stocks or Bonds…A Simple Tale

Occasionally the most powerful ideas are revealed to us with the most down-to-earth explanations and with a kind of simple beauty that teaches its lesson well.  Here is one such story.

Steven L. Pomeranz

When I was a young stock broker in the early 1980s I came across a new client with a little money to invest. She was in her 60s and was looking for something to produce income. Back then the interest rate on bonds was 8% so I invested her excess cash. I also noticed she held 432 shares of Chevron in her account which had a dividend yield of just 4% so I suggested she sell the stock and buy more of the bonds which I reasoned would more than double her income. She would not to sell however, and when I asked her why she told me she had purchased the stock in the 1960s and had noticed throughout the years that she received a fairly steady increase of the dividend. In her words there was no reason to sell because the company had treated her well.

I didn’t understand her thinking so I looked a little deeper and discovered she had spent $5,632 for 108 shares some 25 years earlier. Immediately I noticed that the amount of dividend income she was currently receiving was $1,732 per year. This amounted to 30% rate of return based on her original investment! I was astonished because she was receiving the equivalent of her original investment back every three years and to top it all off, the value of her Chevron shares had grown to over $36,000. What was this all about?

It turned out the dividend yield on Chevron at that time was 5%. $1,732 (the current dividend payout) was 5% of $36,000.

The rise in price was a direct reflection of the increase in dividend which was a reflection of the financial condition and value of the Chevron itself.

Moral of the Story

  • It’s basically the Warren Buffet strategy. Buy very good quality companies and watch them increase in value over long periods of time. Concentrate on the ability of the company to produce earnings which will increase over time.
  • Trading day to day or month to month will probably not generate these types of returns
  • Even a few large mistakes will not significantly hinder your overall success. The magnitude of the “wins” will offset the losses.

A final note: There were many years in which Chevron did not raise its dividend, did not advance in earnings or price or fell in value. Nevertheless, those cycles ended and the advances continued rewarding investors who held on for the right reasons.

 

S.P.

 

 

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