Wednesday, July 09, 2008

A Trillion Dollars Down the Crapper

Today the S&P 500 index closed at 1244, which is lower than the closing price on November 18, 2005.

Stock prices are ephemeral, so nobody can honestly claim to have "money" in an investment account unless he actually sells his stocks and collects the cash. That's why it's incorrect to claim that investors have lost such-and-such amount of money during this bear market. The truth is that not a single dime has been lost due to price changes. Every time there is a stock transaction, a buyer gives money to a seller. The only difference between today and October of last year is that less money is changing hands during the exchanges. The only real loss in the whole process is the brokerage fee.

Dividends, however, are not ephemeral. Dividends are payments of cold, hard cash to stockholders of profitable corporations. As I've discussed in more than one previous post, the last several years have seen corporations replacing dividend payments with stock buybacks - to the point where nearly all of the S&P 500's total earnings have been used up in stock repurchases. The masses of irresponsible talking heads on Wall Street have assured us that buybacks are good for investors, because they reduce the number of shares on the market and push prices higher. I've already pointed out the fallacy of the former point: corporations that buy back shares with one hand are usually giving new shares to executives with the other, so the share count isn't improving as much as advertised.

Now we can safely put to rest the second buyback lie: that investors benefit from them because they make stock prices go up. Remember, the market is lower today than it was in November 2005. In 2006 and 2007, the S&P 500 companies spent over $1 TRILLION on stock repurchases, and that number doesn't include the as-yet untabulated buybacks in the first half of 2008. Since the average price of an S&P 500 stock today is the same as it was before that $1 trillion-plus was spent, we now have a super-sized example of buyback money that had absolutely no permanent effect on stock prices.


So where did that money go? The truth is that you could have collected some of that money if you sold your stocks in 2006 or 2007, because many of the buyers were in fact the corporations themselves. But that's part of the problem. Buybacks actually encourage the savviest investors to sell their stocks! So much for long-term investing.

Loyal stockholders who chose to hold their shares for the long haul collected not one penny of that buyback money. To add insult to injury, they also collected relatively little in the way of dividends. Even worse were those poor souls who actually bought stocks in that time frame, because they were competing with the companies themselves to buy shares, and therefore had to pay the temporarily inflated prices.

Consider what would have happened if corporations had instead given that $1 trillion to buy-and-hold investors in dividend payments like they used to do. One trillion dollars works out to about $3,300 for every man, woman, and child in the United States, or perhaps $10,000 for every household. I'll wager there's not an investor out there who wouldn't mind another $10,000 cash in his retirement account right now. To top it off, there wouldn't have been as much share price inflation in 2006 and 2007, meaning the current bear market probably would have been more mild.

One trillion dollars down the drain.

Right now stocks look more like weekly lottery tickets than long-term investments.

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