Take a deep breath and try to relax

The time to buy stocks—and they should be ones that pay dividends—
is a time like now

By Kevin O'Leary
Globeinvestor Magazine Online,
Oct. 15, 2008

Kevin O'Leary is chairman of Gencap Funds LP, manager of the O'Leary Global Equity Income Fund (OGE.UN-TSX).

In the last 80 years there have been 13 economic recessions with 13 bear markets to mark each of them. Each was different and caused by different reasons. We are going into this one with unemployment in the United States and Canada at only 6 per cent and many emerging market countries still growing their economies in the high single digits.

Still, to any student of history it is obvious that the world economies and financial markets have cycles. Each downturn is met with disbelief, panic, capitulation and recovery. Each cycle teaches a lesson to its generation of investors - that is why when it comes to investing there is no substitute for experience.

So what will this latest cycle teach us? I think it will be this. Equities that pay dividends are worth more than those that don't. In the early 1950's individual investors could not be enticed to buy stocks that did not have a yield higher than a bond. They were concerned that a stock had no guaranteed redemption value and could lose value. To offset the risk companies had to provide high sustainable dividends in order to issue equity.

Somewhere over the last 50 years investors collectively became more and more risk tolerant until in the 1990's they were prepared to own stocks that traded with price-to-earnings ratios in the hundreds and paid no dividends at all. The only way to make money owning such a security is to hope someone will buy it from you tomorrow at even a higher price. For a while it worked until one day it didn't. Remember the dot-com crash.

Welcome back to the 1950's

The world markets are going through a massive de-leveraging. Although it is painful to watch, it is very healthy. This global event is creating incredible dislocations in the valuation of high quality equities, lowering P/E ratios and providing unprecedented dividend yields.

How long will it last? Again using history as our guide, since the late 1940's recessions have lasted an average of 10 months and stocks bottomed out an average of 90 days before the downturn ends. Could it be worse this time? Sure, but it's not the end of the world-it just feels like it. Here is the other lesson history teaches us. The time to be buying stocks is when you feel like throwing up on your shoes. Like right now.

So, if you are an investor, take a deep breath, and jump back in but this time remember that the path to positive returns is to own a diversified portfolio of equities that provides returns in two ways. One, through the potential of capital appreciation as earnings grow and secondly through the payment of a sustainable and growing dividend payment stream. In a downturn or during flat markets dividends provide stability and often all or a material amount of the total return. I have never understood why any investor would not want the majority of their equity holdings to pay a dividend.

It is also true that the only free lunch in investing is diversification. However to be truly diversified in today's economy you must be globally invested.

Why? Because the best values are no longer found in the Canadian or even U.S. markets. They are found in companies that are operating in markets and economies that have better long-term growth metrics than we have in North America. These markets have sold off in sympathy with the financial crisis originated in the United States by defective loan practices even though most countries never practised these aggressive lending policies or ever originated "toxic waste" derivatives.

I'm an old school investor. After I finish dinner with the family and make sure the kids have done their homework, I pour my second glass of cabernet (okay maybe my third!) and I go down to my office to visit my money. I mark to market every position I have every night. My money and I are emotionally involved together and share a mutual respect. I only ask one thing of my money. Work hard like I do. That is why 97 per cent of positions I own pay me a dividend or have yield.

Traders and analysts that work for me have long ago stopped trying to sell me stocks that don't pay a dividend. I always ask them the same question " if everything is so damn good at the company why can't they afford to pay me a dividend? Today I think it's a question every investor should ask.

Special to The Globe and Mail