Barron's Streetwise - Bitcoin, Dividends, Tech Overload--Listener Questions

Episode Date: December 25, 2020

Jack answers your questions in this special holiday episode. Plus, the dark side of elves. Learn more about your ad choices. Visit megaphone.fm/adchoices

Calling all sellers, Salesforce is hiring account executives to join us on the cutting edge of technology. Here, innovation isn't a buzzword. It's a way of life. You'll be solving customer challenges faster with agents, winning with purpose, and showing the world what AI was meant to be. Let's create the agent-first future together. Head to salesforce.com slash careers to learn more. Hello, I'm Jack Howe. The Barron Streetwise podcast is taking a break for the holidays. Listening in now is our audio producer, Meta.

Hi, Meta. Hey, Jack. Are you ready for some time off? I am. I'm so ready. But first, let's make a short episode for Christmas week and we'll answer a few listener questions. How does that sound? That sounds great. We've got some really good questions.

One about dividends, one about tech stocks, and finally a Bitcoin question. Now, Mehta, this episode will be published on Christmas Day. And earlier you were telling me about a Danish tradition involving elves. And earlier you were telling me about a Danish tradition involving elves. I think it would be a gift to listeners if you let everyone in on the Danish elf tradition. Can you tell us? The Danish Christmas elves are these little people dressed in red, pointy hats, woolen sweaters, wooden clogs. Sounds so nice. What could go wrong?

So they are really cute, especially if you bring them rice porridge with butter and cinnamon sugar. If you put it up in the attic. Pretty specific. Go on. That's what they want. And if they don't get it, they might get really mad. Uh-oh. And? They might, like, have their revenge on you and burn down your barn. Now, let me stop you there.

Because it's, I mean, you got my porridge order wrong. You know what? Time to have your barn burned down. Those are the rules. I always see Denmark near the top of the list of the happiest people in the world, but do not screw with their elves is what I think we're saying here. Exactly. If you go to Denmark and you see all those elves everywhere, you'll see them in a totally different light. People are not doing it because they want to. They're scared. Let's get to the questions. I'm going to be looking over my shoulder while I answer them. All right. So our first question is from Alex, who is from Hudsonville, Michigan. Let's hear it. Hello, Jack. I stumbled across an investing strategy called dividend capture. Seemed intriguing,

but upon further reading, I have developed an unfavorable view on the strategy, which was born from my disdain for speculation and playing the market. What is your take on this strategy? Is there any evidence that it is effective long term? Thank you, Alex from Michigan. I have a favorable view of your unfavorable view of the dividend capture strategy. Like you, I don't think it's a good idea. For folks who don't know, a dividend is a cash payment made by a company to its shareholders. And in the U.S., dividends are typically paid once per quarter, although there are a lot of exceptions. Not all companies pay dividends. Let's say there's a company that trades at $100 a share, and it pays 50 cents per share each quarter as a dividend. That adds up to two bucks over a year, which,

when divided by the $100 share price, gives the company a 2% dividend yield. That part is easy enough. But when it comes to a dividend capture strategy, things get more complicated, because that has to do with timing. A company's board of directors will announce dividend payments well ahead of time, along with the payment date and what's called the record date. You have to own the stock by the record date to receive the dividend on the payment date. But you can't just buy the stock on the record date. That's because stock trades take three business days to settle. So you have to buy the stock at least three business days before the record date if you want to be eligible for that dividend.

The day after that, in other words, two business days before the record date, that's called the ex-dividend date or ex-date. If you buy shares on the ex-date, you're not going to get the dividend. Something important happens to the stock price on the ex-date. It tends to adjust downward by roughly the amount of the dividend payment. And that's because dividend payments reduce a company's net worth. Just like how if you give a $10,000 gift to a relative, you'd be worth $10,000 less. It's important to note that the share price reduction that occurs on the X date isn't exact, because there are usually other factors affecting the stock, like how the overall market is doing that day. The dividend capture strategy calls for, as you might have guessed by now,

buying the stock just before the X date to become eligible for the dividend payments and selling right after. So you buy, let's say, Exxon, you hold it for a day to become eligible for the dividend, then you're gone. You're out of that stock and you're into another to qualify for that dividend, and so on and so on. The reason I don't like the strategy is that if the share price reductions offset the amount of the dividends like they should, you'd be spinning your wheels. You'd buy that $100 stock, qualify for a 50 cent dividend, and sell the stock at $99.50. And if that doesn't make sense to you, it's because it's not an especially sensible strategy.

On top of that, you'd be spending a lot of time and effort and generating transaction fees. If it's not an account that's shielded from taxes, you'd also end up with a lot of activity to report come tax filing time. In other words, the costs are pretty clear and the benefits are theoretically non-existent. clear and the benefits are theoretically non-existent. I haven't seen any studies documenting widespread regular share price underreaction to dividends. If that did happen, I'm guessing the companies would have figured it out and would be paying much higher dividends. Except if it happened, I'm also guessing sophisticated traders who use computer models to exploit inefficiencies would have figured it out first and traded it into oblivion. So Alex, I'm with you.

You can capture plenty of dividends as a long-term holder. Leave the dividend hopscotch to others. Matt, a quick follow-up question about the rice porridge. Let's say that you make it for the elves. You put the butter, you put the sugar, you forget the cinnamon. You're still screwed, right? I mean, it's very specific. No one's ever forgotten the cinnamon, so I can't tell you. That somehow makes it so much worse. Who's up next, Metta? Up next is Matthew from Arizona. Let's hear it.

