Why Management Likes to Toy With Your Emotions

To decode Wall Street is to tear down those conventionally held wisdoms fed to the average Joe by the men and women controlling the global flow of mooolah, in addition to trying to make sense of their funny jargon (see the “Financial Jargon Word of the Day” on our homepage). We have a couple more “words of wisdom” spewed by Wall Street pros that if adhered to, could bring excruciating pain to your investment portfolio (including that 401k that you aren’t sure on).

First, is that “investing in companies that shell out dividends is preferable.” We would agree as the sending of checks to your mailbox every three months gives you money while the stock of the company could head higher in value, also allowing for untold riches. Here is the rub: dividends are not guaranteed by the company and not required by law to be paid. Dividends are not Treasury bonds! That is not groundbreaking news, but it’s news that gets lost on investors both big and small. How do we know? Let’s touch upon JC Penney, a now former dividend payer. In order to have money to fund its turnaround plan, it decided recently to do away entirely with its quarterly dividend. It will be savings millions of dollars a year by opting for this unfriendly shareholder strategy. However, that money is being invested to turn the business around, the rub here being earnings will stink and the stock price is likely to stink. JC Penney shares were whacked on news of the dividend, evidence of forgetful investors to the dividend risk. Talk about a rude awakening!

Another example is share repurchases. Investors hear these two words and immediately envision years of bountiful profits to send their children to college with as billions of dollars are spent by a company to reduce the number of shares outstanding, thus pumping up earnings. When a company announces a “$1 billion share repurchase plan”, the investor believes it will spend this money in a year or less and announce another plan thereafter. All appears to be fine and dandy, right? To an extent. Companies are essentially buying back stock to drive “fake earnings growth” that in all honesty, raises the chance executive bonus targets are hit for the year. Moreover, like dividends, nothing is guaranteed and as we learned in the recession, share buybacks could be stopped on a moment’s notice.