January 20, 2016

Back before the crash of 2008, the majority believed that the housing market was untouchable. Bankers that worked for the big guys on Wall Street vehemently defended mortgage-backed securities, yet no one was looking at these mortgages and had they been better regulated, it would’ve been clear that a crisis was coming. A handful of investment managers were aware of the fraudulent activity but they were laughed out of big bank board rooms for their theories and warnings of an impending crash once these subprime mortgage loans were reset to much higher rates in 2007- ultimately making them worthless and putting millions of people out of their homes and jobs. Just for clarification, a ‘Subprime Mortgage‘ is a type of mortgage that is normally made out to borrowers with lower credit ratings. As a result of the borrower’s lowered credit rating, a conventional mortgage is not offered because the lender views the borrower as having a larger-than-average risk of defaulting on the loan.

So here we are in 2016 and even though the price of crude oil has dropped over 70% since 2014, many investors are sticking with their Exxon and ConocoPhillips stock because “oil always comes back” (sound familiar?) and they love that dividend income. Gerald Loeb, founding partner of E.F. Hutton and author of The Battle for Investment Survival writes, “Trying to get a stated ‘income’ from dividends, interest or both of 3%, 4% or 5%, or whatever it is, really amuses because of the simplicity of the point of view displayed. There is no doubt that the average individual, seeing this point of view accepted without question, moves with the masses”. Investing with the herd for income from dividends and yields will cause you to miss a lot of opportunities.

Companies that pay dividends are deceptive, because the dividend provides the illusion of constant income, but that dividend is not guaranteed. Shareholders will hold onto stocks that pay dividends even after the stock has lost half its’ value. With the price of oil looming to possibly $20 a barrel, many oil companies are slashing their dividends to cut costs but some companies have not cut their dividends at all; some have maintained and even increased the dividend pay out. This is not wise due to the current energy slide, but I bet companies like Exxon Mobil and ConocoPhillips are worried of a mass exodus if they were to cut their dividend. These companies can’t find growth in their fragile industry, so the dividend keeps the investor quiet for now. ConocoPhillips currently has negative earnings yet they pay out a 7% dividend. This year’s earning projections are negative too, so they are either selling off assets, firing tons of workers or taking on more debt to keep the dividend.

In conclusion, OPEC has said they will not decrease production until it has cooperation from all other major oil-producing countries. You can imagine how challenging that endeavor is. Experienced financial journalist & analyst Michelle Toovey writes “With this in mind, it could be years before oil prices see a consistent recovery, and weak oil prices will continue to cap oil companies’ earnings and their ability to fund dividends”. If oil continues to drop or the oil prices remain weak for an extended period of time, a company’s cash will erode and then there is no choice but to lower or discontinue the dividend. The only other option is for the company to take on debt during these lean times in order to pay the dividend. We feel that one should invest for long-term growth, not for immediate gratification or “mailbox money”.