Up next is Matthew from Arizona. Let's hear it. Hi, Jack. I really enjoy listening to the podcast every Friday. With just 10 stocks making up over 25% of the total market cap in the S&P 500, do you think we're in a sort of tech bubble where these companies have a monopoly? And second, what are your thoughts on whether to invest in an equal-weighted index fund versus a cap-weighted fund, considering the over-concentration of a handful of stocks? Thanks. Great question, Matthew. I think valuations for the stock market as a whole look high right now.

The S&P 500 trades at 22 times projected earnings for 2021, even if we assume a boom year that puts earnings back at record levels. By that measure, stocks are about 40% more expensive than the historical average. But if you compare stocks with interest rates, which are extraordinarily low, then stocks look more reasonably priced. Now, Matthew, as you say, the index looks lopsided. It's not so much that tech as a sector makes up a big part of the index, although it does. It's that the index is concentrated in a handful of massive tech companies. When Tesla joined the S&P 500 this past week, it started with a weighting of close to 1.7% of the index, making it the sixth largest company. The reason it started at such a high value is that companies have to meet a minimum threshold of profitability to join, and investors had bid Tesla's stock price up to incredible levels long before the company became

profitable. The six biggest companies in the S&P 500 now, Tesla along with Apple, Microsoft, Amazon, Alphabet, and Facebook, make up nearly one-quarter of the index's weighting. Maybe that's a sign of a bubble, as you say, a period of dangerously inflated valuations that could lead to a crash. But we should also note we've never before seen companies this large growing this quickly. Amazon, for example, is expected to grow its revenues by 35% this year, which is unusually high due to all the quarantining and shopping from home. But even next year, Wall Street predicts 18% growth.

If you look out a few years, you find that today's share price for Amazon is 21 times the free cash flow it's expected to generate by 2023. That's not such a bubbly price. So Matthew, I guess I would say that I see a mix of justifiably high prices for some tech companies and bubbly looking prices for others. Now you asked whether investors should buy an Equal Weight Index. That's where each company gets the same weighting instead of being weighted by stock market value. An Equal Weight Index removes the problem of a handful of companies dominating the index.

And there are ETFs that track an equal weight version of the S&P 500. Invesco has one, for example. The ticker is RSP. Just be aware that you never avoid bias altogether with indexes. You just trade one bias for another. With a regular S&P 500 fund, you're saying, I want to favor big companies. With an S&P 500 equal weight fund, you're saying, I want to favor industries that are made up of many companies. That means that compared with the regular S&P 500, you might have relatively low weightings in tech and telecom and relatively high ones in industrials, real estate, materials, and utilities. Personally, that's not the kind of overweighting I'd want for the long term. If you want to stick with indexing but reduce your tech exposure,

and if you have, let's say, millions of dollars to invest, you can always look for a money manager that offers direct indexing. That's where you track an index like the S&P 500 by buying shares of the companies in the index directly. When you do that, you can fine-tune the exposure any way you like. If you don't have millions of dollars, or if you want a simpler approach, you can keep your index fund as a core holding and add some things that will offset all that big tech exposure, like international or sector funds or individual stocks from outside big tech.

Hope that helps, Alex. One more question, Meta. Who do we have? So our last question is from Dawn. Do you want to read it? Should I read it? You can read it. All right.

So Dawn is asking about a statement that she saw online, and she is asking whether it's too good to be true. And it goes like this. If over the past 10 years you had put just 1% of your money into Bitcoin and put the other 99% of your money into a checking account that paid zero interest, you would have made about 300 times more money compared to investing every penny in an S&P 500 stock market index fund. So Don writes, I'd love to know if this is true and your thoughts. Great to hear from you, Don, and thank you. I'm going to take your word for those returns because the first time I wrote about Bitcoin was around a decade ago when it was relatively new. The price at the time had jumped from a fraction of a penny to over 10 bucks, making it the world's best

performing currency by far. Recently, the price topped $23,000. Dawn, have a listen to the podcast episode we did on Bitcoin in late July. We can skip over the background details here. I'll just say that I can't tell you for sure that Bitcoin isn't just an elaborate game of financial musical chairs, or that the whole thing won't come crashing down one day. But I also know plenty of smart, sensible people who own Bitcoin. Mohamed El-Erian, the chief economic advisor of Allianz, told us on this podcast that he has some. If you're wondering what Bitcoin will do next,

I recently heard two price forecasts from smart people that, if they're taken together, won't help much. Scott Minard is the chief investment officer at asset manager Guggenheim Partners. He said recently that Bitcoin should be worth $400,000. That's based on his analysis of its scarcity and what he sees as its ability to be as useful as gold, hedging against inflation, for example. for example. At Barron's, where I work, we have a contributor named Mark Hulbert, who recently wrote about a $12,000 forecast for Bitcoin. That's about half where it is now. That prediction is deduced from the relationship between the number of bitcoins and how frequently they've been trading lately.

So I don't know, Dawn. Based on those projections, you'll either make 17 times your money or you'll lose more than half of it. And I think that sums up pretty well the state of our knowledge about Bitcoin and what's driving it. It has no earnings or dividends or cash flows that we can use to tell what it should be worth. Now that Bitcoin's price is going vertical, I'm seeing Bitcoin bulls on Twitter and elsewhere issue a lot of chest-thumping I-told-you-sos to the bears and the skeptics. Just remember, we don't know how the story ends yet.

If Bitcoin is meant to be a currency or a savings tool, its price should be fairly stable, not soaring every day. And if its price is soaring every day, what is it beyond a new kind of purely speculative vehicle? Dawn, if you want to buy some Bitcoin, rest assured that you'll have plenty of smart company. But I recommend you keep your bets small. Thank you for listening. Meta Lutzoft is our producer. Meta, you live in a city now. You don't have a barn.

I say screw the elves this year and their porridge. What do you think? They're listening. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's at Jack Howe, H-O-U-G-H. See you next week.